A Model for Us All: Iran's Subsidy Reform

Iran's elimination of its subsidy for gasoline, combined with direct payments to the population, is a bold plan that makes a lot of sense. A similar bargain (increased carbon taxes combined with reduced Social Security contributions) would make tremendous sense for the United States, but is unlikely. The mullahs are outdoing us in innovative energy policy!

From The Brookings Institution:

On December 19, 2010, the [Iranian] government ended the decades-long subsidy program for bread and energy products like gasoline, and replaced it with direct payments of about $45 per month per individual. . . .  

The recent subsidy reform is the single most important market reform program undertaken since the unification of the exchange rates under President Rafsanjani in the 1990s. . . . 

President Khatami originally thought to reform Iran’s massive subsidies—estimated today at about $70 billion, nearly 20 percent of GDP, and mostly geared toward energy products—but failed in his attempt due to parliamentary opposition. President Ahmadinejad decided to launch his version of the subsidy reform program—grandly named the Economic Transformation Program—in an unlikely time, in the wake of popular uprisings following his controversial election in June 2009 and economic recession. He had the support of the Supreme Leader Ali Khamenei and the parliament, but his program was attacked as reckless and a grave danger to the anemic economy. His reformist opposition dismissed it as a populist stunt to win the approval of the poor and appease the middle class.  

Two features of the program have political salience, prices of bread and all energy products were increased to market levels in one shot, and at the same time money was transferred back to people’s bank accounts. One reason for the failure of previous attempts was gradualism, which allowed opponents of subsidy reform several opportunities to stop it. President Ahmadinejad braved political waters by going for shock therapy, albeit a managed one, price discriminating in favor of the poor using an innovative gasoline card, which registered how much gas each car used per month, and the meters for utilities at homes and offices. The rich are charged a higher price than the poor for the same product. The cash-back program was also initially designed to heavily favor the poor, but this plan collapsed last summer when the government found out that its method for identifying the poor based on income deciles calculated from self-reported survey data was highly flawed. In a rare display of pragmatism, President Ahmadinejad appeared on national television to ask the “good people of Iran to forget the plan [based on income deciles].” Contradicting the critics who believed his main objective in the subsidy scheme was to pay off cronies and recruit an army of poor followers, he dropped the graduated payment scheme in favor of uniform payment to all citizens. All the work to fill and analyze 15 million forms that families had filled revealing (or not) their income and wealth had gone to naught. 

In order to forestall angry reactions to the sudden hike in prices and to overcome deep cynicism of the Iranian public about ever seeing their government give anything back to them—especially with large sections of the population in open revolt—the government chose an innovative plan. Bank accounts were set up in the name of household heads, usually a male, into which the government deposited the first tranche of the cash subsidy, about $90 per person covering two months. The money deposited in these accounts could be seen but not withdrawn until further notice. What to do with the cash subsidy (yaraneh) once it was to be released soon became the talk of the town. Then, in a dramatic gesture, at 10 pm on December 18, President Ahmadinejad appeared on television to announce that prices would increase as of midnight and the bank accounts would release the funds the same day.
Many had predicted that skeptical Iranians would be rushing to their banks the next morning to collect their money before it disappeared, but bank offices remained calm. Perhaps it was the numbing effect of skyrocketing fuel prices, or a rare display of trust in the government, we will never know. But, surprisingly, the day on which the price of key necessities increased multiple times went by without an incident. Bread, the national staple, at 20 cents per loaf had doubled in price; gasoline, powering 12 million cars on Iran’s roads increased four times; natural gas, which flows directly to the homes of 75 percent of Iranians, increased by a as much as eight times; and diesel fuel that powers the nation’s commercial transportation increased nine-fold.

For the poor, who spend much less than the rich on driving and heating their homes, the excitement of getting a chunk of cash per month most likely outweighed the pain of disappearing subsidies.

Update, May 14, 2011: Much as Iran's price reform is necessary in the long run, it undoubtedly presents, in the short run, a potent target for popular disaffection. One Iranian blogger predicts riots and noncompliance. She tells the story of a young man she met in a taxi, who said:

"I'm a student and I have a job as a worker. I make 200,000 tumans per month [about $170]. I have rented a small place in Zourabad for 50,000 tumans per month (I don't think the rent is as low as this anywhere in Iran) with the remaining 150,000 tumans I would hardly manage to pay for food, transport, and university costs.

"I have now received a gas bill for 150,000 tumans. As soon as I saw the bill I got so angry that I tore it into pieces. The bill for water and electricity is also several times more expensive than before. Please tell me how I can survive under such conditions." His face had become red out of anger. The none of us in the taxi had a response. Just that "Well, it's good that you didn't pay, we have decided to do the same. God willing things will get better...."