8.4.2 Types of Subsidies

Categories: 8.4 Subsidies
Time of issue: 2022-04-28 10:59:08
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There is a wide array of subsidy mechanisms that can be used to deliver public financing to sanitation. Through the Water Supply & Sanitation Collaborative Council, Evans et al. (2009) prepared a Primer on public funding for sanitation. The Primer provides a comprehensive overview of the different types of subsidies, how they work, how they benefit and the advantages and disadvantages of each. The following section provides an overview and summary of the key information presented in the Primer. For a more in depth review of this information the reader is encourage to review the Primer.

Evans et al. (2009) identified ten (10) types of subsidies, including:

Direct subsidies;
Infrastructure subsidies;
Connection subsidies;
Operational subsidies;
Subsidies to small scale operators;
Cross-subsidies;
Consumption subsidies;
Output-based subsidies;
Regulatory subsidies; and
Subsidized credit.

Direct Subsidies. Direct subsidies involve payment (in the form of cash or vouchers) directly to the recipient household, which is then able to ‘spend’ to access a range of services. Direct subsidies have been not widely used as a single sector intervention because of the high costs to identify needy households. However, if the poorest households can be accurately identified, direct subsidies are both efficient and effective.

Infrastructure Subsidies. The use of public money to construct new infrastructure is one of the most common forms of subsidies. In rural areas, infrastructure subsidies are utilized to pay part or all of the costs for household or ‘private’ elements of the project, such as toilets. The cost is justified on the grounds that these expenditures are the most significant barrier to certain households accessing services. A general problem with infrastructure subsidies is that inadvertent targeting may occur because particularly advantaged groups (e.g. those with land tenure, or those who are literate and can apply for a subsidy) are disproportionately benefited.

Connection Subsidies. Many urban utilities charge households to connect to networked sewage services. Households are often charged for part or all of the capital costs of connecting the house to a sewer in the street and often must also pay a ‘deposit’ on some of the infrastructure repairs. Typically these connection costs can be very high and are often regarded by utilities as an important income stream. From the householder’s point of view, however, high one-off connection fees can form a very real barrier to connecting to the public services. The levying of such fees is inherently anti-poor since the poor are the least able to pay.

The barrier created by high costs of connections can be easily removed either by amortizing the costs of new connections across all utility bills, by providing credit, in the form of staggered payments over months or by the provision of a direct subsidy to targeted households to cover the costs (a connection subsidy). Output-based arrangements are particularly well suited for the delivery of connection subsidies. All of these have progressive outcomes and promote rational decision making by the utility.

Operational Subsidies. Operational subsidies involve the payment of money to a private service provider to offset some or all of the costs of supplying the service. Operational subsidies for utility operations and software services are often ignored. They are rarely fully transparent but often represent a very significant transfer of public funds to the sanitation sector. In addition, they can end up encouraging inappropriate capital investment in infrastructure with very high running costs, because the service provider has no incentive to strive for cost effectiveness or efficiency of the service. If the utility or public agency funding this subsidy charges a very low tariff, the subsidy may be very large and as it recurs every year it places a heavy burden on the public budget. If there are insufficient funds to maintain the subsidy, the utility will be forced to under-invest in maintenance, resulting in poor operation of the sanitation system, which in turn may pose risks to public health and the environment.

Subsidies to Small-scale Operators. A less common form of operational subsidy is provided to bring down the costs of operation of small-scale service providers (the types of small enterprises that build rural toilets or empty septic tanks for example). These can be provided in the form of subsidized training and the provision for small business development services, such as business planning, book keeping, accounting, and auditing. Subsidies to small-scale operators can be highly effective in some locations, but it is important to have a good understanding of the market for their services and the availability of suitable entrepreneurs with capacity to absorb and make use of any subsidies on offer.

Cross-Subsidies. A cross-subsidy occurs when one group of users contribute to part of the costs of providing services to another group. Cross-subsidies through the tariff in the water sector are relatively common and theoretically in some urban areas there is also a cross subsidy for sanitation – with a high-volume water consumer paying more for water and sewage services than those who consume less, even though each group benefits equally from the operation of the sewage network and treatment plant. In rural areas some programs use cross subsidies designed and wholly generated within the community to support the poorest and least-able households to construct or purchase new septic tanks or connect to a sewer line. This type of cross subsidy uses households’ own money directly; the flow of funds is not through public funds. Cross subsidies within the community do have some possible negative side effects, as they can interfere with the social relations between different groups and may put some households in ‘debt’ in some subtle ways to others.

Consumption Subsidy. Consumption subsidy reflects a poorly conceived and unsustainable tariff structure where tariffs for sanitation services are kept artificially low. This represents a subsidy towards the cost of ‘consumption’ of the service. When prices are kept low in this way, the service provider will inevitably sustain losses. These losses must either be covered through operational subsidies to the supplier or they will result in systematic underinvestment leading to a failure of the facility and service, leading to impacts to public health and the environment.

Output-Based Subsidies. Output based subsidies are delivered against services successfully delivered (effective sanitation) rather than inputs (excavation, pipes, and toilets). Thus an output-based subsidy might be paid to a utility or service provider when they have connected poor households to the sewerage network and demonstrated that a service is being provided for a pre-agreed period. Output based subsidies can also be provided to operating companies running sewage treatment facilities or private pit-emptiers (for instance through voucher schemes) if they meet the required discharge standards or the volume of sludge pumped from on-site facilities. The advantage of output-based subsidies is that they are only paid once services have successfully been delivered – thus removing one of the major drawbacks of more conventional infrastructure subsidies that may be paid to a service provider who fails to deliver a working service. However, under this scheme the cost of services may rise due to the fact that the service provider must finance the investment upfront and only recoups the costs once the services are being delivered. Like other forms of subsidies, output-based subsidies rely on good quality verification and monitoring. However, unlike other forms, the verification process can be driven by the users themselves that whether the services are being delivered as agreed.

Regulatory Subsidies. Inadvertent subsidies occur when policy is used to favor certain types of services. For example in a large scale project the central or local government may favor a large company or design institute to complete the work by making the regulations or requirements too arduous or difficult for small companies to compete locally for the work. These subsidies are usually hidden and in many instances unintentional, but can result in higher costs to fund large inefficient service providers; ultimately they cost the households and villages a high rate.

Subsidized Credit. A final mechanism for the delivery of public funding into the sector is through subsidies and guarantees to micro-finance institutes (MFIs) who can then lend money for sanitation investments to households at reduced interest rates. MFIs may also provide other important services, such as micro-saving and micro-insurance, which can also enable households to make needed investments and manage their sanitation facilities over the long term. Channeling public money through MFIs has the dual advantage that it stimulates the development of micro finance services and leaves households in control of decisions about the type and cost of services to be paid for. It also has the advantage of not interfering with the supply-side market for goods and services. MFIs may also be better than government at assessing whether households can afford the tong-term costs of their investments.