Fuel Subsidies, Smuggling, and Income Inequality

Fuel subsidies lead to social and economic distortions including smuggling to neighboring countries where price differentials are significant. However, fuel smuggling can also serve to mitigate poverty in deprived places across the borders. Despite myriad studies on various economic impacts of fuel subsidies, research on smuggling and its impacts on income distribution is limited. In this paper, we first develop 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 neighboring countries and distance from the borders as the sources of identification to separate smuggling from the domestic demand and to estimate monthly profit of smuggling in each region. 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 neighboring countries for the period of study. Our findings also show that one percent increase in smuggling profit has reduced the Gini coefficient by 0.68 to 1.39 percent.