The Political Economy of Reforms

Following the previous section where we looked at the impacts of the proposed reforms, here we examine the safety nets in place in Djibouti and attempt to estimate the effect of compensating schemes to offset perverse effects on poverty.

Fuel Subsidies

The government is currently considering abandoning the use of the discretionary tax element on certain fuel products (super and diesel) for private consumers, but the privileges for other exempt groups such as the military and embassies would remain. At the time of analysis (based on prices of December 2013), such a reform would have resulted in a small reduction in super prices and an increase of around 13% for diesel. The substantial fall of crude oil prices is relevant to the calculations shown. In December 2013, Brent crude sold for about US$110 a barrel, and it remained around that level until July 2014. Since then it has steadily declined until falling to around US$50 a barrel in January 2015.

Before the drop in oil prices, the government had not taken any firm decision, in part due to fears that higher fuel prices would increase inflation. In addition, there are concerns over the impact on the poor, the middle class, and certain sectors, such as transport, fisheries, and bakeries. The impact of fuel subsidy reforms on the transport sector is of particular concern to the government. Ticket prices for public transport are set by the state and have been more or less stable since 2006. The bus and taxi fleet is outdated, and current discussions center on decreasing the cost of transport by updating the fleet. The government is considering financing new vehicles, which the bus and taxi operators would pay back over time, thereby reducing the consumption of fuel.

If the government wanted to abandon the discretionary tax, this would be the time for action. With falling oil prices, an elimination of the discretionary tax elements would not necessarily lead to higher prices for consumers. In fact, given the low prices seen in early 2015, removal of discretionary tax on diesel would be small in comparison to the fall in underlying costs—so that the effect of its removal will be negligible and the effect on bus prices will be easily absorbed. If bus operators do not lower their prices at all, their margins will increase.

With the elimination of discretionary tax on fuel products, however, the government would relinquish a tool to smooth fuel prices in times of price fluctuations. With falling oil prices, government tax revenues will decrease accordingly. The removal of discretionary tax at this point would lower the tax revenue further. It is likely that the government has adjusted the magnitude of the discretionary tax since January 2014, which would warrant further analysis. Furthermore, an analysis of the optimal tax structure would be warranted. The following analysis based on December 2013 prices confirms that a negative tax on fuel products effectively subsidizes the better-off. Any reform of the current energy tax system should be pro-poor,and social safety nets would be the channel to reinvest savings in pro-poor policies.

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