The report identifies the impact of energy subsidies on public finance in Ecuador and looks at the distributional impacts of subsidies. To inform policy design, the authors use the household survey data from Ecuador, in combination with augmented input-output data, to assess the distributional impacts of energy subsidy reform. Energy subsidies account for about seven percent of Ecuador’s yearly public spending or two-thirds of the fiscal deficit. The study finds that it costs USD20 to transfer USD1 to the bottom income quintile through gasoline subsidies; USD10 through electricity; USD9 through diesel subsidies; and USD5 through liquefied petroleum gas (LPG) subsidies. Relative to household income, subsidy removal without compensation would be regressive for diesel and LPG, progressive for gasoline, and approximately neutral for electricity.

While removing these subsidies would yield clear economic and climate benefits, the expected adverse effects on vulnerable households are likely to make such reforms politically difficult. The authors analyze how a fraction of financial resources, freed up by the subsidy reform, could be used to mitigate the income losses of poor households by means of in-kind and in-cash revenue recycling schemes. The results indicate that removing all energy subsidies and increasing the existing social protection program, Bono de Desarrollo Humano, by nearly USD50 per month would confer net benefits of almost 10 percent of their current income to the poorest quintile and also free up significant amounts in the public budget.

The authors also conduct expert interviews to evaluate the political and institutional challenges related to the energy subsidy reform. They identify two combinations of reform options and recycling schemes that would benefit the poorest 40 percent of households, namely eliminating subsidies on gasoline, while increasing the amount transferred to vulnerable households through Bono de Desarrollo Humano; and replacing the universal LPG subsidies with targeted LPG vouchers. The authors suggest that countries in Latin America may benefit from increasing energy prices to fund development programs, reduce public deficits, and incentivize a transition to a low-carbon economy. The cash transfer programs of the region could be an instrument to reduce the impact of energy price hikes on poor consumers, thereby making price reforms more palatable.