In this week’s episode, host Kristin Hayes talks with Joseph Aldy, a professor at Harvard Kennedy School and a university fellow at Resources for the Future. Aldy describes the challenge of reforming fossil fuel subsidies, given uncertainty about how much subsidies actually cost governments and given provisions in the US tax code that privilege fossil fuels over renewable energy sources. Aldy also elaborates on some policies that the Biden administration—which has committed to removing fossil fuel subsidies—could target as policymakers develop infrastructure legislation.
Listen to the Podcast
- How much is the United States subsidizing fossil fuels?: “In the United States, if we were talking about just the tax expenditures, we might be on the order of, over the past decade, anywhere around $3 billion to $5 billion per year. But the International Monetary Fund would say, if we’re accounting for the climate change damages of consumption of fossil fuels in the United States and the premature mortality, we’re now looking at something closer to $500 billion a year.” (7:40)
- Fossil fuel subsidies don’t reduce costs for consumers: “If [fossil fuel subsidies were] having a big impact on the decision whether or not to develop more fossil fuels, that might lower the price of energy. That might actually be a benefit to households when they think about how much they have to spend to drive their car or heat their homes or turn on the lights. But when we look at the evidence, most of it shows that very little of the subsidy actually influences production decisions … We might expect that it’s having an impact of maybe less than 1 percent increase in production. A 1 percent increase in a world market probably isn’t going to influence the price that much.” (18:33)
- Fossil fuel subsidies have persisted for more than a century: “The thing that’s really distinctive about how the tax code has favored fossil fuels, in contrast to how the tax code has favored clean energy technologies, is that these tax provisions—intangible drilling, percentage depletion, and there’s about 10 or so others—that target specific ways of production in the oil and gas or in the coal industry … none of them have sunset provisions. You have to pass a law to take those provisions out. You need Congress to actually affirmatively get rid of these.” (25:08)
Top of the Stack
- “Testimony on the Elimination of Fossil Fuel Subsidies to the US Subcommittee on the Environment” delivered by Joseph E. Aldy at an Earth Day hearing hosted by the US House Oversight Committee
- “The Role of Fossil Fuel Subsidies in Preventing Action on the Climate Crisis,” a video of the testimony delivered by Joseph E. Aldy at the Earth Day hearing hosted by the US House Oversight Committee
- “Money for Nothing: The Case for Eliminating US Fossil Fuel Subsidies” by Joseph E. Aldy
- “Protection for Sale” by Gene M. Grossman and Elhanan Helpman
The Full Transcript
Kristin Hayes: Hello, and welcome to Resources Radio, a weekly podcast from Resources for the Future. I'm your host Kristin Hayes. Today, I'm welcoming Joe Aldy, professor of the practice at the Harvard Kennedy School and RFF university fellow back to the program. We at Resources Radio believe it's very important to showcase a diversity of guests, but sometimes it's really great to have a good conversation with a longtime friend and colleague too. And given that Joe knows a lot about a lot of things, it's easy to want to tap his expertise.
So today, Joe and I will be talking about fossil fuel subsidies, an area that he has researched extensively and a subject that has been rekindled in the policy dialogue after President Biden suggested removing such subsidies when he released his American Jobs Plan back in April. But this somewhat amorphous concept of fossil fuel subsidies has been notoriously difficult to define and equally difficult to take action on. Joe and I will reflect on how the Biden administration is approaching these definitional questions and what they're hoping to achieve both in terms of policy action and in terms of emissions outcomes. Stay with us. Hello, Joe.
Joseph Aldy: Hi, Kristin.
Kristin Hayes: Well, given that you've been on the program before, I will skip the long introduction, but perhaps I’ll still ask you to share how you got interested in researching fossil fuel subsidies in particular, and maybe I'll also ask you how your recent beach vacation was.
Joseph Aldy: Right. So it's a topic I've been working off and on since the late 1990s when I was a junior staffer at the Council of Economic Advisers. We were looking at this in the context of what other countries were doing in terms of subsidizing, especially oil and gas production. And in fact, that year was I think the first time the International Energy Agency (IEA) spent considerable focus in one of their World Energy Outlooks looking at fossil fuel subsidy reform, a topic which the IEA has been a leader on ever since.
