Download Impact of Adjusting Consumer Subsidies

Towards More Effective Policies for Achieving Social Justice
in Egypt: The Case of Consumer Subsidies versus Direct Taxes
Tarek Abdelfattah Moursi 1
1. Introduction
Justice arguments are now widely invoked in Egypt within the social, political and
economic spheres in search of a fair framework for achieving economic development
and raising the living standards and welfare of citizens. Different social groupsincluding politicians, majority and opposition partisans, state officials, social and
religious activists, academicians and journalists- have been engaged in those
arguments. So far, however, the dialogue among those groups has been too general to
produce a blueprint for a well focused empirically informed framework for achieving
social justice. We reckon this is not only because of the amorphous nature of the
concept of justice but also due to the absence of sufficient agreement on the pragmatic
definition of the notion of justice that considers the socioeconomic, political and
religious realities of Egypt, on how social justice could relate to the developmental
process and on the basic instruments that can relate the concept of fairness and justice
to economic development.
Recently, the Egyptian government has underscored the need for achieving social
justice defined in terms ensuring fair distribution of commodities to all members and
social classes in the society whilst ensuring efficient utilization of the resources
directed to the poor through social security and solidarity networks. This definition
like other definitions of social justice is not infallible. On the down side, it is myopic
focusing only on specific distributive (i.e. equity) goals of justice in development 2 .
Nevertheless, the definition is straightforward enough to provide for a good point of
departure towards the design of a short-run development plan that is potentially
capable of improving the wellbeing of the poor with an eye kept on productive
efficiency and economic growth considerations. Since there is nothing that is too
compelling to suggest the adoption of an alternative definition of social justice, we
employ the government's notion of justice in our analysis.
The main objective of this note is to contribute objectively to the ongoing national
dialogue on social justice through sketching an effective doable strategy, which might
help the government move closer towards achieving that goal. Perhaps the two most
likely candidates that can currently be used as policy-related instruments to achieve
distributive economic justice in Egypt are consumer subsidies and direct taxes. The
proposed strategy, therefore, is developed based on an assessment of the impact of
selected adjustments in the structure of consumer subsidies and direct household taxes
1
Faculty of Economics and Political Science, Cairo University and the Information and Decison
Support Center (IDSC). I am grateful to Mai El Mossallamy for valuable suggestions and comments. I
also thank Saeed El Masry, Sherine Gamal and Ahmed Helmy for helpful discussions and Asmaa Adel,
Enas Zakareya and Basma El Gazzar for research assistance.
2
In particular, the above definition only considers distributive justice among different groups in the
society to achieve welfare improvement of the poor and to avoid social mayhem. Other critical goals of
development that must be considered are thus either totally ignored or downplayed such as sustainable
development goals (e.g. environmental protection), intergenerational justice (e.g. for sustained welfare
improvement) and modernization targets as well as political goals e.g. securing democracy and
establishing prerequisites for a fair and responsive judicial system.
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on consumer welfare across the urban rural divide as well as on government budget
and other key macroeconomic indicators 3 .
2. Policy experiments and analysis
A computable general equilibrium (CGE) model was employed to carry out selected
counterfactual policy simulations. The latest social accounting matrix (SAM) for the
reference year 2004/2005 (IDSC 2007) was used as a historical benchmark for
calibrating the model. Two sets of experiments were conducted. Set A presents three
scenarios for consumer subsidy adjustment. According to scenario 1, consumer
subsidies are increased uniformly for all subsidized commodities by 25%
corresponding to LE 3.6 billion. In Scenario 2, an amount of LE 3.6 billion is
distributed as public cash assistance for households. Scenario 3 stipulates that
consumer subsidies for all subsidized commodities (LE 13.8 billion) are consistently
reduced by 30% and the withdrawn subsidies (LE 4.6 billion) together with an
additional LE 3.6 billion are reallocated as cash handouts intended for poor
households. Set B considers the household direct tax adjustment simulations. Scenario
4 proposes direct tax exemption for poor households. Alternatively, scenario 5
examines the result of 10% rise in direct taxes for the highest urban and rural
expenditure deciles. Finally, in scenario 6, we explore the socioeconomic impact of a
35% uniform decrease in the direct tax rate on households. Table 1 in the Appendix
reports the reference values for selected indicators and the simulation results.
