The issue of subsidies has once again become front and center for the Islamic Republic. Both the ‘moderate’ Rohani administration and the ‘conservative’ Majlis deputies have come to the conclusion that a substantial overhaul of the program is in order.
While the program’s actual financial balance sheet (ie total income and expenditures) and the exact number of registered (and phantom) cash recipients are still murky and in dispute, its deficit is real and transparent.
According to a senior official in the Rohani administration, the program’s current monthly payment obligations amount to IR35 trillion while its total revenues come to no more than IR18 trillion — with the shortfall being made up from other sources.
BACKGROUND TO REFORM
Iran’s 2010 Subsidies Targeting Act (MEES, 31 May 2010) aimed at ending the 30-year old across-the-board and costly practice of selling government-supplied energy, water, power, and other items to the public at below cost – often at as little as 20-25% of their international prices. This cost the treasury more than $25bn annually in cash, and close to $90-110bn in opportunity value. The law called for the gradual raising of prices to international levels over five years. Some 50% of the resultant savings to the treasury were to be paid back to consumers according to need in order to compensate for their higher expenditures; 30% was to go to energy-intensive industries to encourage innovation, and partially make up for their higher cost outlays; and the remaining 20% was to be kept by the treasury to cover the program’s administrative costs.
TROUBLE FROM DAY ONE
The cash subsidy program’s deficit started almost from day one. This outcome was not hard to predict, but it had not been anticipated for two basic reasons. First, the actual cost of the program was grossly miscalculated in all its components: the potential number of welfare recipients; the magnitude of monthly cash payments to each individual; and the scope for potential cheating and fraud. Due to the statistical difficulty of identifying various income groups, and the relatively small number of rich who voluntarily excluded themselves, the program’s basic concept of ‘welfare for the poor’ became a universal handout.
Similarly, while the monthly cash payment to individuals was rather meager at IR455,000 (compared to the legal minimum monthly wage of IR4.9mn), the total magnitude of cash outlays was not accurately assessed, and in retrospect, it was set too high. The number of potential recipients was also uncontrolled.
The Rohani government has found that the number of current monthly welfare recipients is 77,000 more than the entire Iranian population of 77mn! These ‘phantom’ beneficiaries – thought to include Afghan refugees, Iranians living abroad, and owners of forged identity cards – have received a total of IR56 trillion over the last three years.
The actual number of current ‘fake’ recipients, however, must be more than 77,000 since the 77mn-plus reported recipients obviously still exclude a sizeable number of voluntary ‘unregistered’ families and individuals choosing to be excluded, and a whole gamut of other ‘non-recipients’ (eg homeless people and inhabitants of remote villages).
The second miscalculation involved the size of potential revenues from higher food and fuel prices. The income estimate was based on a set of static and symmetrical assumptions, with no regard to underlying demand elasticity. Thus, while average prices for all energy products, water, power, bread, and some other items were raised much higher than allowed by the statute, or expected by the legislature, the projected new revenues were still grossly overestimated. It was implicitly (and wrongly) assumed that higher energy and food prices would have little effect on consumers demand – ironically at the same time that higher prices were aimed at reducing waste and profligacy!
As the outlays grew larger, and the deficit mounted while revenues proved inadequate, the shortfall was temporarily financed by borrowing from the Central Bank of Iran (CBI) in the hope it would be ‘repaid’ from subsequent higher receipts. Failing to receive the expected income, the share that was to have gone to the government (20%) was eliminated, and the industry share was drastically cut from the intended 30%. Faced with continued revenue shortfalls, consumers finally became the sole beneficiaries of the program in the second and third years of operation. The shortfall has been made up from various other sources including the sale of a state enterprise.
AN INTERIM ASSESSMENT
The Subsidies Targeting Act of 2010 aimed at achieving both social justice and economic efficiency. As it turned out, it did neither. In actual implementation the new law was merely a change in form from universal commodity assistance to partial cash payments to all – a fact which again brings into question the rationality of involving the entire population in the government’s largesse.
The program has also been presented to the public and the world as one recommended and endorsed by the World Bank. In reality neither the World Bank nor the IMF recommended a specific program in their annual consultations with the Iranian authorities, but rather a general guideline. Based on the libertarian principle of ‘consumer sovereignty’ these organizations’ advice was that if you are going to give a person welfare assistance, it is more effective in the form of cash rather than a commodity because the recipient will have total discretion as to how it is spent.
