energy subsidies

The optimal position for your industry in any tax reform is to see general tax rates drop while also keeping all of your old subsidies.  The political lobbying on these bills is enormous, and given the scale of the energy sector in the US economy, and the need to transition towards lower carbon fuel sources, it seemed important to look at the tax reform proposals through the lens of energy.

When the Joint Committee on Taxation assesses the cost to Treasury from the proposal, they are focused on the new rules or repealed line items a particular bill may put forward.  But the economic impacts of a new tax regime is affected by three major threads:  whether general changes in tax rules disproportionately affect some energy resources relative to others; energy-specific line items being repealed, changed, or added; and whether political power among particular industry-subsectors has enabled them to have their cake and eat it too by keeping their old subsidies while also getting lower top tax rates.

This working paper is a first cut at doing this.  I've no illusions I've captured everything, or mapped out all of the interactions.  But even the first order effort to combine these three main threads is important in gauging winners and losers under the proposals.  This is a discussion draft, so email your comments, concerns or corrections if you've got them. 

To better see patterns, the tax line items have been grouped into three general energy categories:  conventional energy (mainly fossil); emerging resources; and mixed (which includes the grid and transport policy).  Both new and (apparently) surviving tax expenditures are included.

There's a great deal of detail in the full summary, but my key takeaways are below:

A lack of access to modern energy services continues to be a major contributing factor to poverty and human suffering throughout the world.  The International Energy Agency estimates 1.3 billion people have no access to electricity, most of whom are located in rural areas.  Roughly 2.6 billion people have no access to clean cooking fuels; too often the search for biomass cooking fuels puts the poor, particularly women, at great safety risk as well.

In December, the Oxford University Press published a remarkable volume (Energy Poverty: Global Challenges and Local Solutions) examining the issue of energy poverty from may different angles.  Edited by Antoine Halff, Benjamin K. Sovacool, and Jon Rozhon, the book pulls together a wide range of thought on the issue from researchers and practioners. 

It was a privilege for me to be able to contribute a chapter on energy subsidies to the effort.  "Global Energy Subsidies: Scale, Opportunity Costs, and Barriers to Reform" explores the size and impact of energy subsidies, and presents ways to group subsidy types in order to increase the likelihood of successful reform.  The chapter is reposted here with permission of the publisher.  You can review other chapters in the volume here.   

Global energy subsidies equal at least 1 percent of global GDP

Table 15.1 summarizes recent trends in global subsidy estimates.  Staggeringly-large though the numbers be (roughly one percent of global GDP), these figures are likely a significant underestimate.  There has never been a systematic global inventory of energy subsidies, and the chapter notes a variety of areas in which subsidy estimates are particularly weak.

Further, the figures on financial subsidies do not include externalities:  the damages to human health and environmental quality caused by energy extraction, refinement, transport, and consumption.  Yet externalities are quite large for fossil fuels and some forms of biomass, and clearly allow these fuels to reach market at artificially low prices -- displacing or slowing the expansion of cleaner fuels and improved efficiency.

Data on global subsidies to nuclear power remain sparse.  Given a push for $4.4 trillion of new spending on reactors by 2050 noted by the Nuclear Energy Agency (much of it subsized by government credit guarantees), far more extensive data collection on the scope, magnitude, and competitive impacts of nuclear subsidies is sorely needed.

Subsidies crowd out limited public funds from core social supports

In theory, this vast amount of public spending could be going to establish access to modern energy services for the world's poorest citizens.  Basic connections to existing energy networks (power, natural gas, or district heat) could be installed; buildings of all sorts could be more effectively insulated and ventilated; more efficient equipment for micro-scale business enterprises could be supported.  The opportunity here seems large:  annual subsidies to energy are more than 30 times the incremental funding needed to achieve universal access to modern energy services. 

Yet, although some of the subsidies do flow in this direction, most do not.  Political economy most often drives subsidies towards the powerful and better-connected members of society.  This occurs frequently even for policies having a stated aim of poverty reduction.   The high "leakage" rates of subsidies to wealthier segments of society has been confirmed in past empirical assessments by IEA, IMF and the World Bank. 

The opportunity costs of these policies can be seen clearly in Table 15.2, comparing subsidy cost to GDP, federal revenues (a good proxy for the sustainable budget constraint of national governments), and public spending on health care.  Nearly 40 of the countries listed spend more to subsidize energy consumption then what their governments spend on all health care for their populace.

