Distributional Impacts of Energy Policy Reform: The case of fuel taxation in Indonesia Michael Schleicher, University of Göttingen Sebastian Renner, GIGA and University of Göttingen 16/10/2012 Preliminary Results

Research Questions Distributional Impacts of energy policy reform – The case of fuel taxation in Indonesia a)Short-term distributional impacts of fuel subsidy reform b)Distributional impacts of fuel subsidy reform when behavioral responses are considered Possible reform scenarios: cutting all fuel subsidies cutting fuel subsidies on gasoline, diesel and gas only …

The case of Indonesia Figure 8: Indonesian fuel subsidies as a share of the respective benchmark price ( ) (Based on multiple sources and own calculations)

The “ideal measure of tax incidence” would include: a.general-equilibrium change in prices through tax increase –increase in consumer prices –increase in sale-prices  affects factor returns –indirect effects arising when good is used as intermediary b.effects of price changes on household’s welfare –change in consumer surplus –compensating and/or equivalence variation

Restrictive assumptions commonly used Standard partial equilibrium setting –Perfectly elastic supply curve  tax burden is completely shifted towards consumers –taxed commodity is not an intermediate input –no behavioral responses (no substitution effects) Advanced partial equilibrium setting –relaxed assumptions on behavioral responses  price elasticities of demand across income groups

Dataset - SUSENAS 2010 cross-section (yearly repeated ) by BPS Statistics Indonesia, sample size: 64,800 households 3 modules: –Social, cultural, and educational information –Health and housing –Consumption and expenditure Michael Schleicher 6 -PurchaseOwn ProductionGift Food Non-Food

a) Short-term distributional impacts of fuel subsidy reform 1. “Budget Share approach” Example (figure 2): 10% increase in fuel tax 2% for 1 st  0,2% of income 6% for 9 th  0.6% of income i.e. progressive tax! Expenditure shares for fuel goods in SUSENAS 2010

Lighting/Cooking different budget share levels Electricity rather stable Kerosene decreasing  regressive effect maximum for lowest income group

Cooking Gas shows slight reversed u-shape  middle-income households highly affected Firewood is clearly decreasing  higher shares in rural regions

Transport similar average expenditure level Gasoline clearly progressive  ownership threshold? Public Transport is moderately increasing  driven by urban areas

2. Tax burden calculation Underlying measure: tax burden as the approx. Compensating Variation -is calculated for each household j : - can take negative values in case of net-subsidies a)for the baseline scenario  Tax Concentration curves cumulative percentage of tax burden plotted against cumulative percentage of population (ordered by total expenditures) b) for tax scenarios  Tax incidence curves calculate the difference between the tax burden under the baseline and under the new tax scenario and present as a share of total expenditures Time indices: x 0 = x before taxes x 1 = x as stated in SUSENAS x scn = x assumed for tax reform

Baseline scenario progressive tax regime by 2010 in absolute amounts in relation to income

Reducing gasoline subsidies similar pattern BUT different levels different peaks progressive impact of gasoline taxation outweights the regressive impact of kerosene taxation CLEARLY PROGRESSIVE taxing GSL only taxing KRS & GSL

Subsidy cut in fuel subsidies to 0% substantial additional tax burden clearly progressive for the first three expenditure quartiles sharply decreasing afterwards subsidy cut to 0%

Subsidy cut & lump-sum distribution of revenues revenues from complete subsidy cut: ~ 256,000,000 USD One time lump-sum transfer: 43,600 IDR a scenario of extreme redistribution lump-sum transfer works progressive and the majority of sample households effectively benefit from the transfer subsidy cut to 0% with lump-sum transfer subsidy cut to 0%

b) Distributional impacts of fuel subsidy reform when behavioral responses are considered Incorporation of behavioral responses –obtain income, own- and cross-price elasticities –relevant for three dimensions SOCIAL:different responsiveness across income levels? CLIMATE: substitutes with different carbon contents EFFICIENCY:market distortions, tax revenue creation Requires estimation of demand models –specify a demand equation and regress fuel demand on the respective determining variables (prices, income, household characteristics) single-equation models complete demand system models (LES, AIDS)

i) OLS regression Working-Leser model: adjustments in order to maximize sample size: max Obs Unit values ELCKRSGASGSLLBRmN ELCX X 22,444 KRSXX 23,326 GASX X 22,444 FWDXX 23,326 GSLXX XX14,990 LBRmX XX15,838 PBT XX15,838 Unit values

Income elasticity of expenditure:Price elasticities of expenditure:

ii) Treatment of zero-values Two problems arise with having zero expenditure values 1)zero unit values  have to be dropped 2)zero expenditure shares  corner solution problem Solutions: ad 1) calculate median unit values at village level and assign them to all households inside of it ad 2) tobit regression with

Marginal effects: ELCKRSGASGSL tot_exp pF_elc pF_krs pF_gas pF_gsl

Conclusion Distributional dimension –Income elasticities reflect budget shares, roughly reflect how taxes on different fuels will be distributed –Coefficients for budget shares can be used for further calculation of tax burden Climate dimension –higher kerosene prices encourage firewood demand (OLS estimates!!) –carbon tax would be progressive (with or without behavioral reactions??)

Further Research –Tobit model very restrictive: assumes that the same factors influence the decision if one chooses to use a certain type of fuel and how much of it they use. –If normal distribution is violated, biased results –Heckman selection model an alternative, but IV is needed to identify selection equation –Estimation in complete systems also attractive but technically demanding –Brings us to the frontier of demand estimation research

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LPG transition program and a carbon tax LPG transition is very regressive carbon tax is ambiguous when both scenarios are compared, carbon tax is progressive Interpretation difficulties: we don‘t see nothing on the actual tax burden amounts and how is it changing with income? taxing kerosene & subsidizing LPG carbon tax (20%)