In scenario 1, the short-run macroeconomic effect of the rise in commodity subsidies
is a general increase in consumption and aggregate production leading to 4.8% real
GDP growth. The producer prices are driven up by the output expansion, which
results in escalation of inflationary pressures. The inflation rate increases significantly
by over 4% and real wages decline in response to higher prices bringing down the
unemployment rate considerably from 10.5% to only 4.8%. The growth impact from
raising the commodity subsidies results in an increase in the level of imports and
exports. Because a large fraction of the subsidies is directed to non-tradable
commodities (mainly subsidized bread) the value of the Egyptian pound falls from LE
5.5 to LE 5.7 per dollar. The depreciation encourages exports and stimulates
importation to meet larger final and intermediate demands. Moreover, while there is a
rise in the real investment of firms (1.9%) household savings as a share of GDP fall in
response to increased consumption. The share of firms' savings in GDP declines
owing to the depreciation of the pound. For a fixed level of foreign savings, the drop
in household and company savings is overwhelmed by the increase in private and
public investment and by the currency depreciation causing a fall in the budget deficit
share of GDP by more than 12%. According to the computed welfare indicator, all
consumers benefit fairly from the selected subsidy adjustment though relatively
higher improvements accrue to poor and rural vis-à-vis non-poor and urban
households, respectively. The findings suggest that in spite of its limitations, the
current subsidy program is not totally unable to target important commodities that
enhance the wellbeing of the poor.
Scenario 2 simulates the outcome from boosting cash transfers. The immediate impact
is substantial increase in budget deficit as a share of GDP (14%) and in the disposable
3
Throughout the analysis, the poor are defined in relative terms as those belonging to the bottom 20%
of the expenditure distribution (the lowest expenditure quintile) within each of the urban and rural
regions (Osman et al. 2007).
2
income of poor- especially the rural- households who realize a significant increase in
welfare. But the increased budget deficit results in lower firms' and, to a lesser extent,
government investment. Higher disposable income leads to a small increase in
household savings as most of the additional income is allocated to consumption
demand. For a fixed amount of foreign savings, the fall in investment and rising
deficit lead to an appreciation of the pound, and, thus, less exportation. Lower real
investment and exports have contractionary effects, which are reflected by the
decreases in real economic growth, the price level and employment.
Scenario 3 postulates that besides direct cash handouts, 30% of the commodity
subsidies are reallocated as cash transfers to poor households. This results in a strong
increase in the welfare of the poor- especially rural households- at the expense of
relatively large reduction in firms' investment and increase in budget deficit that
reduces government investment and company savings. The lower levels of investment
adversely affect economic growth and employment. But the decline in real GDP is
stunted by a significant rise in total consumer demand as poor households increase
their expenditure. The additional consumption also stimulates producer prices
bringing about a mild increase in the rate of inflation.
The second set of experiments (B) considers how variance in the structure of direct
taxes can affect growth and the distribution of welfare benefits in the economy.
According to scenario 4, waiving direct taxes for the poor increases their household
consumption demand. The benefits for the urban poor are higher in comparison with
poor rural households because of differences in demand elasticity between the two
classes. Since this scenario involves tax exemption for poor households only, the nonpoor are bound to lose from this structural tax change. The decrease in welfare of nonpoor households more or less neutralizes the effect of the tax cut on household and
company savings while foreign savings are left virtually unchanged. Moreover, the
forgone government revenue from the tax adjustment raises the budget deficit. This
results in a decline in investment especially for firms. And the decrease in investment
reduces real growth, inflation, exports and imports and raises the rate of
unemployment.
Increasing the direct tax rate for the richest urban and rural deciles (Scenario 5) has a
positive but almost insignificant impact on real economic growth. The initial outcome
of the tax hike is reduced consumption demand for the non-poor and a reduction in
government deficit. The improvement in the deficit reflects positively on exports,
imports and employment. In this experiment, the poor households are not subjected to
increasing tax rate; consequently, they tend to benefit relatively more from the rise in
growth. The positive change in economic welfare, however, is limited due to the small
increase in real GDP.
Finally, scenario 6 shows that unvaried 35% reduction in the direct tax rate on
households raises consumption demand- and consequently welfare- for all consumers
with relatively larger impact on the non-poor, especially urban, households. As a
result, imports and domestic output increase causing significant economic and
employment growth. The real GDP expansion ultimately reduces the budget deficit
despite the tax cut. The rise in consumption has a negative effect on household
savings, which are compensated for by foreign savings via depreciation of the pound.
