Sylvie Willis
Fossil fuel subsidies are any government action that lowers the cost of fossil fuel energy production, raises the price received by energy producers, or lowers the consumer's price. These subsidies have been around for a century, and while they have contributed to economic growth, they are increasingly being questioned due to their negative environmental and health impacts. Despite calls for a phase-out, fossil fuel subsidies have risen to a record $7 trillion, with China leading the way at $2.2 trillion in 2022. The elimination of these subsidies could significantly reduce global carbon emissions, improve air quality, and generate revenue, but it is politically challenging.
| Characteristics | Values |
|---|---|
| Purpose | To lower the cost of fossil fuel production and incentivize new domestic energy sources |
| Impact | Negative carbon price, uses government money, encourages excess energy use, promotes inefficient allocation of resources, hinders growth, encourages pollution, contributes to climate change, and premature deaths from local air pollution |
| Fiscal Consequences | Higher taxes/borrowing or lower spending |
| Global Fossil Fuel Subsidies in 2022 | $7 trillion or 7.1% of GDP |
| Explicit Subsidies | Undercharging for supply costs |
| Implicit Subsidies | Undercharging for environmental costs and forgone consumption taxes |
| Fossil Fuel Subsidies in the US | $31 billion each year |
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What You'll Learn
Fossil fuel subsidies are a negative carbon price
Fossil fuel subsidies have been defined as "any government action that lowers the cost of fossil fuel energy production, raises the price received by energy producers, or lowers the price paid by energy consumers." They are intended to protect consumers by keeping prices low. However, fossil fuel subsidies have sizable fiscal consequences, such as higher taxes, inefficient allocation of resources, and the encouragement of pollution. They also disproportionately benefit higher-income households and can be considered a negative carbon price.
Fossil fuel subsidies have a long history, with some having been in place for over a century. While they may have been justified in the past, the circumstances that led to their implementation no longer exist. Today, the domestic fossil fuel industry is highly profitable, and there are many renewable and clean energy alternatives available. Despite calls for their removal, fossil fuel subsidies are increasing. In 2022, they reached a record $7 trillion globally, reflecting a $2 trillion increase since 2020 due to government support during the energy price surge caused by the Ukraine war and the economic recovery from the pandemic.
The negative consequences of fossil fuel subsidies are significant. They contribute to climate change, local air pollution, and public health issues, with an estimated 1.6 million premature deaths annually attributed to air pollution caused by fossil fuel consumption. They also hinder the transition to renewable energy sources and make countries more vulnerable to variations in international energy prices. Removing fossil fuel subsidies would reduce air pollution, generate revenue, and contribute to slowing climate change.
While there are arguments for maintaining fossil fuel subsidies, such as protecting vulnerable groups from high energy prices, the negative externalities they create far outweigh any potential benefits. The rich benefit the most from fossil fuel subsidies, and while removing them may lead to indirect price increases for the poor, the overall benefit relative to their total income is significant. Additionally, removing subsidies would encourage the consideration of environmental costs in consumption and investment decisions, leading to cleaner energy sources and improved public health.
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The US offers oil companies a federal tax rule to avoid double taxation
Fossil fuel subsidies have long been a feature of the US economy, with the aim of lowering the cost of fossil fuel production and incentivising new domestic energy sources. However, with the increasing price competitiveness of renewable energy and the urgency of addressing climate change, the justification for these subsidies is being questioned.
The US offers many tax breaks to oil companies, allowing them to pay significantly lower taxes than other corporations. One of these tax breaks is the federal tax rule to avoid double taxation. Oil and gas companies operating in multiple countries may face double taxation, where income earned in a foreign country is taxed by that country and also by the company's home country. To mitigate this, the US has introduced mechanisms such as foreign tax credits, tax treaties, and international tax rules.
The ability to defer federal tax payments is another advantage for oil companies. From 2009 to 2013, the 20 largest oil and gas companies were able to defer payments on up to half of their federal income taxes, paying only 11.7% of their pretax income. This is achieved through various tax provisions, such as the "depletion allowance", which allows companies to deduct significant portions of their revenues.
The structure of many oil and gas companies as Master Limited Partnerships (MLPs) also provides tax benefits. MLPs combine the investment advantages of publicly traded corporations with the tax benefits of partnerships. While shareholders pay personal income tax, the MLP itself is exempt from corporate income taxes.
While there have been discussions about repealing fossil fuel subsidies, no significant action has been taken. The phase-out of these subsidies could generate revenue, reduce air pollution, and contribute to slowing climate change.
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Fossil fuel subsidies soared during the global energy crisis
Fossil fuel subsidies have long existed in the US tax code, incentivising the production of cheap and abundant fossil energy. However, the existence of such subsidies is increasingly controversial. The 116th US Congress is considering policy mechanisms to reduce the impact of climate change, and several international institutions, including the G20, have called for the phase-out of fossil fuel subsidies. Despite this, fossil fuel subsidies soared during the global energy crisis.
The global energy crisis, triggered by Russia's invasion of Ukraine, caused fossil fuel consumption subsidies to reach an all-time high in 2022, exceeding USD 1 trillion for the first time. This was more than double the 2021 levels, which were already almost five times those seen in 2020. The crisis led to international fuel prices surpassing the actual costs paid by many consumers, with governments supporting consumers and businesses through subsidies.
