Curbing leakage in public programs with direct benefit transfers. Evidence from India’s fuel subsidies and black markets

Abstract

In many developing countries, pervasive corruption and evasion often undermine the provision of public programs. I focus on India where a large universal program provides USD 8 billion in fuel subsidies for domestic cooking. The subsidy given to households, combined with taxes on commercial users, gives rise to a black market, where fictitious “ghost” beneficiaries are used to divert the subsidy from the domestic to the commercial sector. This paper studies the impact of a major policy change by the Indian government to curb leakage in welfare delivery. Introduced in 2013, Direct Benefit Transfer for LPG (DBTL) policy transfers subsidy directly to the bank accounts of verified beneficiaries in order to improve the state’s capacity to purge ghost beneficiaries. The analysis is based on unique data that combine the administrative records from 23 million fuel purchase transactions and distributor-level fuel sales, with a novel survey data set which allows me to infer black market prices. My empirical strategy exploits two quasi-experiments: (i) the phase-wise policy roll-out across districts, and (ii) its unexpected termination. I document four main findings: (1) directly transferring subsidies to households reduces fuel purchases in the domestic fuel sector by 11% to 14%, suggesting a reduction in subsidy diversion; (2) after the policy is terminated, fuel purchases in the domestic sector revert to a similar level that existed before the policy was introduced; (3) a positive supply shock induced by the policy termination reduces black market prices between 13% to 19%, and; (4) in response to the lower prices, commercial firms reduce their fuel purchases in the formal sector and re-enter the black market for fuel. In sum, this paper illustrates that investment in enforcement capacity can significantly strengthen the state’s ability to target program beneficiaries