So it was one of those where it was in the policy world where people are like “hey, this seems kind of important.” And it's just one of those things that has continued to be of interest both in my academic research and in my policy engagement ever since. And the beach vacation was fantastic.
Kristin Hayes: That’s great; nice. So our listeners will know by now that I like to start with definitional questions, but I think that's a particularly tricky exercise when we're talking about defining fossil fuel subsidies. My understanding is that can actually be quite challenging. So let's start there, if you could talk us through that. What are people talking about when they say, quote, “fossil fuel subsidies”? And where are the points of contention in coming up with those definitions?
Joseph Aldy: So they can disagree on a number of fronts, and you're right that there are many different stakeholders who have different perspectives about what counts as a fossil fuel subsidy. One way we can think about this is to look at the producer side and the consumer side. And if you're a producer, and if there are public policies that enable you to produce oil or gas or coal at less than what is the full, if you will, social opportunity costs of bringing oil and gas and coal to the market, then we think about that as being subsidized.
So we can talk about this a little bit like in the United States where we use the tax code effectively through tax expenditures to spend federal resources for producers. With consumers, do you end up paying less for say your gasoline or your natural gas for heating or for your coal? Do you pay less than what it actually costs when we take into full account the expenditures to bring those resources, to bring those fuels to the market? And this is an issue especially in many energy-exporting countries and some developing countries where the state sets the price of fuel or electricity well below this opportunity cost for producing it.
And we would think that in a market that isn't distorted by the subsidies that what a producer has to pay to bring something to the market in terms of its expenditures would reflect all those opportunity costs and that all those opportunity costs would then also be reflected in the price that consumers are paying when they are buying the fuel or the electricity. So that's sort of conceptually how we think about it. In practice, there's a couple big issues that come up. In the international sphere, there's the question about whether or not, say, Saudi Arabia, which has very low cost of bringing oil to the market, whether their gasoline and diesel and kerosene that they sell in their country, is it subsidized if it's just covering their cost of extraction? And they would argue it's not. But it ends up being well below the cost they would get if they actually sold that gasoline or diesel or kerosene in the international market.
And if you were to look at say the IMF, the International Monetary Fund, or the International Energy Agency, they would look at what Saudi Arabia is doing and say “you're selling in your home market well below what is the competitive price,” and in the international market, that’s a subsidy. So the Saudi perspective differs from the IMF or IEA perspective by something on the order of maybe $50 billion a year. So it's kind of a big difference there. On the US side, when we look at our subsidies, which typically have been on the production side as opposed to for consumers, the big issue is how you count different tax provisions and whether or not they are creating oil and gas industry–specific and coal industry specific benefits towards their investment.
And most economists will look at that and say that is a subsidy, but there are those advocates in the oil and gas industry and in the coal industry who argue that it's just their version of tax favors that other industries get. And we can get into some of the detail on that. I would also note one other key distinction, which is, do we also count the fact that the burning of fossil fuels contributes to climate change and contributes to premature mortality and morbidity through local air pollution? And there, the IMF for the last maybe 8 or 10 years has been trying to say, “Look, when we're counting the subsidies, it's both how much less do consumers pay than what's really the fair market price, or how much are we giving away to producers to subsidize their production, but also the fact that we're not pricing the harmful effects of fossil fuels in the prices that producers see or consumers see in these markets.”
And that ends up having a big effect in terms of how much you estimate fossil fuel subsidies and their magnitudes. So for example, in the United States, if we were talking about just the tax expenditures, just the spending through the tax code, we might be on the order of over the past decade anywhere around $3 billion to $5 billion per year. But the IMF would say if we’re accounting for the climate change damages of consumption of fossil fuels in the United States and the premature mortality, we're now looking at something closer to $500 billion a year.
Kristin Hayes: Tremendously different in terms of orders of magnitude. You've mentioned several times the tax code and the way that these things play out in practice. I wonder if you could give just a few examples of what some of these subsidies might be called, what they might look like, and how fossil fuel producers might take advantage of them.