The depreciation stimulates exports and growth. The favorable effect of the reduction
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in the budget burden on firms' investment is, therefore, thwarted by the increase in
foreign savings leading finally to little rise in investment.
3. An action program for social justice
We draw on findings from the above simulations to derive effective policy lessons for
achieving short run improvement in distributive social justice with growth in Egypt.
The suggested policies are cast within a general framework for progressive
development that emphasizes the importance of maintaining wide distribution of the
benefits of growth across a broad spectrum of the population, increasing welfare for
the whole population and constraining discrepancies in welfare between poor and
non-poor and between urban and rural citizens to ensure that the interests of the poor
at least in the short term are well-served.
The selected subsidy program and direct tax adjustment strategies have different
implications on welfare and on growth. Increasing commodity subsidies or reducing
direct taxes for all households raises consumption, which in turn leads to significant
economic growth. The expansionary effects in either case are more than ample to
increase the welfare of poor households despite the higher level of (consumption
goods) inflation. The poor rural households stand to benefit relatively more with the
expansion of the commodity subsidy program- as it currently stands- since it is able to
target key commodities that directly enhance their wellbeing. Alternatively, a uniform
tax reduction is likely to induce significant increase in household welfare for Egypt as
a whole since it is relatively biased in favor of non-poor households with higher
incomes and expenditure elasticity. The economic forces that induce growth in the
case of those two strategies are also different. Expanding commodity subsidies
substantially increases firms' investment while reducing direct taxes raises
consumption demand. In both cases there is an initial reduction in the budget deficit
that is translated into higher growth and employment. Accordingly, growth is
instigated by diverting resources to relatively wealthier groups, be it the capitalist
investors or non-poor consumers.
The simulation results emphasize that the economic condition of the poor in Egypt
depends a great deal on the structure of the subsidy program configuration especially
with respect to the choice between commodity subsidies and direct cash transfers.
Targeted cash handouts immediately improve the welfare of the poor, particularly in
rural regions; and the improvement is significant in comparison with potential gains to
the poor that might arise from expanding the commodity subsidy program. This
welfare enhancement comes at the expense of rather disappointing macroeconomic
performance. Increasing cash transfers immediately leads to a reduction in
investment, exports and imports and to a rise in the budget deficit and this adversely
affects economic growth. In contrast, discriminatory taxation policies exempting poor
households from direct taxes or raising the tax burden on the non-poor result in
welfare gains for the poor. The benefits, however, are not as pronounced as those
obtained from direct cash transfers, but neither are the adverse macroeconomic
consequences for investment, budget deficit and real growth 4 .
4
Moreover, not only are such discriminatory tax strategies economically inefficient but also morally
dubious if they lead to unfair adjustment of socioeconomic burdens and benefits among different
classes in the society.
4
The above results are employed to develop a set of guidelines for a strategy for
achieving social justice. Widespread poverty among the Egyptian population justifies
the need for a swift poverty-first strategy of economic development that puts the poor
first. We have seen it is likely that the implementation of such strategy would conflict
with growth-first objectives and goals for sustainable development and improvement
in the incomes and wellbeing of all members of the society. Hence, in the short run,
we propose, a mixed strategy that focuses primarily on raising the welfare of the poor
without jeopardizing growth objectives. At the outset, we discard depending on
strategies that employ discriminatory or uniform tax adjustments because of their
small expected impact on the welfare of the poor and possible adverse effects on
savings and investment and, consequently, on sustainable growth. Accordingly, the
proposed guidelines are built around exploiting consumer subsidies as a policy
instrument for attaining social justice.
In the early stages of abject poverty, we favor tipping the balance of strategy priorities
to expansion of the current system of transfers to poor households through efficiently
targeted cash handouts subject to as strict as possible leakage control. The cash
transfers would be responsible not only for improving the welfare system but also for
regaining occasionally lost public confidence in government altruism and sympathy
for the underprivileged. Besides, reasonable increase in commodity subsidies would
encourage investment and growth without jeopardizing welfare benefits for both the
poor and non-poor and without straining the fiscal budget. Though effective in the
short run, we do not advocate prolonged increase in commodity subsidies as
protracted dependency on such subsidies is likely to overstrain the budget thereby
reducing growth and welfare in the long run. As the situation of the poor begins to
improve, the priority of the policy mix should shift gradually towards a growth-first
strategy with less dependence on cash transfers. Meanwhile, effective complementary
strategies for integrating the poor into the mesh of the productive fabric of the society
(e.g. illiteracy eradication, education for employment, enabling skills development,
etc.) must be fully exploited to realize the expected long-run benefits from consumer
subsidy rescindment.
