Subsidising fuel won't deal with long-term problems

19 Jun 2008

Consumers only receive part of the benefit of fuel subsidies, writes FLAVIO M. MENEZES.

QUEENSLAND motorists have had access to a subsidy on fuel for over over a decade, introduced by the state government in order to offset the fuel excise imposed by the federal government. The performance of the Queensland scheme is worth considering now that the national debate over fuel proces has intensified.

In the course of his inquiry into the scheme last year, Justice Bill Pincus found that up to a third of the subsidy, which is currently equal to 8.35 cents per litre, was not reaching motorists. As the total outlays with the scheme add up to around half a billion dollars, this means that roughly $170 million is being absorbed by suppliers. On top of that, taxpayers are paying the substantial administrative costs of a complex scheme.

The reason that the scheme does not work is simple: markets do not take taxes or subsidies lying down. As markets react to a subsidy or a tax, the benefit is spread through buyers and sellers. A subsidy to petrol shifts the demand for petrol - that is, at the same pre-subsidy price consumers demand more petrol. This often results in increases in the incremental costs of meeting the additional demand. So prices rise as a result. The extent of the price rise depends on how responsive demand and supply are to changes in price. Importantly, even in markets that are considered to be very competitive, consumers might not get more than 80 per cent of the subsidy. In other words, there is no reason why motorists should expect 100 per cent of the subsidy.

The recently announced modified scheme, under which Queensland motorists would swipe a bar code on their drivers licence at the point of sale to receive the 8.35 cent a litre subsidy, is also destined to fail. Retailers could set a higher browser price, which would partially offset the subsidy, just like under the current scheme. In addition, there will be significant administrative costs. It will be another scheme that does not work.

Excluding interstate motorists from the scheme sounds like a neat idea, but it is full of problems. Once the subsidy is added to the current price, bowser prices in Queensland might actually be higher than in other states, and visitors to the state will pay the full price. Treating visitors in this way will do nothing good for our tourist industry. And there is the risk that other states might retaliate, by requiring visiting Queenslanders to show ID before getting access to public services.

What are the alternatives then? Perhaps the best alternative is to eliminate the subsidy altogether and spend the half billion dollars each year on improving transport infrastructure. This might reduce travel times and result in less congestion, pollution and produce a lower fuel bill for everyone. Following the same logic as outlined above, the elimination of the 8.35 cents per litre subsidy is likely to lead to a price increase of less than the full amount of the subsidy.

Of course, it is a difficult political issue to convince voters, who currently face higher prices for groceries, petrol and increased mortgage repayments, that they should give up a 5 to 6 cents-per-litre subsidy in exchange for expenditures of the full 8.35 cents per litre on infrastructure improvements that will only felt by the public in a few years time.

Nevertheless, if the Queensland government made a serious effort to explain the issues, it should be able to sell the idea. Apart from the attraction of a constant and significant flow of new resources invested in transport there is the elimination of the $170 million per annum transfer to the oil industry. The Pincus inquiry showed that this slippage is inherent in the current system. Queensland’s new scheme will do nothing to change it.

Nationally, the lesson from Queensland is clear: subsidising the cost of fuel is no solution to the problem of rising prices. 

Flavio M. Menezes is a Professor of Economics at the University of Queensland. He provided economic advice to the Fuel Subsidy Commission of Inquiry.

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