Targeted transfers in Scenario 5, which assumes that current FMS recipients qualify for an increased transfer to offset higher electricity tariffs, would reach a low share of the poor. The Government of Montenegro would need to develop a well-targeted and broad-based program of social assistance if benefit provision through direct income transfers were to be the chosen mitigation option. However, this would be an expensive program and the Government does not currently planning to re-design the social protection system in order to broaden the recipient base and improve benefit targeting.

**_<u>Table 7. Subsidy recipients (in percent of total households in the income category)</u>_**

|||dec|iles of t|otal per|capita|househo|ld expe|nditure|s|||
|---|---|---|---|---|---|---|---|---|---|---|---|
||1|2|3|4|5|6|7|8|9|10|Total|
|Scenario 1|100|100|100|100|100|100|100|100|100|100|100|
|Scenario 2|100|100|100|100|100|100|100|100|100|100|100|
|Scenario 3|100|100|100|100|100|-|-|-|-|-|57|
|Scenario 4|74|54|47|32|31|-|-|-|-|-|29|
|Scenario 5|22|19|10|11|6|9|10|16|7|4|12|
|_Total number of_<br>_households (‘000)_|_29_|_25_|_17_|_18_|_18_|_18_|_16_|_16_|_15_|_16_|_187_|

Source: calculated from 2004 ISSP Montenegro Household Survey.

**_Limitations of benefit incidence analysis._** In this section we have conducted a static analysis, assuming that households do not adjust their consumption of electricity to the price increase. In reality, some households will adjust by reducing their electricity consumption and switching away from electricity to fuelwood.  To the extent that the poor switch at a higher rate than the non-poor, the distribution of the beneficiaries of a subsidy can change in the policy scenarios examined. This is especially true for the VDT scenario. The poorest households whose consumption is close to the 500 kWh threshold are likely to reduce their consumption below the limit so that they would qualify for the lower tariff, especially if some mechanism is in place to prevent them from accidentally exceeding the limit and switching to the higher tariff.

The benefit incidence analysis in this section is informative for comparing the efficacy of alternative tariff structures at reaching the poor in the process of electricity tariff reforms. However, it is also important to recognize the limitations of this approach. The distribution of a subsidy does not imply anything about the distribution of the welfare impact of different programs. For example, poor households with low consumption of electricity may have a higher valuation of each additional unit of consumption and it may be more difficult for them to substitute away from electricity than it is for households with a high consumption volume. By the same token, households with no access to substitute fuels or facing technical constraints in switching fuels would also incur higher welfare losses from an electricity tariff increase than households with easy access to substitute fuels. Furthermore, switching to fuelwood gives rise to externalities from an increased rate of deforestation. Benefit incidence analysis is not intended to address any of these issues. This type of analysis is useful for comparing the distribution of the subsidy via different mechanisms, but not to determine the socially optimal level of a subsidy.

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