The current subsidy program, however, follows this theoretical principle only in name and not in spirit. In the program, the targeted cash recipients do not individually enjoy the intended ‘sovereignty’ because the IR455,000 monthly assistance to each member of the family is placed at the disposal of the family head. Individual members (wife, children, and other dependents) have no ‘sovereign’ control over their share. And there is no guaranty that the family head will behave in the best interest of his members. In fact, with some 2.5mn officially estimated drug addicts in the country, the chances of some being the head of a family (and therefore not competent to handle the family assistance) cannot be ruled out. The same would be the case with a family head being a gambler, a drunk, or suffering from similar afflictions.
The more deplorable aspect of the program, however, has not been its large deficit or its distributional shortcomings but its failure to achieve any of its major objectives: ending wasteful energy consumption, increasing energy efficiency, a fairer distribution of Iran’s oil and gas bounty, improving industrial technology, reducing fuel smuggling, ending gasoline imports, and improved environmental protection.
A cursory look at Iran’s current consumption pattern shows that while fuel use was temporarily reduced after the initial price increases, no further reduction has occurred, and gasoline consumption is now back to its previous level. There has been no increase in industrial efficiency as the share of savings slated for industry was not fully paid. The poorest 20-30% of the population’s share of national income may have slightly improved at first as a result of monthly cash receipts, but subsequent increases in inflation have erased the early benefits. Smuggling has returned. The environment has been further degraded: an international environmental protection ranking has seen Iran fall 36 places to 114 (of 132 countries) in the last few years.
The nearly $38bn spent on monthly cash payments over the last three years could have been used: (1) to complete 10,000-plus unfinished development projects, in particular in crucial natural gas exploration in the Persian Gulf; (2) to set up educational and training workshops to raise productivity; or (3) to establish an effective social safety net.
TOUGH REMEDY CHOICES
To deal with the accumulated deficit and prevent further monthly shortfalls there are only two alternatives: either (1) cut the program’s expenditure commitments (the size of monthly cash payments and/or the number of recipients), or (2), further raise the program’s revenue source (fuel and food prices). However, cutting the number of cash welfare recipients would be politically hazardous, as it would undoubtedly lead to protests by those losing out. With nearly 40% inflation and close to 20% unemployment, new price increases would also be economic folly. That is why both the Ahmadinejad and Rohani administrations have refused to raise energy prices, although the 2013-14 budget law permits a 38% rise in order to deal with the deficits.
Leaning towards the second choice, the Majlis on 23 October voted in principle to eliminate the top 30% of subsidy recipients at the start of the 2014-15 Persian year (in March 2014). The law gives the government three months to identify 23mn well-to-do cash recipients to be eliminated. This, however, has proven easier legislated than accomplished. The original Subsidies Targeting Act also required individual income categorization. And the task was attempted through several different measures – self-declaration of income, answers to income questionnaires, visits by state agents to individual residences – all to no avail. The government saw no other solution but a uniform monthly cash payment to all, including thousands of top rated professionals and corporate executives with annual income of half-a-million dollars or more!
INCOME CATEGORIZATION: MISSION IMPOSSIBLE
Nothing has changed since. And income categorization remains a mission impossible. The magnitude of individual wealth and income in Iran has never been surveyed or known. Nor can it be easily and accurately ascertained.
In a country with no enforced income tax returns, no other reliable sources of income data, or easily assessable individual assets, the categorization and classification of cash recipients are an impossible task. According to a consensus among statisticians and accountants, the current sources of information at the government’s disposal are in no way helpful in identifying the rich one-third. Current data collected by the CBI are focused on families’ expenditures rather than incomes.
Identification of a limited number of rich could of course be made on a case by case basis: high-salaried government employees, owners of prime real estate, drivers of luxury cars, CEOs, bank’s key account holders and frequent travelers abroad, for example. But, the number will not reach 23mn. And, snooping into some of these sources of income (eg bank accounts or lifestyle) may involve gross violations of personal privacy.
Facing these difficulties, President Rohani, in submitting the 2014-15 budget to the Majlis on 8 December, told the deputies that his administration has lost no time studying the flaws in the current welfare system, and that he intends to come up with a new plan for the management of subsidies in a comprehensive bill to be presented to the assembly next year. In the meantime, and until the new plan is put into operation, the current system will continue. Accordingly, the proposed budget appropriates IR388 trillion to pay IR455,000/month to some 74mn citizens.
RATIONAL ALTERNATIVE NEEDED
By most criteria Iran is not an egalitarian society. The officially claimed Gini Coefficient of around 4 indicates relatively acceptable income distribution, but all other evidence shows a different picture. In a recent Gallup poll, some 50% of Iranian respondents considered themselves ‘poor’, ie not being able to feed their family from time to time. According to Iran’s High Council of Elders, there are now 6mn old people in Iran of which 30% (1.7mn) live below the poverty line and are assisted by various charities. Another private study shows that the third of the population at the bottom of the income pole consumes only 15% of the national product, whilst the top third enjoys 60% – four times the share!