4. Conclusion
We propose a consumer subsidy adjustment strategy that could be utilized to improve
social justice by significantly raising the welfare of the poor. We focus on a mixed
strategy that gives bigger priority to targeted cash transfers with moderate expansion
in consumer subsidies to stimulate short run growth. The suggested strategy only
provides a short run panacea for poverty alleviation and cannot be maintained in the
long run. The inward orientation of subsidy adjustment is one important reason that is
likely to deplete long run benefits of such a strategy. For instance, as Table 1 shows,
all the selected adjustment strategies result in considerably lower trade openness. In
the short run however, we have seen that consumer subsidy adjustments can provide
quick fixes for poverty and government budget relief.
References
IDSC. 2007. Estimating a social accounting matrix for the Egyptian economy
2004/2005. IDSC, Cairo, Egypt.
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Osman, Magued, Enas Zakareya and Walaa Mahrous. 2007. Targeting the poor in
Egypt: a ROC approach. A research presented to the ERF 13th Annual
Conference.
Appendix
Table 1: Simulated Responses to Alternative Subsidy and Tax Adjustment Scenarios
Base•
Macro Indicators
Real economic growthb
Nominal GDP (LE bill)
Firm's investment♦a
Government investment♦a
Imports♦a
Exports♦a
Unemployment rateb
Inflationb
Exchange rate (LE/$)
Openness**
Nominal sharesc
Government deficit
Household savings
Company savings
Welfare Indicatora
All Egypt
Poor
All Egypt
Urban
Rural
Non-Poor
All Egypt
Urban
Rural
Set A: Consumer Subsidies
Scenario 1
Scenario 2
Scenario 3
Raise
Reallocation
Add Cash
Commodity
to Cash
Transfers
Subsidies
Transfers
Set B: Household Direct Tax
Scenario 4
Scenario 5
Scenario 6
Exempt
Poor
Raise for
Top Decile
Uniform
Reduction
529.71
73.39*
23.41*
33.66*
30.96*
10.50
5.50
0.69
4.80
581.46
1.88
5.86
3.63
4.20
4.85
4.14
5.74
-1.19
-0.53
524.43
-5.73
-0.06
-0.69
-0.80
10.98
-0.49
5.48
-0.04
-0.03
532.39
-4.50
0.72
-0.06
-0.05
10.63
0.40
5.51
-0.41
-0.12
528.53
-1.08
-0.03
-0.14
-0.17
10.61
-0.11
5.50
-0.01
0.10
530.77
1.03
0.02
0.12
0.15
10.40
0.10
5.50
0.00
4.27
576.91
0.09
5.44
3.26
3.78
5.72
3.94
5.72
-1.14
6.33
17.23
10.62
5.56
16.35
10.04
7.23
17.33
10.64
7.12
17.31
10.58
6.48
17.23
10.62
6.19
17.23
10.62
5.81
16.39
10.08
32.55**
0.03
0.20
0.81
0.04
-0.05
0.63
3.00**
1.49**
1.47**
0.29
0.28
0.29
5.03
4.68
5.39
11.21
10.44
12.00
1.67
1.75
1.58
0.13
0.13
0.13
0.23
0.25
0.21
29.47**
16.40**
12.68**
0.01
0.00
0.01
-0.31
-0.32
-0.29
-0.28
-0.32
-0.23
-0.13
-0.13
-0.14
-0.07
-0.10
-0.02
0.67
0.81
0.49
7.06
6.71
7.06
6.71
7.23
6.77
0.00
0.00
0.00
0.00
0.00
0.00
Subsidies and Transfers
Consumer subsidies (LE bill)
Wheat-flour-bread
7.06
9.23
7.07
4.87
Other
6.71
8.54
6.70
4.69
Cash transfers (LE bill)
Poor
0.00
0.00
2.85
6.16
Non-poor
0.00
0.00
0.71
1.54
Note:
•
Reference year 2004/2005.
♦
At constant 2004/2005 prices.
a
In percentage change except * and ** which indicate the base value in LE billion and the
reference index level, respectively
b
In percent.
c
As a percent of GDP.
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