Joseph Aldy: Right. So one thing that is interesting about these is that a number of these provisions have been in the tax code for more than a century, and probably most notable are the so-called intangible drilling costs. And the bottom line for this is that it represents a departure from how we have typically done taxation of capital investment in the United States, where typically when a company or business undertakes a capital investment, they have to estimate what they think is going to be the economic lifetime of that investment. And so from a standpoint of their taxes today, if they made a capital investment today, they can't reduce their tax liability in terms of the actual accounting of their province, they can't use the full cost of that investment. They actually have to spread that cost, they have to amortize that cost over the economic lifetime of that capital project.
So this gets to the issue of depreciation and it's a bit of a complicated mess in the tax code. And in fact, some argue we shouldn't do this at all, and the tax code is too complicated. But the thing is the way we've done it for a quite a long time, some of it was changed temporarily into the 2017 tax law. But the bottom line is intangible drilling costs says these costs that you make investing in an oil and gas well that may be productive for decades, you get to expense all those costs in year one.
And so what that does is that it reduces a lot on paper of what your profits look like. And, of course, that's what's subject to taxation in that year. And in contrast, say, if I were to build, let's say, a steel mill that might have a similar economic lifetime, I actually can only expense a small fraction of the cost in year one because I have to spread them out over say 20 years. And from the standpoint of an investor who cares about the timing of when they get money, that matters. And so that is something that has been a value on the order of $1 billion to $2 billion a year over the past several decades.
We also have something called percentage cost depletion that allows an independent producer that doesn't produce that much to further reduce what their obligations are going to be, because it effectively is subsidizing that upfront investment costs. And a lot of these really are focused on allowing you to put more of your investment costs in the current tax year and give you the value now as opposed to spreading it out over time. And it is fairly distinctive from most of the provisions that would apply to other kinds of capital investment in the US economy by businesses.
And that's why if it were sort of a level playing field across everybody, we wouldn't think it would be distorting investment from one industry to another one. We might not think of it necessarily as a subsidy, but it is something that is favored for this industry. The one other thing that I would say that's come up more recently in the discussion about how we think about tax policy in the United States relative to tax policy in other countries and how do we think about taxable income that is US-based or foreign based, is there have been some proposals by the Biden administration this year to change the way we would think about the tax liabilities of foreign income from oil and gas companies.
And this gets into another area that some people think is a category of subsidies. If you count this as a subsidy, it might triple the estimate of what we subsidized through the tax code, what I said earlier, that's on the order of $3 billion to $5 billion a year. But that gets into a large debate that we're going to have about how we can have a more consistent approach to corporate taxation around the world, which is something that the Secretary of the Treasury has been leading over the course of this year.
So I don't want to spend too much time getting into that, because then we get into the weeds of international tax policy, but it is another one of these dimensions because they are a big player. Of course, many of these oil and gas companies are big players around the world. And this question about how we think about their taxable income from these resources that they develop in other parts of the world may be covered in the future by the IRS.
Kristin Hayes: Interesting. Well, I really appreciate your reminding us though that particularly for oil, this is an international market and there are international players and that's something to be considered as we're talking about this. One more question for you, if you will, which is about who pays for these subsidies. We're talking, and you've given us a sense of magnitude of what we're talking about here. But I imagine some of this is paid for by consumers at, for example, the gasoline pump, some of it's paid for by the federal government, but I'm not really sure how to think about that. So who pays?
Joseph Aldy: Right. So I think a key thing when we look at, say, US subsidies for the production of fossil fuels, we should recognize that almost all of it is going through the tax code. And it's what we as economists call tax expenditures and that's basically because it's spending. It's not the federal government appropriating money, like when the government does a budget and says here's the budget, and we're going to appropriate monies for all the different departments of the federal government and all the different federal government programs. But it's recognizing that to finance the government, we have taxes, but we have different provisions in the tax code that reduce a company's tax liabilities. These are foregone tax revenues that have the exact same effect as if we decided to have a spending program targeting whatever the favored investment is by those tax provisions.
So whether we were going to spend a billion dollars a year or so for the intangible drilling costs provision of the tax code, or whether we wanted to have say, I don't know, the Secretary of Energy design a program that would give the equivalent subsidies for oil and gas companies to develop reserves, it would have the same effect for the federal treasury. It's either forgone revenue or it's spending; the bottom line is that it’s the same for us. We have less money in the treasury because of that. And it's going to these companies that are undertaking this favored form of capital investment.