Escaping subsidy "traps" and achieving successful reforms

For the many countries with substantial government intervention in fuel prices, reform is challenging. Efforts to protect domestic consumers or industries often become entrenched and difficult to end. Governments end up 'trapped' into continuing these policies over a long period of time despite high fiscal, social, and environmental costs. The economic and political constraints to subsidy reform tend to feed on each other. Economic factors drive increased political activity, while political activity protects and expands the financial transfers.

Successful reform efforts have involved a number of common themes (see also Table 15.4 in the chapter). Leveraging macro-economic changes to incorporate price reforms can help governments implement reforms during periods that will cause less dislocation. Advance planning is needed, however, so as to be ready to implement changes when conditions are good. Assessing which groups are likely to lose under reform and building in appropriate mitigation measures from the outset, particularly to protect the poor, has been critical in avoiding popular unrest as subsidies are phased out.  Integrating subsidy reform more directly with universal energy access targets is also important.

Many existing subsidies have been justified based on claims that they helped the poor; it is only fair to ensure that a portion of the savings is deployed to help achieve that goal. However, just as improperly-targeted government energy subsidies bleed budget capacity away from higher-impact social spending, so too does underpricing of grid-based power or gas erode the ability of utilities to remain viable and expand. Accurately measuring both utility subsidies and cross-subsidies is a first step in fixing the problem. Even if tariffs do not immediately change to target only those who need them, better decisions amongst core options can be made, such as whether to  extend grids, to subsidize connection and fixed costs to existing grids, or to reach new areas via decentralized power resources rather than line extensions.

The Inter-American Development Bank (IDB) is embarking on a major work program to identify and assess fossil  fuel subsidies throughout Latin America and the Carribean.  I had the privilege of presenting a number of ideas on how to leverage their effort during an expert meeting on the topic a few weeks back.  The slides from my presentation can be viewed here.

Growing consensus that fossil fuel subsidies need to go

IDB joins a growing array of global institutions that have recognized the importance of finally addressing large and pervasive subsidies to oil, coal, and natural gas.  The list includes the World Bank, OECD, IMF, IEA, UN, G-20, and many national governments, including even a growing number of OPEC members. The degree of attention, including at the top levels of many governments, was unimaginable 25 years ago when I started working on the issue. 

Even recognizing that political attention is but first step of a much more difficult process of reform, this is still an exremely positive trend.  It is progress that data series (such as IEA's price gap figures) are being developed annually rather than intermittently, and for a growing number of countries.  It is progress that the types of market interventions being measured and tracked are slowly expanding to include policy instruments on the producer side (work undertaken most broadly by OECD).  And it is progress that these organizations are starting to talk to each other on a regular basis to more effectively leverage the limited funding available to track the subsidy programs.

Why now?  Partly it's about the money:  well over half a trillion dollars per year goes to subsidize fossil fuels around the world, and with at least as much in associated damage to environmental quality and human health.  The expenditures are stressing many governments, and even though some of the subsidies aim to help the poor obtain access to energy services, it is well recognized that there are more efficient pathways to do so. Partly it's about the environmental impacts:  subsidy elimination is a no-brainer if one wants to deal with bringing down greenhouse gas emissions.  It hardly makes sense to institute a carbon tax while you are subsidizing the exact same fuels a the same time.  And partly there is an internal momentum that builds once enough organizations have put an issue on their agenda and other groups pick up the discussion as well.

Recommendations to leverage IADB's work

The areas covered in my presentation included:

• Understanding why global subsidy estimates reported by OECD, IMF, and IEA differ from each other (see Slide 1 below), and what subsidy types nobody is tracking.
• Taking steps to ensure that work is coordinated across the international organizations, such that methodologies are consistent (so results can be more easily combined) and key unanswered questions are divided up amongst them to avoid duplication.
• Separating environmental externalities from fiscal subsidies in the presentation of data on government support.  The wide variance in externality estimates (see Slide 2 below), along with some methodological issues in what specific external costs are being attributed to fossil fuels (as opposed to vehicles, or roads, or congestion), both contribute to this recommendation.
• Supplementing price gap data with critical case studies of energy market distortions in the Latin America and Carribean region (LAC).  Expanding price gap coverage is useful, but it is not sufficient to properly map subsidies in the LAC region or the political impediments to reform.  Recommended case studies include examining subsidies to bulk energy transport and how those policies can undermine market entry points for distributed energy; and evaluating in detail the multi-layered subsidies to government-owned energy enterprises (such as in Mexico and Brazil), even if the fuels they produce are sold at world prices (and therefore would not show up as subsidized using the price gap approach). 

Slide 1

Slide 2