By Robert Lyman
Economists are used to having their terminology misinterpreted, co-opted and misused, usually in the interests of politics. One of the most common words to suffer this fate is “subsidy.” The Gage Canadian dictionary defines a subsidy as “a grant or contribution of money, especially one made by a government.” Economists would agree with that definition. Governments, on the other hand, rarely acknowledge that they subsidize anything. They “invest” — though, curiously, they seldom refer to the rate of return on their investments.
I was reminded of all this by the news last week that the International Monetary Fund (IMF) has published an updated version of its 2015 Working Paper on global and country-level subsidies for fossil fuels. According to the paper, total global subsidies “surged to a record $7 trillion last year,” equivalent to 7.1 per cent of world GDP. The paper’s authors estimate that scrapping these subsidies would: prevent 1.6 million premature deaths annually, raise government revenues by $4.4 trillion and put emissions on track to reaching official global warming targets. An annex to the report indicates that in 2020 Canada’s subsidies to fossil fuels were US$64 billion, or 3.8 per cent of GDP.
The paper’s extraordinary findings are almost entirely the result of how it defines “subsidy.” It divides subsidies to fossil fuels into “explicit” and “implicit” subsidies.
Explicit subsidies are the kind economists and ordinary people would recognize as subsidies: grants to cover some portion of the costs of production, as well as tax incentives and deductions (e.g., capital cost allowances) to fossil fuel producers for such things as investing in exploration and development.
By contrast, “implicit” subsidies are defined as “under-charging” producers for the environmental costs they generate from their exploration and production activities and consumers for perceived environmental costs not adequately covered by various consumption taxes (e.g., sales taxes, value-added taxes and carbon taxes). So when, for instance, a country fails to impose a consumption tax high enough to cover the perceived costs to society of climate change, congestion or local pollution, the paper would classify that as a subsidy.
The working paper indicates that explicit global subsidies were US$450 billion in 2020, or six per cent of the total. Most of these are actually so-called tax expenditures: tax credits or deductions for investments in high-risk exploration and development activities, similar to those provided to firms in other sectors of the economy.
That leaves the 94 per cent of subsidies that were what the paper refers to as “externalities.” Let’s be clear. Externalities are not subsidies. They are a cost or benefit of an economic activity that affects a third party not directly related to that activity. The cost is not always evident, nor is it clear by what mechanisms such costs and benefits should be shared. While the paper does not break down the percentages attributed to externalities, its 2015 predecessor estimated that the costs of global warming were 37 per cent, local air pollution 13 per cent, congestion 32 per cent, vehicle accidents five per cent and road damage two per cent. In effect, the paper is arguing that not making the fossil fuel industry pay the full cost of global warming constitutes a subsidy to the industry. The same for its not paying the full cost of local air pollution or of traffic congestion or road deaths, and so on. Attribution of any of these costs to fossil fuels is highly questionable, but one obvious question is why fossil fuels are to blame for road congestion. If all vehicles were electric, would there be no congestion?
The vast majority of what the paper calls “subsidies” thus relate to charges not imposed for the harmful external effects of consuming fossil fuels, especially in oil-producing countries that choose to impose lower excise and sales taxes on gasoline and other fuels. The paper finds that East Asia and the Pacific regions account for almost half of total global energy subsidies. In effect, the report concludes that the prices of energy should be substantially raised for the world’s poor. This, of course, was not noted in the media summaries of the paper.
The paper did not explain how it calculated Canada’s 2020 subsidies to fossil fuels but, given its general analysis, one can only assume it was based on the judgment that fossil fuel costs to consumers were not high enough. But in 2018, total taxes on gasoline alone were roughly $24 billion. One has to wonder how the IMF’s math figures that this, and the more recent increases in carbon taxes, still constitute under-charging for externalities.
A final difficulty with the IMF paper is that it excludes any consideration of the positive externalities from reliance on fossil fuels. They are the most secure, affordable, storable, and reliable energy sources we have, and the ones upon which the remarkable advances in the global economy over the last century have been based. That is well worth bearing in mind as we consider the meaning of “subsidy.”
Robert Lyman is a retired energy economist.
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