When we think about the economic incidence of this, one question is, do we subsidize enough that it changes the price of energy, right? If you really thought that subsidy was having a big impact on the decision whether or not to develop more fossil fuels, it might lower the price of energy. That might actually be a benefit to households when they think about how much they have to spend to drive their car or heat their homes or turn on the lights. But I think when we look at the evidence, when we look at the research that has been done, most of it shows that very little of the subsidy actually influences production decisions. That at the end of the day, the price of oil and what we think the price of oil is going to be over the next few years has a much bigger impact on decisions to invest or not. That the cost of production technology is coming down with the fracking revolution and horizontal drilling and all that, that has had a much bigger impact on production decisions than the subsidies.
And that probably, when we look at the evidence, we might expect that it's having an impact of maybe less than 1 percent increase in production. And when we think about why the United States is now one of the largest producers of oil and gas in the world, a 1 percent increase in a world market probably isn't going to influence the price that much. So it's not that these subsidies really help the consumer with lower energy prices for them to meet their basic needs in their household. The costs are being borne by the government, which means it's being borne by the taxpayer.
These are taxes that these companies don't have to pay in order for us as a society to continue to finance our government and the spending from the government. We have to have taxes somewhere else in the economy. So it eventually comes back to the taxpayer who ends up having to pay for this. But I think the benefits of this stop with the owners of the companies, the owners of the capital. If they're publicly traded companies to get this, the shareholders, are the ones who are really enjoying the benefit from the subsidies as the taxpayer is paying for them.
Kristin Hayes: Okay. Thanks. I realized I used the word consumers in my phrasing of this question. But I think you actually made a really helpful distinction between consumers of oil and gas versus taxpayers at large, and the taxpayer role in covering the cost of these subsidies in other ways. So thanks for that. Alright. So I'm going to set up a pair of questions for you, and I'm going to set them up with a quote from a climate and environment journalist David Roberts, who recently wrote that quote, "Fossil fuel subsidies are a vexed and peculiar topic. On one hand, everyone seems to agree they're bad and should be eliminated. Biden's jobs bill takes aim at them, for instance. On the other hand, they never go away." End quote.
So to start off, of course, I'm guessing not everyone actually thinks they're bad; obviously there are some beneficiaries here. So let's discuss that and kind of the arguments, or at least the arguing parties for and against. Who is arguing against them? If it's not everyone, who isn't? Or is it everyone? I don't know. And I presume that fossil fuel companies would like to see them stick around. And so when they're making their best argument for why they should be kept, what is that argument?
Joseph Aldy: So I think this gets back to our discussion at the top on the definition of subsidies, and it's the disagreement on the definition that can sometimes make this a challenge, right? So in the international context, we can go back to 2009 and at the G20 Summit in Pittsburgh, where we had an agreement to phase out fossil fuel subsidies among the G20 countries. We spent the better part of the next year—this was one of my jobs as a staffer in the White House and also working within the Obama administration—we had to identify and catalog, what are our subsidies? And we actually had to report that to the G20 and all of our counterparts had to do that as well. But as a part of that, we had a number of conference calls with staff at other G20 countries trying to figure out how to define fossil fuel subsidies. And after a year of not reaching agreement, we agreed to disagree.
And so what that meant is that each country would define its own fossil fuel subsidies with whatever definition it's going to use. And so I think part of the challenge is that you would have in the context of an international sphere some energy exporters, some developing countries, saying these aren't really subsidies. They might argue, "Hey, these subsidies are actually designed to help low-income households." And in fact, for the United States, there is one subsidy that we identified that we said was exempt from the agreement, which is the Low-Income Home Energy Assistance Program, LIHEAP. And we said that is a program that is means tested, focusing resources primarily for heating, but some for electricity, for low-income households throughout the country. And because that is a poverty fighting program, that's exempt. There's some language in the agreement about that.
