Sylvie Willis
Fossil fuels are a significant source of tax revenue for governments worldwide, with subsidies for oil, coal, and natural gas costing around 7.1% of global GDP. However, as the world shifts towards renewable energy and targets to limit global warming, the revenue generated from fossil fuels is expected to decline. Removing fossil fuel subsidies would significantly reduce global carbon emissions and air pollution, improving health outcomes and slowing climate change. The revenue generated from fossil fuel taxes and subsidies is substantial, with estimates ranging from $4.4 trillion to $7 trillion globally. In the United States alone, fossil fuels generate $138 billion in annual revenue. As countries phase out fossil fuel subsidies and implement new taxes, the distribution of tax revenue and investment in clean energy will be crucial for a sustainable future.
| Characteristics | Values |
|---|---|
| US revenue from fossil fuels | $138 billion annually |
| Largest subsidizers | China, the United States, and Russia |
| US fossil fuel revenue sources | Petroleum product taxes, oil and gas extraction, coal revenue |
| States dependent on fossil fuel revenues | Wyoming, North Dakota, Alaska, and New Mexico |
| Fossil fuel subsidies | $5.2 trillion globally in 2017, a half-trillion-dollar increase since 2015 |
| Intangible Drilling Costs Deduction | $1.59 billion in revenue in 2017, or $13 billion in the next ten years |
| Master Limited Partnerships | Exempt from corporate income taxes |
| Domestic Manufacturing Deduction | Decreases effective corporate tax rate |
| Fossil fuel subsidies as a percentage of global GDP | 7.1% |
| Fossil fuel subsidies in monetary value | $7 trillion |
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What You'll Learn
Fossil fuel subsidies
According to the International Monetary Fund, fossil fuel subsidies in the United States totalled $757 billion in 2022, including $3 billion in explicit subsidies and $754 billion in implicit subsidies. Explicit subsidies occur when the retail price is below a fuel's supply cost, while implicit subsidies refer to costs like negative health impacts and environmental degradation that are borne by society at large rather than producers. Globally, fossil fuel subsidies were estimated to be as high as $7 trillion in 2022, reflecting a $2 trillion increase since 2020 due to government support during the energy price surge caused by the Russian invasion of Ukraine and the economic recovery from the pandemic. This amount is equivalent to 7.1% of global GDP, more than what governments spend annually on education and about two-thirds of what they spend on healthcare.
There are several negative consequences associated with fossil fuel subsidies. Firstly, they contribute to higher taxes, borrowing, or lower spending, hindering economic growth. Secondly, they encourage pollution and premature deaths from local air pollution, as well as contributing to climate change. Additionally, they are not well-targeted at helping the poor and mostly benefit higher-income households. Removing fossil fuel subsidies and using the revenue for better-targeted social spending, reducing inefficient taxes, and productive investments can promote sustainable and equitable outcomes. It would also reduce energy security concerns related to volatile fossil fuel supplies.
However, removing fossil fuel subsidies can be challenging. While it would lead to a significant reduction in global carbon emissions and cleaner air, it could also result in higher fuel prices, impacting vulnerable households. Governments must carefully design and communicate reform policies while investing existing revenues into savings funds and diversifying local economies. A portion of the increased revenues from removing subsidies could be used to compensate vulnerable households for higher energy prices, cut taxes on work and investment, and fund public goods such as education, healthcare, and clean energy.
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Petroleum product taxes
In the United States, petroleum product taxes represent the single largest source of revenue related to fossil fuels. This includes taxes on motor fuels, such as gasoline and diesel, used in licensed motor vehicles. These taxes are included in the price at the pump and are imposed at both the state and federal levels. For example, Washington State imposes a Petroleum Products Tax (PPT) on the wholesale value of petroleum products within the state, specifically on the first possession of these products. The PPT revenue is deposited into an environmental cleanup account, and the tax is temporarily suspended when the account balance exceeds a certain threshold.
Petroleum tax rates can vary based on the specific product and the jurisdiction. For instance, the Internal Revenue Service (IRS) in the United States imposes a per-barrel tax on certain crude oil and imported petroleum products. This tax rate has changed over time due to court decisions and the reinstatement of certain financing rates. As of January 1, 2023, the petroleum tax rate is the sum of the Oil Spill Liability Trust Fund financing rate (petroleum oil spill tax rate) and the Hazardous Substance Superfund financing rate (petroleum Superfund tax rate).
It's worth noting that certain exemptions and deductions exist for petroleum product taxes. For example, fuel used for non-highway purposes, such as in construction activities or for heating commercial buildings, may be subject to sales or use tax instead of petroleum tax. Additionally, fuel used in agricultural or industrial production for items ultimately sold at retail is exempt from both petroleum tax and sales or use tax if the appropriate exemption forms are provided.
While petroleum product taxes have been a significant revenue stream for governments, there is an increasing focus on transitioning away from fossil fuels to address climate change. As a result, government revenues from these taxes are expected to decline over time. However, removing or reducing fossil fuel subsidies can help generate additional revenue while also contributing to the reduction of global carbon emissions and improving air quality.
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Oil and gas extraction
Fossil fuels are a significant source of tax revenue for governments worldwide. In the United States, for instance, fossil fuels generate an estimated $138 billion in tax revenue annually. While petroleum product taxes are the largest revenue source, oil and gas extraction are the second-largest contributor. According to a study by the Joint Committee on Taxation (JCT), eliminating tax breaks for intangible drilling costs would have generated $1.59 billion in revenue in 2017, or $13 billion over the next ten years.
