subsidy reform

The "End Polluter Welfare Act (EPWA)," introduced by Sen. Bernie Sanders (I-Vt.) and Rep. Keith Ellison (D-Minn.) last week aims to strip away as many federal subsidies to fossil fuels as possible.  The bill reaches well beyond the short-list of most obvious subsidies that past reform efforts have targeted.  This elevated reach can be seen in the length of the subsidy list (four pages); in the estimated fiscal benefits of reform ($110 billion over ten years, roughly 2.5x the take of the narrower proposals, such as in President Obama's budget, or bills introduced by Sen. Robert Menendez (D-NJ)); and in the variety of groups supporting it (including the grass-roots powerhouse 350.org, run by Bill McKibben).  You can read the full text of the proposed legislation here.

Will Sanders and Ellison succeed where far more modest reform attempts quickly ran aground?  Perhaps not.  But that is hardly the only point of introducing something like this.  There is much to be gained simply by making a subsidy list that is far more comprehensive than the lists that have come before.

The bill takes the first step in undoing a big limitation of the prior, narrowly-cast legislative reform efforts.  Those initiatives focused only on a handful of the ways the feds have bolstered the fossil fuel industry for nearly 90 years.  As a result, they created the impression that the whole oil and gas subsidy trough wasn't really that large:  four billion or so per year and a handful of tax breaks -- end of story.  Such an impression was not accurate, of course.  But it has been quite useful to the lobby groups fighting to protect their fossil fuel pork.  With the number of targeted policies smaller, the lower fiscal savings from reform also led to more muted public outrage.  As a result, the lobbying job for industry to deter subsidy elimination was vastly simplified.

Enter EPWA.  By listing a much wider range of policies subsidizing oil, natural gas, and coal, the EPWA forces a more honest debate on the distortionary effects of federal policies on energy markets.  Though earlier reform efforts have primarily focused on stripping away tax breaks, the subsides to conventional fuels come in many guises.  There are below-market royalty rates, subsidies to fuel-related pollution controls, direct spending, caps on liability, and assorted subsidized credit for domestic power plants and exports of oil and gas-related goods and services.  There are subsidies to transporting bulk fuel, and to corporate structures particularly useful for natural resource extraction firms.  And there is subsidized oil security -- an area that despite it's large size was too political even for Sanders and Ellison to take on.  But other OECD countries with oil stockpiles to stave off supply disruptions (required of all member countries of the International Energy Agency) routinely recover the cost of these activities from oil markets rather than taxpayers.  The US should do the same.

Here are some of the subsidies I was particularly happy to see included in the EPW Act:

• Royalty relief.  Energy resources are a public endowment, and selling them for less than they are worth is foolish.  EPWA targets a number of these areas.  It increases the onshore royalty rate for production on public lands to equal the rate of offshore production.  It eliminates reduced royalties on all "special" types or locations of fossil extraction, recognizing that a variety of factors have changed:  market prices are higher, technical capabilities have improved, and high-cost "marginal" oil reserves ought to be viewed as competing not just against other oil, but against any other marginal energy resources.  The bill also includes language to claw back some value from a small "mistake" in the late 1990s that resulted in a huge amount of oil and gas from leases in the Gulf of Mexico being given away with no federal royalties at all.  Since the losses on this error are likely to exceed even Bernie Madoff's ponzi scheme, it would also be nice to see somebody prosecuted for this negligence.  I don't believe anybody has ever been called to task.

