Government subsidies can be used to make a project commercially viable from the perspective of the private operator even if the desired combination of service and tariff levels does not result in sufficient cost recovery. This will only make sense if the aggregate cost to the government under PPP (including subsidy) is lower than the cost to the government of operating the service fully under the public sector or the cost of not providing the service at the required service levels.
Government subsidies can be "general", i.e., applying to the overall project, or "specific", in which case they are tied to service provision to deserving (low-income) consumer segments. Some subsidies are designed as community service obligations and mandated in regulatory or license standards or paid for by direct and indirect public sector transfers to beneficiaries.
Cross-subsidies do not involve government payments but are a compensation mechanism built into the tariff structure. They serve as a means of reducing average tariff charged to one group of customers by increasing the average tariff charged to another group of customers. The most common forms of cross-subsidies include subsidies from nonhousehold to household customers, and subsidies from high-volume customers to low-volume customers, through rising block tariff structures. Subsidies can be established for access (connection charges) or for consumption.
Governments typically provide subsidies to reduce tariff levels for the purposes of helping the poor, addressing public health issues, addressing environmental issues, and/or because of political constraints on raising tariffs.
In many cases, the subsidy is already effectively in place before PPP, though hidden. To the degree that unprofitable service activities are provided by a public sector institution are loss making, they are reliant on budget support, essentially a public subsidy. As such, implementing an efficient PPP with short-or medium-term subsidies may still result in a net improvement relative to the status quo. However, the subsidies enhance the overall value of the project and do not remove incentives for efficiency or serve to perpetuate services of limited value.
Different types of subsidies can be used to address different issues. Options are cash subsidies, including output-based aid, unremunerated bearing by the government of business risks, cheap capital, and in-kind grants and tax exemptions. Each of these options is described further below.