20 Second, a subsidy that applies to any level of consumption may encourage excessive use of the service. For example, a subsidy scheme in Argentina involving a discount on utility bills for pensioner households had to be discontinued owing to evidence of escalating consumption levels because neighbors and friends had been taking advantage of the lower cost of using utility services in pensioner household. It is therefore considered best practice to cap the subsidy at some pre-determined subsistence consumption threshold. In Panama, the subsistence consumption level was set in line with existing practice at 6,000 gallons per household per month. This is equivalent to 150 litres per person per day for the average fiveperson household6.

Finally, the shorter the duration of the subsidy and the higher its absolute level, the greater the probability that the potential loss of the subsidy may act as a disincentive for households to attempt to improve their economic circumstances. This effect, known as the 'poverty trap', suggests that eligibility for subsidies should not be reassessed too frequently. In Panama, a period of three years was recommended for the duration of the subsidy. This is in line with existing practice in Chile.

# **Summary**

The following conclusions can be drawn from the discussion about determining the size of the subsidy for the Panama case.

- The evidence reviewed suggested that there was no real case for a consumption subsidy at current tariff levels, but that such a subsidy may be advisable if tariffs increases of 2550% were needed to assure the financial sustainability of IDAAN. Based on narrow economic criteria, these subsidies would need to be of the order of US$ 1-3 per eligible household per month, and would be confined to those in extreme poverty. A fixed cash payment of this size would have the desirable property of continuing to face households with a positive marginal price for water consumption, thereby providing an incentive for rational use. Moreover, since only a fraction of the overall bill would be covered, the household would not lose the habit of paying for the service. The major drawback with this subsidy is its poor performance in terms of cost-effectiveness, with 25-40% of the overall budget being absorbed in administrative costs. These percentages are so high as to question the overall case for making subsidy payments of such a small absolute value.

- The willingness to pay survey suggested that the private benefits of a sewerage connection fall well short of the associated cost of provision, implying that a substantial subsidy would be required if the expansion of the sewerage network is deemed to be justified by wider social benefits. The empirical analysis suggested that an appropriate level for this subsidy would be at US$750 per new connection. Given that this subsidy would be no more complex to administrate than the consumption subsidy, while the individual payments are very much larger, it is not surprising that such a scheme

6 It is certainly questionable whether the basic consumption level of 150 litres per person per day adopted by IDAAN can truly be regarded as a _subsistence_ consumption level. This is a parameter that should always<sup>be</sup> questioned in the light of local evidence and real needs for water use.