In a modern, civilized society facing this type of inequality, it is taken for granted that the clearly deprived segment of society – the real poor – should be helped through what is generally referred to as a social safety net. The Islamic government’s across-the-board subsidies, in either price discount or cash payment forms, fail to meet the universal criteria of efficiency and equity. They also present many flaws from both a political and a psychological perspective.
From an equity standpoint, the inclusion of middle and high income earners in any subsidy program makes no sense. While a payment of $45/month or so to the truly poor (ie 50¢/day over the absolute poverty line) would presumably be of some help, an equal sum to the rich and the well-to-do may not even pay for a day’s dog food! On efficiency grounds, across-the-board cash subsidies needlessly encourage increased consumption, and are patently wrong-headed in a country with relatively meager national savings and in desperate need of substantial investment to reduce unemployment. Encouraging increased consumption is also ideologically incompatible with a constitution which emphasizes frugality and parsimony as man’s principal guide in life – a country whose leaders have been trying to establish an ‘Islamic’ and frugal ‘consumption model’ for years.
Across-the-board and indiscriminate cash distribution is also fraught with great political hazards. While the initiation of small monthly payments would receive a lukewarm welcome from recipients, their reduction or termination would be fought tooth and nail. The government can always give; but it can seldom take anything back. In fact, the greatest challenge for the Rohani government is how to cut, and ultimately to end, the current program. From a socio-psychological viewpoint too, equal monthly payments to the entire population would initiate, promote, and perpetuate a culture of dependence on the state instead of encouraging self-reliance and hard work. Creating one new, even minimum-wage, job for one family member would be more beneficial than giving 10 members a monthly welfare check.
A BETTER ALTERNATIVE?
The past three years’ experience with the Subsidies Targeting Program has clearly shown that the initiative, no matter how well-intentioned, has been neither equitable nor cost-effective in dealing with the basic problems of poverty and financial inequity. The program’s equal treatment of the rich and poor has had no welfare or distributional merits. A program which was thought to be not only self-financing but also income generating has turned out to be a money losing fiasco. Its burden on the treasury, substantial addition to inflation and high administrative costs have been far too high a price to pay for an arguably slight improvement in the absolute poor’s living conditions.
The program’s ‘second phase’ – slated to start in the new Persian year (2014-2015), presumably after a satisfactory resolution to the current financial and distributional problems, should hopefully begin with a better outlook, structure, and financial support. To begin with, since the drastic devaluation of the rial over the last few months has once again widened the difference between domestic and world prices to the pre-2010 levels, the current statute’s provisions are already outdated, and a new price adjustment program must now be tried.
Under any such new scheme, the current gaps could be closed over the next five years by means of a 20%/year price hike. The proceeds from new higher prices could have two distinct and separate outlets.
The first portion could be earmarked for direct subsidies to the real poor at the exclusion of the majority of current beneficiaries. Currently some 12mn people in Iran are considered poor. Of these, an estimated 6mn are now under the partial umbrellas of various welfare agencies (The Imam Khomeini Relief Committee, Behzizty Organization), or charitable bonyads (Mostazafan, Shaheed). They can easily be identified and included among the new subsidized groups.
The other 6mn eligible recipients for public assistance would be those who by sworn affidavit declare themselves to be below the official poverty line – under the threat of heavy legal penalty for false claims. These 20% lowest income earners should then be given the equivalent of $2/day in cash, or kind (food stamps, shelter coupons etc.) as long as they remain in the ‘poor’ category.
BROADER SAFETY NET
A larger portion of the expected revenues could be earmarked for broader safety net projects.
With unemployment, underemployment and low wages being the main causes of poverty and deprivation, priority could be given to such endeavors as a more accommodating education system, labor training workshops, higher minimum wages, adequate unemployment insurance and more effective labor mobilization. Physical and mental impairments being other causes of poverty, a comprehensive health insurance system, adequate mobile health units, day care centers and accessible rehabilitation centers could receive priority. Pension funds should also be strengthened given rising numbers of old and infirm. Adult literacy classes to target the estimated 14% who are illiterate and improved public transport are other candidates.
These measures would be much more effective, less costly, more equitable and by far superior to the current monthly welfare checks.
*Dr Amuzegar is a distinguished economist and former member of the IMF Executive Board.