Tiered pricing can cut petrol subsidies

by PROF DR GEOFFREY WILLIAMS / Pic by Muhd Amin Naharul

AS OIL prices remain stubbornly high and the costs of the prolonged subsidies on petrol prices in Malaysia start to bite, there are many calls for universal petrol subsidies, enjoyed by rich and poor alike, to be replaced by so-called “targeted subsidies”.

There are two main objections to universal petrol subsidies in the public debate, neither of which make any sense in economic terms. The first is that high-income groups benefit more from the subsidies than low-income groups. 

This is self-evident. People who buy more petrol benefit by receiving more of the subsidy and since the rich generally buy more petrol, of course they will receive more subsidy in total. 

High-income groups pay the same price and receive the same discount at the petrol pumps. They do not benefit more per litre and only benefit more as percentage of their income because petrol purchases are a higher proportion of their income than for low-income groups. 

Rich people who don’t use petrol don’t get the subsidy. The benefit is therefore related to how much petrol you use, not how high your income is.

The second objection to universal subsidies is that the overall bill, estimated to be at least RM28 billion this year, is too expensive. 

This makes no economic sense either because this money is a transfer from government specifically to keep prices low for consumers. Without the RM28 billion subsidy, consumers would have to pay the RM28 billion from their own pockets, there is no free lunch. 

As an aside, Petronas (Petroliam Nasional Bhd) posted profit after tax of RM48.6 billion for the financial year ended Dec 31, 2021, and made a further RM23.44 billion profit in the first quarter of 2022. This amount belongs to the government, or rather it belongs to the rakyat and is held in stewardship by the government. It almost covers the RM28 billion and so the subsidies can be afforded if necessary.

One possible objection to the subsidies in principle is that people who do not use petrol do not benefit from subsidies, whether they are rich or poor. So, there is a welfare loss to them because they could otherwise benefit from the RM28 billion if it was spent more widely in ways that impacted their lives positively. 

This has some merit and goes beyond the populist arguments we hear too often, which also ignore other objections to petrol subsidies such as the market distortions of price intervention, the transfer of funds to petrol companies from the rakyat and the artificial suppression of prices, which keeps petrol cheap and damages the environment.

Despite this, removing universal subsidies and replacing them with targeted subsidies is a terrible idea for three reasons. 

First, we have no way of targeting subsidies to the poor because we cannot identify the poor and anyway, we should be targeting the subsidy according to need, which is not necessarily associated with income. 

Second, we have no effective mechanism to implement a targeted subsidy. The usual solution is some form of voucher given to the targeted groups or a digitalised alternative using MyKAD or MySejahtera. None of these will work and it is actually the absence of a technological solution which is delaying the targeted subsidy idea. 

Of course, any form of voucher or discount will also be immediately traded for profit in a grey market, and this will lead to illegality and huge enforcement costs. Even with digital technologies there is no effective mechanism to stop this.

Third, at the moment price rises are mainly in fuel and food and are controlled by price controls and subsidies, which keep general inflation low. 

Removing subsidies will raise petrol prices and cause a general rise in prices across any category in the consumer price index dependent on fuel. It is a recipe for hyperinflation and massive interest rate hikes to control it.

A tiered price system is one solution in which subsidies would apply for low volume purchases and would be removed for higher volume purchases. We need a quick study to find the optimal quantities and costs, but for example, the current RON95 subsidised price of RM2.05 could be applied for purchases below 10 litres and the full market price of over RM4 could be applied above that threshold.

Of course, it can be tiered further, so purchases between 10 and 20 litres or 20 and 30 could be charged higher prices in stages. An upper limit of above 30 litres would be charged the full market price without subsidies.

There are very many advantages to this type of system over the universal subsidy or the targeted subsidy. 

For example, it can be introduced almost immediately by simple changes at point-of-sale at the petrol pumps. The subsidy would only be available at low volumes at point-of-sale and so it is not open to a grey market in traded discount vouchers. 

It is targeted at low-volume users who are mainly in the low-income groups buying small amounts for their motorcycles or small cars. Gas-guzzlers who want to save money would have to make multiple trips to fill their tanks at discounted rates and this is an effective deterrent to all but the most cheapskate SUV-owners.

For the government, the tiered prices system will reduce the overall subsidy bill because a large percentage of petrol sales will no longer be subsidised. This eases the pressure on government coffers and releases funds for other uses, in social welfare for example.

In wider economic terms, tiered pricing is less distortionary in terms of market prices and has fewer damaging impacts on petrol companies or suppliers. It is also less inflationary compared to removing universal subsidies.

Tiered prices can also be retained in the long-term environmental policy to discourage high-volume petrol users and encouraging fuel efficiency. 

So, while many people do not support subsidies of petrol prices, the reality is that they do serve a purpose of helping to keep down specific and general price rises, and this has significant social and economic benefits. Removing subsidies completely would cause massive economic damage and the “targeted subsidy” idea is a non-starter for practical reasons. 

Tiered pricing offers a real opportunity in facing this dilemma and the government should consider it seriously as we look forward as we see prolonged elevation in oil prices and increasingly expensive subsidy costs.

Prof Dr Geoffrey Williams is provost for research and innovation at Malaysia University of Science and Technology and a non-resident senior fellow at the Malaysian Institute of Economic Research. The views expressed are those of the writer.