So part of it is that there are some subsidies where we could say, maybe this is helpful in the United States to help low-income households heat in the winter. Certainly an argument that some in developing countries say is this is a way to help their low-income households as well meet their basic needs so they view it as part of their anti-poverty strategy as well. I think for the United States and for producers, some will argue, but the evidence is just not there that this is good for jobs. If it's not changing investment, it's not changing employment. There's also smarter policies we can think of that the federal government can pursue if we need to be creating new jobs than to subsidize what actually tends to be a very capital-intensive industry.
We would want to subsidize a more labor-intensive industry if we really wanted to have the government just doing straight-up subsidies of activity to create new jobs. So we do get some pushback on that. And I think one thing that's a really key distinction about the argument for keeping them is that the fossil fuel industry actually doesn't have to make this argument. And it's the thing that's really distinctive about how the tax code has favored fossil fuels in contrast to how the tax code has favored clean energy technologies. That is these tax provisions—intangible drilling, percentage depletion, and there's about 10 or so others—that target specific ways of production in the oil and gas or in the coal industry.
Kristin Hayes: Do they not expire?
Joseph Aldy: None of them have sunset provisions.
Kristin Hayes: Right. Okay.
Joseph Aldy: So you have to pass a law to take those provisions out; you need Congress to actually affirmatively get rid of these. Whereas we can look at, say, the history of the production tax credit for renewable power.
Kristin Hayes: Sure, it has to be reauthorized regularly.
Joseph Aldy: Huge impact for the wind industry. By paying now it's on the order of about two and a half cents a kilowatt hour for every unit of electricity a wind farm produces. Really critical to helping enable the financing of wind farms and help us realize the great and really truly impressive growth in wind power investment over the past decade. But that is a policy, and it was first in the 1992 Energy Policy Act. I've lost track now how many times it has lapsed and has to be reauthorized. But typically it gets reauthorized for only one or two years. We did it in the Recovery Act of 2009 for three years, that was kind of a long extension at the time.
You got a longer extension in 2015 when we had the big tax and spending agreement and at the end of 2015. But whether it's that, or just the investment tax credit for solar, whether it's tax credits for hybrid or electric vehicles, they've all had sunset provisions. And so they're in order to keep subsidizing a kind of energy that actually helps us deal with those unpriced damages, the climate change and air pollution damages from fossil fuels. So you've got a good public policy rationale in a world in which we're not taxing the pollution directly and not taxing the fossil fuels for their contribution to pollution directly to subsidize an alternative that is low or zero carbon and low or zero in terms of other air pollutants.
The political economy of this is that you have to constantly be lobbying to keep that in tax law because of the sunsets. Whereas the oil and gas industry, they saw it in the Obama administration, they've seen it now in the Biden administration, it gets put out into the annual budget proposal. We want to get rid of these subsidies. But to be honest, I'm not sure they've had a fight that hard since the fight over the 2007 energy bill where there was a serious effort to think about getting rid of in that legislative vehicle, to get rid of the tax expenditures for fossil fuels. And in the end, the oil and gas industry fought hard for that.
Kristin Hayes: Inertia.
Joseph Aldy: Yeah, but it's a function of how we've written our laws and the way Congress works or doesn't work, it rewards the status quo. And if the status quo is that there's no sunset provision then it makes it a lot easier for these kinds of fossil fuel tax expenditures to persist.
Kristin Hayes: In perpetuity, yeah. And then actually you anticipated my second question, which was about the second half of that David Roberts quote where he talks about how they never go away. And so I really was curious if that's just politics and strong lobbying efforts or something particularly sticky. And you did a great job of explaining that there really is something particularly sticky about these subsidies.
Joseph Aldy: Yes.
Kristin Hayes: Okay. So then let's turn to the Biden administration, then. And as I mentioned at the top of this show, President Biden's American Jobs Plan suggests some specific plans for fossil fuel subsidy removal. So here we go, somebody else is going to try. So what is his administration targeting? What are they hoping to achieve? And maybe I'll add on one extra question, which is given what you just told us about the stickiness of these, what hope do they have of actually doing something that's been very difficult to do?
