Government Budget

What are the gains in budget revenues? How much is required in cash transfers to offset the increase in the poverty gap determined by the reform? Figure 2.10 shows the increase in per-capita government revenue of a 30% reduction in subsidies. The graph also shows the necessary universal transfer required to offset the change in poverty gap resulting from the reforms. This amount can be considered as the minimum universal transfer to keep the poverty gap unchanged.

Government revenues are always much larger than the universal cost of compensation to bring the poverty gap back to its prereform level. It is also possible to target compensation and reduce further the cost to the budget, but governments that implemented large reforms in recent years, such as the Islamic Republic of Iran, have not followed that route. On the other hand, governments may want to compensate some of the non-poor, particularly the middle-class, to reduce the risk of political backlash in the aftermath of the reforms. This may rise substantially the cost of compensation but Fig. 2.10 shows that the space for maneuver to compensate beyond the poverty gap is quite large. Therefore, unless compensation benefits are extremely large and universal, reforming subsidies with compensation is most likely to reduce the overall cost of subsidies substantially.

For food items, in general, we observe that the impact is relatively low for the countries with limited subsidy programs, as is the case for Djibouti and Morocco. The picture is different for Libya, where the food subsidy program is very large. In this country and with a universal transfer designed to offset the poverty gap, the increase in per capita government revenue can be large but still below the overall gains in revenues determined by the reforms.