Evaluating the Fiscal and Social Costs of Increases in Domestic Fuel Prices

387 R ecent increases in international oil prices have resulted in substantial fuel subsidies in many developing and emerging market economies. After a long period of stability over the last two decades, international oil prices increased substantially from 2002. Prices increased from around US$25 per barrel in January 2003 to over US$65 per barrel by August 2005, an increase of about 260 percent. Rising fuel subsidies reflect the fact that many countries regulate domestic prices and, especially in the face of sharp price increases, do not pass on higher world prices to domestic consumers. 1 These subsidies have adverse consequences both for government finances and the efficient use of energy. Large subsidies redirect public expenditures away from other valuable social expenditures or contribute to unsustainable budget deficits. Low energy prices fail to provide the appropriate incentive to households to be more efficient in their use of energy, which would help to mitigate the adverse effect of higher international prices on households and the economy. In fact, given the relatively low price elasticity of energy demand and the negative consumption exter-nalities associated with its use, taxing energy consumption is generally regarded as an efficient way of raising government revenue. A key motivation behind such price subsidies is to protect the real incomes of households, especially poor households. However, it is also the case that energy subsidies may not be a very cost-effective approach to protecting the real incomes of poor households and that large cost 11 savings can be provided through the use of better-targeted subsidies, transfers, or other social expenditures. Therefore a comprehensive evaluation of energy price reforms must explicitly incorporate both the range of alternative social protection mechanisms that could be used and other public expenditures that could be financed from the budgetary savings resulting from the reduction or elimination of fuel subsidies. Over the course of 2004–5, for a number of countries, the Poverty and Social Impact Analysis (PSIA) Group at the International Monetary Fund (IMF) evaluated the fiscal and social implications of domestic fuel price increases. In this chapter we present the analysis undertaken for Ghana, which was the first of the evaluations undertaken by the group. 2 The format of the chapter is as follows. In order to provide some general insights into the PSIA process and to motivate our approach to PSIA in the present context, in the second section we briefly describe the policy …