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On Energy Subsidies

The forces supporting fossil fuel energy subsidies are unbelievably strong, so the topic of energy subsidies is a potent political boogeyman that few have dared to touch. However, that may be changing.
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To an economist, subsidies are powerful and dangerous things. They are powerful because they work. They are dangerous because they encourage economic actors to take actions that have direct impacts that are often unanticipated and wanted, and at the expense of other positive actions that could otherwise be taken but aren't due to resource constraints.

In the case of energy, subsidies are legion, though hard to identify. A recent report by the Environmental Law Institute (ELI), "Estimating U.S. Government Subsidies to Energy Sources", attempts to do just that.

The ELI report estimates that the U.S. government subsidized energy with $101 billion during the period 2002-2008, with $72 billion to fossil fuels and $29 billion to renewable energy.

$29 billion to renewable energy sounds fairly impressive, particularly when renewable energy represents only about 10% of overall U.S. energy supply. However, underlying these statistics are three important observations:

1. The fossil fuel industry is over a hundred years old and is still receiving sizable subsidies even though enormously profitable, whereas the renewable energy sector is young, developing and (by most accounts) worthy of encouragement by public support to make more financially attractive to market participants.

2. Most of the subsidies for fossil fuels are permanently embedded in the tax code, whereas the renewable subsidies tend to have finite durations that undercut their effectiveness in providing clear incentives for long-term investment or behavioral decisions.

3. About half of the renewable subsidies are for corn-based ethanol, prompted by support from the agricultural community, but at questionable cost-effectiveness and impact on greenhouse gas emissions.

So, the amount of funding support received by renewable energy is less impressive than initial impressions would suggest.

The forces supporting the preservation of fossil fuel energy subsidies are unbelievably strong, so the topic of energy subsidies is a potent political boogeyman that few have dared to touch. However, that may be changing.

In a September 10 statement to the Senate Subcommittee on Energy, Natural Resources, and Infrastructure by Alan Krueger (Assistant Secretary for Economic Policy and Chief Economist) of the U.S. Department of Treasury , the Obama Administration is clearly aiming to unwind several provisions of beneficial tax treatment that the U.S. oil and gas industry receives.

As Krueger concludes, current tax subsidies for the oil and gas industry "divert resources from other, potentially more efficient investments and they are inconsistent with the Obama Administration's goals to reduce [greenhouse gas emissions] and build a new, clean energy economy....Removing these subsidies will have a very small effect on the price of oil and gas, the production of oil and gas, and domestic jobs. In fact, removing these subsidies could actually make our economy more efficient by reducing distortions in the tax code."

On a global basis, as widely reported from the recent G-20 meeting in Pittsburgh (see Washington Post article), world leaders pledged to phase out fossil fuel subsidies in the "medium term". As bad as the situation in the U.S. is, energy subsidies in developing economies are arguably much worse: according to estimates by the International Energy Agency (IEA), $310 billion per year is spent on subsidizing energy, mainly transportation fuels.

Of course, these subsidies are implemented in the name of aiding the poor citizens in these countries, but they cause massive distortions in public sector budgets, national trade balances, private sector investments and behavior, global security, and environmental protection. And, frankly, the main beneficiaries of the subsidies are urban upper- and middle-income citizens, as the poor are much too poor to afford cars anyway.

Removing subsidies on fossil fuels will not, in itself, drive the world economy to full implementation of desirable energy efficiency and renewable energy options. But, it will definitely help: a step in the right direction. Let's hope that our leaders can summon and sustain the political will to overcome the inevitable opposition and phase these fossil energy subsidies down and out, so we can get on with building the clean energy economy in a more efficient manner.

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