Just as prices and taxes signal costs and penalise anti-social behaviour that jeopardises water security, so subsidies reward actions that promote water security and mitigate the impacts of policies, which are unfavourable for poor and other underprivileged groups. This way, subsidies are a financial assistance given by the government in order to reach a specific policy goal (such as water security). Subsidies are generally defined as any form of payment that is not directly connected to paying for a service. A particular kind of subsidy that is given to farmers and other land users when they follow environmentally friendly practices is called Payment for Environmental Services (C7.06).
Subsidies and positive incentives typically arise in the following circumstances:
- In a default setting to cover debts and deficits incurred by a public water service provider;
- To depress the general level of tariffs or charges for political motives;
- To favour certain groups of consumers over others, through the tariff structure, or by paying water bills through social security schemes, or providing farmers with free water or subsidised power;
- To encourage the take-up of socially desirable services, e.g. providing household water connections or toilet facilities free or at reduced rates;
- Promoting water efficiency by households, farmers, companies etc. by subsidised loans or product prices for conversion to improved practices such as drip irrigation, or water-efficient production processes or household appliances.
Although subsidies may be introduced with the best of intentions, they are difficult to remove, and may have unintended, negative side-effects. For example, subsidies may have the ostensible purpose of protecting vulnerable and poor groups in society but the weight of evidence is that, in practice, most of their benefits accrue to better off consumers. Another unintended side-effect is that subsidies for appliances often undercut the growth of local producers, which has plagued the promotion of cheap domestic sanitation in many places.
There is significant subsidisation of fertilizers and pesticides in agriculture, which has large negative impacts on water resources by encouraging over-use of these polluting substances. In fact, it is generally acknowledged that subsidies run contrary to the Polluter Pays Principle and are therefore popular among polluters. To overcome this challenge and to ensure compatibility with the Polluter Pays Principle, subsidies should be financed from charges on polluters.
Furthermore, subsidies often promote excessive consumption of water:
- Low water prices for industry and power companies encourage excessive use of water;
- Free or cheap irrigation water leads to its excessive use and might trigger increased planting of thirsty crops;
- Low household bills may result in profligate domestic water use and neglect of leakage reduction.
These side effects and distortions lie behind the quest for smart subsidies, which ideally should be targeted (to specific users or practices), transparent (obvious and accountable, rather than occult), and tapering (reducing and phasing out over time). Subsidies and incentives should also be efficient – achieving their goals with least outlay and minimal unwanted side effects.
- The introduction of new subsidies should be very carefully considered, since they tend to be difficult to remove and can become a fiscal burden.
- Subsidies and other (e.g. tax) incentives can encourage the uptake of unfamiliar technology (e.g. recycling and water-efficient irrigation methods) or stimulate pilot schemes that might lead to wider acceptance of desirable practices.
- Subsidies (such as low-interest loans) might also be a way of tackling stubborn market failures, for instance those hindering the uptake of recycling or water-efficient appliances and processes.
- Subsidies for price may help those who already have water services, but do not benefit those without access to water. For urban household water distribution, it may be preferable to use subsidies to encourage new connections by poor households, rather than to keep the tariff down for everyone.