The subsidies in 2022 reflected a $2 trillion increase since 2020, reaching a record $7 trillion or 7.1% of global GDP. The vast majority of these subsidies were implicit, with consumers not paying for over $5 trillion of environmental costs in 2022. This figure would be almost double if the damage to the climate was valued at levels found in a recent study published in the scientific journal Nature. Fossil fuel subsidies are projected to rise to $8.2 trillion by 2030 as consumption in emerging markets increases.
The surge in fossil fuel subsidies during the global energy crisis highlights the political challenges of phasing them out. While phasing out fossil fuel subsidies is a fundamental ingredient of successful clean energy transitions, as advocated in the Glasgow Climate Pact, high and volatile fossil fuel prices during an energy crisis can overshadow government commitments to removing subsidies. During such crises, the priority shifts to protecting consumers from price increases, reducing incentives to switch to alternative energy sources, and using up public funds.
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Subsidies have sizable fiscal consequences
Fossil fuel subsidies have significant fiscal consequences. In 2022, global fossil fuel subsidies reached $7 trillion, or 7.1% of global GDP, reflecting a $2 trillion increase since 2020. This surge in subsidies can be attributed to government efforts to support consumers and businesses during the spike in energy prices caused by the Russia-Ukraine conflict and the post-pandemic economic recovery. The fiscal implications of these subsidies are far-reaching, often leading to higher taxes, increased borrowing, or reduced government spending in other areas.
The fiscal impact of fossil fuel subsidies is not limited to direct costs. They also contribute to higher taxes or borrowing by hindering economic growth. By promoting the inefficient allocation of resources, these subsidies act as a barrier to economic growth. For instance, the fossil fuel industry in the United States, including coal, oil, and natural gas, is already mature and highly profitable. Subsidies in this context do not incentivize new domestic energy sources but instead hinder the development and competitiveness of cleaner, renewable energy alternatives. This results in reduced investment in renewable energy sources and hinders the transition to a more sustainable energy landscape.
Fossil fuel subsidies also have substantial environmental costs, which further contribute to their fiscal consequences. The extraction, production, and consumption of fossil fuels result in significant greenhouse gas emissions and local air pollution. These negative externalities have been estimated to impose costs of $5.3 trillion globally in 2015 alone. The environmental costs associated with fossil fuels often go unaccounted for in pricing, leading to a situation where consumers do not bear the full cost of their energy choices. This underpricing of environmental impacts, including local air pollution and climate change, is the largest contributor to global fossil fuel subsidies.
The fiscal consequences of fossil fuel subsidies extend beyond their direct and indirect economic costs. Removing these subsidies can have positive fiscal implications by generating additional revenue for governments. For example, eliminating tax breaks for intangible drilling costs in the United States was estimated to generate $13 billion over a decade. Similarly, removing fossil fuel subsidies could increase government revenues by $4.4 trillion, according to estimates. This additional revenue can be redirected towards social spending, reducing inefficient taxes, and making productive investments that promote sustainable and equitable outcomes.
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Removing subsidies would reduce health risks of air pollution
Fossil fuel subsidies are a long-standing feature of energy markets, particularly in the US. These subsidies have helped to promote economic growth and incentivize domestic energy production. However, the negative consequences of fossil fuel use, including air pollution, are now well understood. Despite this, subsidies for fossil fuels have increased, with global subsidies reaching $7 trillion in 2022. This money could be used to address the health risks of air pollution and other societal challenges.
Air pollution is a significant health risk, causing respiratory and cardiovascular diseases, and even premature death. It is also an economic issue, reducing labour productivity and agricultural yields. Fossil fuel subsidies promote the use of fossil fuels, which are a major contributor to air pollution, and discourage the transition to cleaner fuels. As such, removing these subsidies would help to reduce the health risks associated with air pollution.
The removal of fossil fuel subsidies would also bring economic benefits. Without subsidies, fuel prices would increase, encouraging firms and households to consider environmental costs when making consumption and investment decisions. This would lead to a reduction in global carbon emissions and cleaner air, with significant health benefits. Removing subsidies would also generate revenue for governments, which could be used to address societal challenges and promote sustainable and equitable outcomes.
However, there are potential drawbacks to removing fossil fuel subsidies. Producers argue that removing subsidies and increasing taxes could lead to unemployment and reduced national energy security. There is also a risk of social unrest, particularly in countries where domestic oil prices are kept artificially low. Additionally, while the rich benefit most from fossil fuel subsidies, removing them may negatively impact poor people through indirect price increases. Therefore, it is important to consider the potential negative consequences of removing fossil fuel subsidies and implement measures to compensate those who may be adversely affected.
Overall, removing fossil fuel subsidies would help to reduce the health risks of air pollution by discouraging the use of fossil fuels and promoting the transition to cleaner alternatives. It would also bring economic and environmental benefits. However, it is important to carefully consider the potential negative consequences and implement measures to mitigate these impacts, particularly for vulnerable groups.
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Frequently asked questions
Yes, fossil fuel operations are subsidized. In 2022, global fossil fuel subsidies were $7 trillion or 7.1% of the GDP, reflecting a $2 trillion increase since 2020.
Fossil fuel subsidies are any government action that lowers the cost of fossil fuel energy production, raises the price received by energy producers, or lowers the price paid by energy consumers.
Fossil fuel subsidies have sizable fiscal consequences, promote inefficient allocation of an economy's resources, encourage pollution, and disproportionately benefit higher-income households. Removing fossil fuel subsidies would reduce air pollution, generate revenue, and contribute to slowing climate change.
