Fuel Subsidies, Smuggling, and Income Inequality

Fuel subsidies lead to economic distortions including excess consumption because of changes in relative prices. They also create an incentive for smuggling to neighbouring countries where price differentials are significant. Notwithstanding myriad studies on various economic impacts of fuel subsidies, research on smuggling fuel is limited. In this paper, we first use a model to specify the demand for fuel smuggling and then estimate its impacts on income distribution in provinces across the borders. We use fuel prices in the neighbouring countries and distance from the borders as the sources of identification to separate smuggling from the domestic demand. We then estimate monthly profit of smuggling in each region and its impact on income distribution across the borders. The data covers monthly gasoline and diesel sales for 160 distribution regions in Iran, a country with highly subsidized fuel policy, for the period 2005-2014. The results indicate that on average 25 percent of total fuel consumption in Iran has been smuggled to its neighbouring countries for the period of study. Our findings show that one percent increase in smuggling profit has reduced the Gini coeficient by 0.68 to 1.39 percent. We discuss some policy implication of our findings