With inflation expected to remain high throughout 2022, economic analysts are turning to policy proposals to better manage the impact on household living costs. Particularly in Europe, where inflationary pressures are due to the rise in energy costs, governments have so far adopted various measures to support citizens financially: broad-based subsidies, fuel tax cuts, price controls, with the aim of reducing the burden on households.
According to a recent IMF’s study, broad-based subsidies delay demand’s adjustment to increased prices, while at the same time putting too much strain on government budgets. Because of that, the study proposes to transfer fully the cost to consumers, in order to reduce demand and achieve energy savings.
Undoubtedly, this will result in a new cost of living burden. According to the same study, the burden of increased energy prices is already significant: the average European household will pay 7% more than predicted at the beginning of 2021 (i.e. before the Russian invasion of Ukraine). The increase is due both to higher prices for energy and fuel, and to the subsequent price increase in goods and services. In most European countries, these increases will be greater for poorer households (see graph). In Estonia and the UK the increase in the cost of living in the poorest 20% of the population is almost twice as much as in the richest 20%. Greece ranks 5th in terms of cost of living increases, and constitutes no exception to the rule that poorer households are more affected by inflation. In particular, the burden due to energy cost increases corresponds to 8.5% of the family budget of the wealthiest households (those belonging to the highest 20% of the income distribution), and 10.1% of the family budget of the poorest households (those belonging to the lower 20%).
According to the IMF analysts, the heterogeneous impact of inflation according to income strengthens the argument in favor of replacing broad-based price subsidies with targeted income support toward vulnerable households. In Greece, according to the study, the complete coverage of the cost of increases for the poorest 20% of the population would cost the public budget only 0.66% of GDP, while if the coverage were for the poorest 40%, the fiscal cost would reach 1.57% of GDP. On the contrary, horizontal price subsidies cost much more: in Greece, where subsidies concern all primary and secondary housing services, for the entire monthly consumption, without income criteria, the final cost is predicted to be significantly higher. (Should be noted that the largest part will be covered by the Energy Transition Fund, while the rest will be charged to the state budget.)
The IMF’s proposal to replace broad-based price subsidies with targeted income support to vulnerable households should be adapted to national characteristics. In countries with high tax evasion, such as Greece, the design of targeted income support should take into account more complex criteria (e.g. wealth). Moreover, to the extent that subsidies are preferred, these could only concern the primary residence, only a certain fraction of kilowatt-hours of energy consumption per year, with the cap scaling according to households’ members and the location (not the size) of the house, so as to address the needs of larger families, as well as those who live in regions with a colder climate.