Joseph Aldy: So, here's where it's interesting because whenever you want to make a change to anything in an existing law, but especially when you think about the tax code, the question is, what's the legislative vehicle? So, if we look back at the Trump administration, we knew they were going to do tax reform. We knew there was going to be a legislative vehicle, and they did that in the 2017 tax law through budget reconciliation. It's fairly common, it's not an annual exercise, but probably every couple of years, there will be a so-called tax extenders legislative vehicle.
Tax extenders is typically to deal with all these provisions that have sunset clauses. So a lot of times the extension of the production tax credit for wind and other renewable sources of power has moved through a tax extenders package. When I look at where things could happen over the course of the rest of this year and perhaps into 2022, budget reconciliation is a natural place where the removal of these provisions in the tax code that favor fossil fuels could be placed. It could be that we would get some kind of combination of tax reform package coupled with a spending bill that might be separate from budget reconciliation, maybe part of the annual appropriations process. So that's another potential vehicle, but I think the most natural one here would be reconciliation.
And I think it would be consistent with one of the themes that the Biden administration and certainly many of the progressive members of Congress have in mind to focus a lot on climate change in the reconciliation package. And so this could be one of those ways that you could raise some revenues and there may be a need to have some revenue raisers. There's already been some discussion among some of the more moderate Democrats about whether or not they're comfortable with the potential price tag of a reconciliation package. By the way, you could tax carbon, that would raise a lot of revenue, but again, let's not get into carbon tax right now.
But this would be a way to raise some revenue and it could be part of the larger package of the revenue raisers that would help to finance the spending you want to do, either the direct government spending or tax expenditures through other changes you'd make in the tax code. So I think that's where we could see this debate play out. But it's going to be a challenge because we have a tightly divided House and Senate. And the fact that these provisions have persisted for so long does reflect not just inertia by design of not having a sunset clause, but also an effective lobbying effort by the fossil fuel industry.
So they would like to get rid of some of these, like intangible drilling and percentage depletion. But there's a number of these that whether you are doing enhanced oil recovery, whether you are trying to expand some of your geological and geophysical expenditures, there's things that get really in the weeds about the capital costs of fossil fuel projects. They would like to get rid of these. There's maybe about, I don't know, 10 or 11 of those that are currently functioning.
There's a couple of tax provisions that phase out depending on the price of oil. But I think those are the ones that they want to get rid of. But part of this also will be a question, as I mentioned earlier, is how much do they end up reforming how we think about the foreign dimension of our tax code? And that would actually be a more meaningful revenue raiser than some of these that focus on subsidizing fossil fuel capital projects here in the United States.
Kristin Hayes: Well, okay, watch this space, I guess we're going to see how this all plays out. But I certainly would welcome your future reflections, maybe we can get you on the blog next time after a reconciliation package comes together and pass this or not. Maybe we can get your thoughts on how they did against the goals that they've laid out in that you've talked us through so well.
Joseph Aldy: I'd love to do that.
Kristin Hayes: Okay. Great. All right. Well, thanks, Joe. This has been wonderful as always. It's great to have someone who's as knowledgeable as you giving a stronger sense of what we're talking about and the challenges here. So let me close with Top of the Stack. I figured there's something new on the top of your stack since the last time we talked especially after catching up on beach reading. But let me close with what's on the top of your stack now that you're back at work?
Joseph Aldy: I have something old that's the newest paper on my stack, and it's a paper from 1994 titled “Protection for Sale,” so this is by Grossman and Helpman. And it's actually an international trade paper. And it's trying to explain the political economy of trade policy. And I think its insights are relevant when we think about carbon border adjustment mechanisms, which is getting attention both in Brussels and Washington now, but also how do we think about domestic engagement and international agreements and what motivates a national government to enter into an international agreement? So it was one of these things where sometimes I feel like there's value in going back, looking at some of these important papers, maybe in other fields of our discipline, to see what kind of insights they might have today as we tackle some of these challenging problems in energy and climate policy.
Kristin Hayes: Great. All right. Well, for those of you who still have your beach vacations ahead of you, there you go. You can take that with you or you can just take Harry Potter either, but that's good, that's a good recommendation. All right, Joe. Well, thank you so much. Great to talk with you and talk to you again soon.
Joseph Aldy: It's been my pleasure, Kristin. Thank you.
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