News Analysis: How to make electricity affordable

THE recent hike in electricity prices has led to a situation where protests have broken out across the country, as electricity bills continue to take up an increasing proportion of household incomes, squeezing room for expenditure on other essentials, such as food, health, or education.

Inflation that continues to remain in excess of 25 per cent has further eroded real incomes, as households scramble to balance their household budgets. Electricity prices have increased by more than 90 per cent during the last five years, while real incomes have stayed flat, or declined.

An increase in electricity prices is a crisis that could have been avoided, had the government been more responsible about reducing its transmission & distribution losses, and reducing the indirect taxation that is levied through electricity bills.

An electricity bill that a household receives can be broken down into five distinct components: energy costs, capacity charges, transmission & distribution costs, cross-subsidies, and taxation & other government charges. Taxation & other government charges make up almost 32 per cent of the total tariff paid by the customer.

It is estimated that more than Rs230 billion was collected as sales tax, and withholding tax by the government in 2021-22 through indirect taxation of electricity consumption. The withholding tax, and the sales tax are pegged to the electricity tariff that is determined by Nepra. Any increase in this automatically leads to an increase in withholding tax, and sales tax which further compounds the electricity bill.

Moreover, the electricity consumer also pays a TV licence fee, as well as a charge in the range of Rs3 per unit to pay interest cost associated with circular debt. Effectively, the consumer is not just paying an extortionate level of indirect taxes due to increase in electricity prices, but also paying for inefficiency of the government which has not been able to bring circular debt under control. It makes absolutely no sense for the already constrained household and commercial business of the country to further subsidize the inefficiency of the government.

The inability of the regulator to stem such charges has led to a scenario where the government has figured out a way to borrow more to fund its inefficiencies -- and charge this to the consumer.

The taxes that are imposed through electricity bills are distortionary, and inequitable. They hurt the most vulnerable, the poorest households, more than anyone else. The imposition of advance income tax assumes that every household in the country would be a tax filer, and thereby they can process a refund for the same.

It is to be noted here that considering how real incomes of households have eroded, the number of households that find it difficult to afford electricity has increased, and they are now being charged an advance tax, for which they may never see a refund. In a country with high illiteracy rates, and low household income (thereby exempting them from income tax), it makes no sense to charge extortionate taxes from consumers.

The long-term solution to the crisis is structural reforms, privatization of distribution companies, and resolution of a never-ending fiscal deficit. In the interim, the government can take quick actions to rationalize the impact of the increase in electricity prices. First, it should completely discontinue all charges, such as TV licence fee, and other surcharges that exist as a result of government inefficiency, and not due to consumer demand. A consumer should only pay for the electricity that it consumes, and not for the inefficiency of the government. Eliminating such charges can potentially reduce the electricity bill by Rs2 to Rs4 per unit.

Second, there is a need to completely eliminate advance income tax, which also has nothing to do with consumption of electricity and has more to do with the inability of the government to expand its tax net and increase direct taxes. Up till now, the government would have acquired sufficient data to precisely identify households whose electricity consumption does not align with the taxes they pay. This is a great opportunity for the tax offices to aggressively pursue such cases, and not harass vulnerable households with spurious taxes.

Finally, the government also has an opportunity to reduce sales tax, or create a flat amount, such that it doesn’t change with increasing electricity bills.

The government needs to decide whether it exists to serve the people, to perpetuate the inefficiencies and self-interests of a select few who have led the country to a position where it transitions from one crisis to another. It is time for the government to utilize its tax machinery to increase direct taxes and reduce the burden that has been imposed through indirect taxes, and other spurious charges.