LPG subsidy: Make choice opting in, not opting out

It was believed that Finance Minister Arun Jaitley would withdraw the LPG (liquefied petroleum gas) subsidy for those who fall in the 30-percent tax bracket. However, this budget included no such measure. Thereafter, Prime Minister Narendra Modi has repeatedly called on people to “give it up” and join the “opt out of subsidy” scheme. While over 300,000 consumers have thus far enrolled in this scheme, this is a tiny fraction of the 150 million LPG users in the country.

Using insights from research in behavioural economics could increase enrollment and thereby reduce the annual public expenditure on LPG subsidies, which is at present Rs.20,000 crore ($3 billion).

Though a rational individual is unlikely to give up an optional subsidy, it is well known that human decision-making is influenced by factors such as social preferences, belongingness, desire for status, and biases. This scheme appeals to social preferences and belongingness by inviting citizens to show “care and concern towards the less privileged” and contribute to “nation building”. Further, it taps into the desire for status by listing those who opt out in an online Scroll of Honour. However, it does not incorporate evidence on biases into its design.

A bias is a systematic error in judgement that results in a deviation from rational choice. While biases may lead to more effective decision-making when speed is more essential than accuracy, they can also result in misperception, illogical interpretation, and poor judgement. The work of David Kahneman, Amos Tversky and others has highlighted the prevalence of biases in decision-making and illustrated their implications for modern economic theory. One bias that could directly affect the outcome of the subsidy scheme is the default bias.

The default bias states that people have a strong tendency to go along with the default option. This bias can be seen in action in case of always picking a particular seat at the dining table or sticking to the manufacturer settings on a new phone. However, research suggests that people tend to choose the default even when the stakes are much higher, such as in selecting a healthcare plan or a retirement savings scheme. Thus, the choice of default is an important policy consideration.

In their book Nudge, Richard Thaler and Cass Sunstein illustrate how an insight into default bias can increase organ donation. In the US, an explicit consent is required to enlist a person as a donor, making non-consent the default. As a result, though studies suggest that over 80 percent favour organ donation, the share registering for the programme is far less, at about 40 percent. In contrast, many European countries that presume a person to be a donor, unless the person chooses otherwise, witness much higher enrollment.

How can the LPG subsidy scheme take advantage of default bias?

Rather than giving people the choice to opt out, the government could set the market price of LPG as the default (or, as suggested by CEEW – Council on Energy, Environment and Water – specify a different default based on economic categories) and allow people to opt in for the subsidy instead. This may have happened to some extent with the introduction of the Direct Benefits Transfer for LPG scheme (DBTL), whereby a consumer must link her LPG account with an Adhaar or bank account to opt in for the subsidy. However, as voluntary surrender of the subsidy was not a goal of DBTL, its messaging does not borrow from social psychology to achieve this objective.

Implementation of a new opt in scheme at this point may be challenging – it should not unduly burden or exclude those in need of the subsidy while also ensuring low administrative overhead for oil companies. As the LPG consumer base will continue to witness significant growth in the future, a starting point could be to exclude new subscribers unless they explicitly opt in for the subsidy. An alternative could be a pilot opt in scheme through distribution franchisees that cater primarily to the affluent. Given the widespread use of mobile phones in India, an Interactive Voice Response (IVR) system with a menu option for opting in to the subsidy might be another mechanism worth exploring.

Though its design and implementation would require careful thought, an opt-in scheme could have a bigger impact on the annual LPG subsidy than the current opt out scheme. At the same time, it might be politically more acceptable than the outright removal of subsidy for a particular economic class. Further, it would signal a stronger intent to test and incorporate emerging evidence from behavioural economics into policy making – a practice whose worth is still underestimated.