Independent producers, for instance, can deduct 15% of gross revenue from their oil and gas properties as percentage depletion. They can also deduct exploration and development costs, including labour and materials for drilling and developing wells, in the year they are incurred, even though returns on these capital investments may take several years. Integrated oil and gas companies, on the other hand, can deduct 70% of these costs in the first year and recover the remaining 30% over the next five years.
Additionally, oil and gas companies structured as Master Limited Partnerships (MLPs) can benefit from tax advantages. While shareholders pay personal income tax, the MLP itself is exempt from corporate income taxes. This structure combines the investment advantages of publicly traded corporations with the tax benefits of partnerships.
While these tax incentives and deductions for oil and gas extraction can provide financial benefits to the industry, they may also have environmental implications. Subsidizing investment in fossil fuel development can divert capital from investments in assets with higher pretax yields, such as renewable energy sources. Additionally, while supporters argue that these tax incentives reduce US dependence on imported oil, they may also encourage the more rapid exhaustion of domestic supplies, potentially increasing dependence on imports in the long run.
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Tax incentives
Fossil fuels generate substantial revenue for the US government, with a value of around $138 billion annually between 2015 and 2020. However, the shift towards clean energy sources and the decreasing demand for fossil fuels pose fiscal risks to governments heavily reliant on this revenue stream.
To address these concerns, governments have traditionally offered tax incentives and subsidies to encourage the production and consumption of fossil fuels. These tax incentives for fossil fuels can be categorized into several types:
Expensing and Deductions
- Exploration, development, and intangible drilling costs can be expensed, providing immediate tax relief for these expenses.
- Independent oil and gas producers can deduct exploration and development costs, such as labor and materials, from their income in the year they are incurred, even though these capital investments generate returns over several years.
- Integrated oil and gas companies can deduct 70% of these exploration and development costs in the first year and recover the remaining 30% over the next five years.
- Percentage depletion, instead of cost depletion, can be used to recover drilling and development costs of oil and gas wells and coal mines. This allows producers to deduct a fixed percentage of gross revenue as capital expenses each year.
Tax Credits and Subsidies
- Tax credits are offered for energy investments, particularly in coal, gasification, and advanced coal projects that sequester carbon emissions.
- Tax subsidies are provided for oil, gas, and coal development, including exceptions for publicly-traded partnerships with qualified income from certain energy-related activities.
- Pollution control tax incentives are available for carbon sequestration and carbon capture technologies.
While these tax incentives have been justified as a means to reduce dependence on imported oil and promote domestic energy production, they contradict the policy goal of reducing fossil fuel consumption to combat climate change. Additionally, they divert capital from investments in cleaner and more sustainable energy alternatives.
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Revenue losses
Fossil fuels generate significant tax revenue for governments worldwide. In the United States, for instance, fossil fuels generated approximately $138 billion annually between 2015 and 2020 for US localities, states, tribes, and the federal government. However, as the world transitions towards cleaner energy sources, the revenue generated from fossil fuels is expected to decline. This transition will have a significant impact on communities that heavily rely on revenue from fossil fuels, such as Wyoming, North Dakota, Alaska, and New Mexico, where more than 14% of total state and local revenues come from fossil fuels.
Subsidies for fossil fuels have sizable fiscal costs for governments. In 2022, fossil fuel subsidies surged to a record $7 trillion globally. These subsidies are intended to protect consumers by keeping prices low, but they have unintended consequences. They contribute to higher taxes or government borrowing, hinder economic growth by promoting inefficient allocation of resources, and encourage pollution and climate change. Removing these subsidies could generate significant revenue for governments and help reduce global carbon dioxide emissions. For example, removing tax breaks for intangible drilling costs in the US was estimated to generate $1.59 billion in revenue in 2017, or $13 billion over ten years. Similarly, closing the loophole that allows American businesses operating abroad in countries without corporate income tax to deduct royalty payments as foreign income tax was projected to generate $12.7 billion in tax revenue over a decade.
Furthermore, the transition away from fossil fuels may result in revenue losses for governments in the form of reduced tax revenues from oil and gas extraction, which is the second-largest source of revenue for the US government. Additionally, petroleum product taxes, which represent the largest revenue source, are expected to decline as well. However, it is important to note that the costs of fossil fuel use outweigh the fiscal losses, and the clean energy sector is expected to become a significant driver of future government revenue.
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Frequently asked questions
Fossil fuels generate a substantial amount of tax revenue, with the latest estimates placing the number at $138 billion annually in the United States alone. Globally, fossil fuel subsidies are estimated to have cost around 7.1% of global GDP, or $7 trillion.
The tax revenue generated from fossil fuels can be attributed to various factors, including direct and indirect subsidies, tax breaks, and societal costs. These subsidies have been in place for decades in some cases and are intended to keep prices low for consumers. However, they also contribute to higher taxes and promote inefficient allocation of resources.
Removing fossil fuel subsidies and imposing corrective taxes would increase fuel prices, leading to a significant increase in tax revenue. It is estimated that scrapping explicit and implicit fossil fuel subsidies could raise government revenues by $4.4 trillion while also reducing global carbon emissions and improving air quality.
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