Who puts the bell… to the subsidy

Who puts the bell… to the subsidy

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In this opportunity I want to share with you the «oil subsidy» problem. As usual, I’ll use an example to outline the Bolivian situation.

Perhaps following a family tradition you are a famous baker in the city, since some time ago you delight to the citizens with three products: 1) bread, 2) delicious cakes and 3) croissants. Naturally for the production of these delicacies, you need 1) ovens, 2) flour, 3) milk, 4) eggs, 5) bakers, etc. Of these products the flour is most important, since it’s the primary raw material.

The Government considers priority the bread and croissants consumption, therefore, approves a law to establish low prices for both products, below the observed prices in the neighbour countries. Additionally, the Government «freeze» the flour prices since is the main input for your product, curiously, the Government also states a Sales Tax of 50% over the products you made.

Time pass and the markets works begin, flour producers reduce their production because frozen prices such a tax, don’t make profitable the production. Moreover, croissants and bread consumers demand significant amounts of both. In this context, you work twice (you ask for a hand from your partner), but of course, your processing capacity is limited. At the same time, the flour, bread and croissants prices, in neighbour countries began to rise, perhaps because friends from China need more calories now their fast growing economy.

If bread and croissants prices become scarce the consumers will protest, because of that the Government decides to buy your bakery and take control of flour production. However, is not enough, eventually the Government needs to buy bread and croissants from your neighbour countries (at high prices) and sell them at low prices.

Unfortunately the system collapse, the flour production drops rapidly, the bread and croissants demand grows and grows (in fact, some crooks buy these products in the country and resell them outside) and the invoice for the bread and croissants imports reaches unimagined numbers.

With that kind of problems the Government states that it is time to take some radical measures and decided to increase the bread and croissants prices… but increasing the sale tax not, as might be expected, improving the flour price. Made the adjustment, the bread and croissants prices increases by more than 70%, the measurement has a 5 days life.

Now, dear readers, change the roles, instead of flour use oil and instead of bread and croissants, use gasoline and diesel oil; so you will have a picture of the Bolivian derivatives hydrocarbons sector problem.

Bolivia import significant diesel oil, gasoline and LPG volumes at high prices and then sold them, to domestic market, at low prices. Let me show you the following chart, for example, by 2007 the diesel oil subsidy was U.S. $ 138 million, but as international prices raise as well the import volumes, rough estimates for 2011 give us the significant amount of U.S. $ 460 million.

This amount of money is too much or too little? To answer this question let me present the following graph; here you can see the diesel oil subsidy as a percentage of total income received by central Government from the export gas sector. For example, in 2007 the diesel oil subsidy represented 36% of total income received by the Central Government; by 2011 this figure rises to 82%. In other words, for every dollar that enters to central government from gas, 78 cents are used to pay the diesel oil subsidy… frankly a nightmare.

How did we reach this situation? Well, we have many answers; however, one is in the oil production tax. Remember the flour production tax? Yes, the 50% sales tax… it was created for the flour for you delicious cakes, because you really made money with them, but unfortunately it was also applied to the flour for the bread and croissants production. (In this analogy, the delicious cakes are the natural gas exports to Brazil).

To end, do you know what is the most interesting and ironical thing? That the diesel oil subsidy for (like all subsidies) are not paid by the President or any of its ministers, is paid by you (through taxes) … as a good friend use to say, «At the end, all the leather comes from the same cow»

Mauricio Medinaceli Monrroy

La Paz, February 7th., 2010

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