# **Box 1: Welfare transfers as a transport subsidy: Chile’s compensatory welfare payments due to rising transport costs**

With the rise in the international price of crude oil during the last five years there was mounting political pressure in Chile —as in many other countries— to shield domestic consumers from the impact of this rise on domestic fuel prices. Bus fares rose 31% between 2003 and 2006 as a direct consequence of the increase in fuel prices. The consumer price index during this same period rose by only 7.5% indicating a very important relative price increase for public transport.

Starting in 2004 authorities chose to give a direct monetary transfer to poorer households to compensate for rising fuel and public transport prices. It was argued that this policy was much more progressive and better targeted than policies aimed at reducing retail fuel prices. Similar transfers were again granted in 2005 and 2006 for the same reason.

In the Presidential address for the budget law that conceded the 2004 transfer, the Executive declared that the transfer was sufficient for a poor beneficiary to fund higher domestic kerosene prices and _nine months of higher public transport fares_ . Rising fuel prices was also explicitly mentioned as the motivation for the 2005 and 2006 transfer.

Starting in 2005 eligible households included pensioners with government guarantees or support, households in the poverty-alleviation “Chile Solidario” program, families receiving the Family Subsidy, and workers who were receiving a family supplement subsidy and who earned less than Ch$180,000 (US$350) per month. The eligible population was close to 2.2 million households, representing 40% of Chilean households.

The fiscal cost of the 2005 and 2006 transfer was US$ 63 and US$42 million, respectively. It is important to note that in 2006, pensions had already been increased for poorer people and they were thus excluded from this special transfer. This explains the lower fiscal cost in 2006. All transfers were funded from general government budget.

Gómez-Lobo (2007a) shows that in Santiago the transfer policy was much better targeted to the poor than alternative subsidies specific to the transport sector such as subsidizing bus fares or fuel prices. Thus, the social consequences of rising transport costs were countered without compromising the resource allocation benefits of cost reflective pricing for fuels and public transport.

_Source:_ Gómez-Lobo (2007a) However, there are at least two important qualifications to the general recommendation of using transfers and the general welfare system to address affordability issues.<sup>10</sup> First, it may be that society has a special interest in the actual consumption of certain goods and services. This may be due to externalities in the consumption of these goods or because they are deemed to be merit goods. Potable water is a good example in this respect since public health concerns indicate that people should consume a minimum amount of this good irrespective of their personal preferences. In this case, a monetary transfer may not be a good substitute to a direct price subsidy since part of the transfer will often be used

> 10 For an excellent discussion of these and related issues see Alderman (2002).

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