Many municipalities continue to - implicitly or explicitly - rely on subsidies to ensure political acceptability of the costs of municipal service delivery. Subsidies are a tool that, arguably, can be justified because of their capacity to promote both equity and/or efficiency.16 Improving access for the poor through lower costs for poor consumers can improve productivity and provide an inherent form of financial services to the poor. It also means that the service gap between poor and non-poor is reduced, by placing some of the financial benefits accrued through economies of scale in the hands of the poor. In simplified terms, subsidies are interventions used by government to affect the absolute or relative price level for consumers. They generally come in two forms.
1. Direct subsidisation The financing mechanism used to cover the shortfall in supply costs by the injection of finance from outside the sector or industry. Examples of direct subsidies include the widespread financing of solid waste services, or donor support to governments undergoing sectoral reform (as seen in the proposal for the Kathmandu affermage contract where the World Bank proposed to assist in a five-year plan to subsidise the transition to full cost recovery).
2. Cross-subsidisation A mechanism to cover costs by shifting the burden from one consumer group to another within that sector or industry. This may be illustrated in the cross-subsidy achieved when the tariff applied to rural or peri-urban consumers is the same as for urban consumers, but the costs of delivery are significantly higher in the more remote, less concentrated areas; or it may mean that high-consumption users pay a higher unit rate than low- consumption users.
Subsidies, however, do not operate in a vacuum: they are a part of a much broader decision-making and budgeting process (see Chapter 4). For the poor consumer in developing countries, they are, and should be, closely related to tariff levels and to livelihood strategies (demand, affordability, willingness to pay and income levels). In choosing to provide subsidies, municipalities must consider their other obligations. The primary step for a municipality considering subsidies is to determine what the fundamental objective of the subsidy is, and how that objective informs, supports or conflicts with the overall objectives for reforming the delivery mechanism through a partnership approach. This objective is important as it may help municipal decision-makers to determine how to structure the subsidy design such that greater equity in the allocation of resources, improved efficiencies or placated political sensitivities are achieved. It will also ensure that the objectives converge and that the subsidisation process is not creating a disincentive to which private partners may object.
In addition to this clarity on objectives, it is necessary for these same decision-makers to familiarise themselves with the nature and impact of subsidies applied to services in the past. This will provide some indication of the patterns of the local context. Accurate information on the costs of supplying a service (often not readily available in municipalities), and information on the patterns of service demand, are both critical to the decision-making process. With this information in hand, decision-makers then need to decide:
• what service they prioritise for subsidy;
• what element/stage/aspect of the service to subsidise;
• how the subsidy should be delivered; and
• who the recipients of the subsidy should be.
Box 7.20 Targeted Subsidies |
Launched with the goal of ensuring that the poor do not pay more than 5% for water and sanitation services, the Chilean subsidy system is now well known as an illustration of a politically and financially viable subsidy and targeting system. As early as 1990, the national government of Chile introduced a direct subsidy system to assist with basic service provision throughout the country. Replacing the earlier cross-subsidy system, the Chilean government now applies a uniform tariff system to the water and sewerage sector with fixed (connection-related) and variable (consumption-related) charges. Utilising the municipalities as a conduit for payment, it then funds operators to subsidise selected low-income consumers. Unlike the former rising block tariff system, subsidies are captured only by the poorer households and are not enjoyed by the non-poor. Criteria for assessing eligible households relate to supply characteristics as well as consumer characteristics, highlighting the different conditions found throughout the country. They include the average cost of water, the regional characteristics, the household income and family size. Eligibility assessments are undertaken every three years. Initially, the law allowed for a subsidy of 50-80% of the variable charge for connections with a consumption of 20m3 or less, for the first 10m3 of the bill, and the subsidy was restricted to households with both water and sewerage connections, and that were not in debt to the water company. In order to improve the effectiveness of reaching the poor, eligibility requirements were amended in 1991 and then again in 1994 to remove the requirements of sewerage connections and no debts. The amendment also increased eligibility by removing the upper consumption limit and raising the subsidised portion first to 15m3 and then to 20m3 per month. These amendments reflected the growing understanding of the ways in which the poor use water, and how the poorest households could be targeted by the subsidy. The lack of a sewerage connection, for instance, outstanding debts and the fact that many households shared connections all characterised household situations in low-income settlements, and yet were the very criteria excluding the poor from accessing the subsidy. Today, the scheme prioritises the poorest, and the subsidy covers 25-85% of the poor's water and sewerage bills. The fine-tuning of this approach has taken some time, and a process of trial and error. Shifting the responsibility for identifying eligible households from the consumer (who had to declare him/herself to be needy) to the operator (which could seek out the households in need) was an important step in improving take-up and overall targeting. The operator (EMOS) took a leading role to bring the subsidy scheme to fruition. It argues that this was for social and commercial reasons. It had a social obligation to ensure that the subsidy ended up where it was supposed to. On the other hand, the failure to implement the scheme effectively would lead to extreme difficulties in collecting payments from poor customers. Not only did the company lobby for changes to the law - changes they could see were needed to ensure that the poor were targeted - but they also actively campaigned to improve awareness of the scheme, to assist in the application process, to verify technical eligibility and to facilitate the verification of poverty criteria. This increased their customer base by 10%. The value of the subsidy in Santiago alone is about US$4 million, covering around 20% of consumers and 2.3% of the total billing. The success of the subsidy scheme is due a number of factors, some of which may be contextually specific and defy widespread replication. The water and sanitation sector was already well developed both in terms of physical coverage and institutional reform. Second, the considered and socially oriented planning on the part of the national government in instigating the scheme, the government's financial capacity to finance the subsidy (and thereby underpin water and sanitation services for the poor to a cost of US$25 million), and the strong capacity of local government to implement the policy, provided a supportive institutional framework. Despite this somewhat rare context, it is an illustration of a coherent and direct subsidy structure that seems to be reaching the intended recipients. As a result of the tariff reforms (which actually led to a price rise of 80% in real terms), arrears diminished from 7.9% in 1990 to 2.9% in 1994. The key reasons cited for this success are better management, incentives for prompt payment and the government's agreement to allow disconnection for non-payment. |
Sources: Komives and Stalker Propky, 2000; Rivera, 1996; Foster, 1998; Britan and Serra, 1998; Blokland et al, 1999 |