Current subsidy mechanism not practical

Your income has been eaten by the termites called 'inflation' and in the recent turn of the event –depreciation of ringgit.

COMMENT

By James Alin

The recent decision by the federal government to increase the retail price of fuel is not the first time and will not be the last either.

Previous increases was in June 2008, when the price of petrol was raised to RM2.70 (from RM1.92 per litre) and price of diesel was raised to RM2.58 (from RM1.58 per litre).

With the fuel hike, Prime Minister Najib Tun Razak had reiterated the government’s commitment in achieving a 3% fiscal deficit by 2015 and a balance budget by 2020.

Najib’s statement implied that the big deficit was caused the substantial amount of taxpayers’ money spent on subsidising consumers’ insatiable appetite for fuel.

However allow me to discuss the reasoning behind the “rationalisation”, the fiscal costs of fuel subsidy and how the gradual increase in prices will slowly and surely asphyxiate (suffocate) the poor people.

The rationalisation of fuel subsidy has many unpleasant aspects. The scariest of all is the gradual reduction in subsidies.

Najib argued that the fuel subsidy is irrational (socially unjust) because it is benefiting the rich and the foreigners.

To discriminate between the rich and poor consumers at gas stations maybe difficult but not really impossible.

For argument’s sake, what if we can ask our elected representatives (YBs) to practice self restrain at the gas stations?

Government obliged to help poor

How will our YBs respond to this kind of moral persuasion? Will the drivers and owners of luxurious cars pay more than the subsidised price?

Evident from the Self Assessment Income Tax has shown that Malaysians have a very high level of compliance.

How about the million foreigners in Sabah (other than the rich or middle class professional foreign experts), especially those Project IC holders?

As long as they are working (therefore are paying taxes one way or another), they are entitled to the discounted fuels.

Both Najib and federal minister Idris Jala argued that subsidising rich people on fuel consumption is unfair on two accounts; first they consume more (maybe wasteful) and secondly, government budget is a limited resources.

The government has an obligation to help the poor people first (BN voters).

Subsidisation of fuel aggravates air pollution and worst still, it is bankrupting our nation.

What were the reasons behind the populist pledge – whatever taxpayers’ money saved from subsidy rationalisation exercises will be transferred directly to intended targets, low income and vulnerable groups (in the form of BR1M and other safety nets)?

Skeptics’ saw it coming; the BR1M and other ad hoc safety nets will be translated into more votes for the ruling party in the next election. Will it?

For those of you who dislike arithmetic or are simply too lazy to go through hard facts, your take home points are as follows:

Old habits die hard

In 2008, subsidy on fuel cost taxpayers 8.9% of total expenditure (3% in 2009 and 4.7% in 2010) and 17.9% of total subsidies (9.8% in 2009 and 11.3% in 2010).

The cost in reducing fuel subsidy has far outweighed the benefits.

The fiscal deficit and high debt to GDP ratio cannot be reduced by increasing fuel price alone.

Exactly how big is the fuel subsidy proportionate to federal government operating expenditure?

We referred to the Annual Statistic Yearbook 2010 and Economic Report 2009. The federal budget deficit doubled in 2008 during the Abdullah Ahmad Badawi (Pak Lah) administration.

Pak Lah’s administration was on a spending spree. In his pre-election expansionary budget, the operating expenditure was slight less than revenue.

The Najib administration’s overspending reached overall budget deficit of more than RM44 billlion both in 2009 and 2010 (recall Stimulus Package 1 and 2?).

Obviously the Najib administration learnt nothing from Pak Lah’s experience.

Fuel subsidy most expensive aid

By 2010 the federal government revenue (earning from direct taxes and indirect taxes) was estimated at RM162,131 million in which RM54, 042 million was spent on Federal Government Development Expenditure (e.g. security, social services and economic services).

The federal government Operating Expenditure amounted to RM152,158 million.

The biggest operating expenditures were RM46, 626 million paid for the emoluments, RM25,459 million paid for “others” category, and RM24,933 million for subsidies.

The operating expenditure on subsidies in 2006 was RM10,112 million. It tripled in 2008 to RM35,166 million but reduced in 2009 to RM20,345 million (or 21.9% of total operating expenditure).

What are the interesting stories behind these figures?

Firstly, the subsidies consists of, inter alia but not limited to:

i) subsidy on fuel at the gas stations ( RM18,100 million in 2008);

ii) incentives and assistance given for food security programs;

iii) scholarships and educational assistance schemes and social welfare for Orang Asli.

Secondly, subsidisation on fuel consumption has been the most expensive form of subsidy.

For example in 2008, half of the total subsidy expenditure was on fuel.

The amount paid for subsidised fuel depended on world market price (Automatic Pricing Mechanism) because petrol and diesel are traded in the world commodity markets.

53% national debt worrying

Unlike educational assistance which is a form of investment in human capital, subsidising fuel is unproductive, worst, it had created a perverse incentive – the undesirable cross borders smuggling and black market.

Thirdly, although the federal government has been increasing fuel prices and in the process causing suffering to consumers, budget deficit is still high.

National debt to GDP ratio is now at the worrying rate of 53%, but as we mentioned in the previous paragraphs, the amount of taxpayers’ money spent on subsidising fuel is far too small to be singled out as the main culprit behind the overspending.

Tiny increase in price of diesel and petrol at the gas station is hurting the consumers most.

It is the déjà vu all over again. For millions of Sabahans who are working to make ends meet, a 20 sen increase in price of fuel is an unreasonable overnight reduction in their disposal income.

The present administration has turned our economic life from bad to worse!

The reduction in disposal income would be much higher once the creeping inflation of 1.6% (in 2010 Consumer Price Index for Sarawak was 1.5% and Peninsula was 1.8%) are factored in.

If you think CPI is not inaccurate (you get it right) then try adding Producer Price Index (PPI) of 7.8% (for local production) or 5.6% (domestic economy) or 1.3% (Imports).

Why should we use PPI? Because it would be impossible to consume without first producing (working).

I hate to break the bad news; your income has been eaten by the termites called “inflation” and in the recent turn of the event –depreciation of ringgit vis-a-vis USD (now ringgit can buy less goods or services).

Current mechanism not practical

We will not delve into the issue of inflation because it requires separate analysis.

To the rich people, fuel subsidy does not make their economic life better nor will the increased in fuel price hurts them deeply.

The same thing cannot be said for the poor people including foreign labourers, fishermen, social welfare recipients, single mother, senior citizen, taxi, school or mini buses drivers.

In 2010, household in rural areas in Sabah spent RM1, 095 for basic necessities; 32% on food and non alcoholic beverages; 23.7% on housing, water, electricity and other fuels and 15% on transportation.

To have a frugal living in the urban areas a household must spend at least RM1,526 in which 26% to buy food and non alcoholic beverages; 25.4% for housing, water, electricity and other fuels; 15.1% for transportation.

That percentage will get bigger because producers will transfer higher fuel price to the consumers.

The existing price controls will make the essential goods (appeared in the household expenditure) to be even more expensive.

Higher fuel price means higher cost of production. A producer has limited room to adjust when price is being controlled by law rather than by the mechanism of free market.

What they can do is to reduce the quantity and quality of the production. When that happens shortage of essential goods will get worst.

I would like to end this commentary with a recommendation to those who want a deeper understanding on this issue; read Khalid Abdul Hamid and Zakariah Abdul Rashid’s interesting Chapter 9 of ‘Economic Impacts of Subsidy Rationalisation Malaysia’.

James M Alin, is a lecturer at the School of Business and Economics, Universiti Malaysia Sabah.