• Lease competitiveness.  Part of ensuring a proper return on mineral resources is making sure that leases are tendered competitively.  EPWA addresses this issue with respect to the Powder River Basin coal region, one of the most abundant coal deposits in the world.  Past problems with leasing in this area have been estimated to provide nearly $30 billion in subsidies to coal producers.
• Manufacturing deduction.  Special tax deductions are available for firms manufacturing products in the United States.  Including the endowment value of extracted minerals as though it is a "manufactured" value is problematic, as I've laid out here. 
• Subsidized pollution control.  One of the main benefits of many emerging clean energy resources is that they are, well, cleaner.  Because at present these newer technologies are often more expensive than coal or oil, it is critical that conventional energy resources not receive subsidies for investments in pollution controls.  The cost of compliance should be passed through to consumers.  EPWA takes on a number of ways we subsdize pollution control from the fossil fuel sector:  more rapid amortization of investments into pollution control equipment (heavily used by coal plants); the ability to expense costs associated with complying with EPA rules on sulfur pollution; deductions for environmental clean-up costs; and tax credits for CO2 sequestration.  The bill also requires that tar sands oil pay into the Oil Spill Liability Trust Fund just like other forms of oil transported across US territories, a simple and logical change given the growing levels of production, particularly imported from Canada.
• Bypass of corporate income taxes.  It turns out that multi-national fossil fuel firms have been extremely skilled at bypassing corporate income taxes.  Sanders and Ellison target the misuse of foreign tax credits where oil and gas companies characterize royalty payments (which are tax deductible) as foreign tax payments (on which they earn more valuable tax credits).  They also target the use of master limited partnerships by oil, gas, and coal companies to bypass corporate taxes entirely.  These structures, which are not available to clean energy firms, have been used disproportionately by the fossil fuel industry.  I reviewed treasury data on this issue (Table 6, page 42 in this report)  and found that for 2008, the sector comprised only 3.9% of total assets owned by pass-through entities (i.e., corporate structures for which all gains an losses pass through directly to partners), but 11.8% of net income.  These statistics include all sorts of corporate forms, such as LLCs that are used by a variety of sectors.  It is likely that the fossil fuel share of master limited partnerships alone would be much higher, and that the surge in fracking-related partnerships since 2008 would result in a higher oil and gas share as well.  Lest one believe killing these subsidies will bring ruin to the industry, it is useful to recognize that Energy Trusts, a similar structure used by Canadian firms, were eliminated due to the high revenue loss to the Canadian government.
• Transport infrastructure and transport. The United States is suddenly exporting large quantities of refined petroleum products.  Coal producers are itching to build huge new export terminals in the Pacific Northwest to move coal out to Asian markets.  These exports require massive infrastructure to move the bulk fuels to ports and load them on vessels.  Ramping up exports raises important environmental concerns about locking us in to many decades of higher carbon power once these facilities are built.  But these concerns are particularly acute where the port projects are not simply built because the returns are so high, but because the construction is subsidized by taxpayers.  Subsidies are quite common in port and pipeline projects.  EPWA would prohibit at least federal transportations funds for rail or port projects to transport and/or export fossil fuels.  It's a good start, but port subsidies also come through credit support as sub-national subsidies.  Those venues need to be targeted as well.

Like so many attempts to strip away senseless subsidies before it, the most recent Congressional push to eliminate at least a handful of expensive subsidies to the oil and gas industry was blocked in May.  But the growing deficits remain, and with them the pressure for fiscal austerity and the need to demonstrate a competant bi-partisan ability to govern.  The push to kill these subsidies may well rise again.

Here's a rundown of some of the coverage of the oil subsidy issue I found notable.

1)  Why end oil and gas subsidies.  Dan Primack's (Fortune Magazine) synthesis of the reasons to end oil and gas tax breaks is concise and articulate.  Well worth a read.  Great suggestions as well in the 2011 Green Scissors Report, produced through a joint effort of Taxpayers for Common Sense, Friends of the Earth, Public Citizen, and the Heartland Institute. 

2)  Save our subsidies:  the role of lobbying.  Steve Kretzmann over at Oil Change ran the numbers on political contributions and saving the subsidies to oil and gas.  Their finding?  Those protecting the subsidies got average donations five times the level of those voting for reform.  I know you are all shocked...  An interesting update on this work looked at links between oil and gas industry contributions and the core "Super Congress" chosen to serve on the Joint Committee on Deficit Reduction, slated with identifying deficit-cutting options for the country.  The hope, of course, is that regardless of past affiliations these individuals can rise above parochial interests to do what is right for the country as a whole.  Time will tell.

3)  What's good for big oil is good for the USA.  Industry profits continue to surge, but this has no bearing on whether or not to get rid of subsidies according to industry boosters.  They are good for all of us, industry officials say.  Here's a quote from the American Petroleum Institute's Kyle Isakower that I think is destined to become an industry classic:

"When our industry does well, much of America does well also," Kyle Isakower, API's vice president of regulatory and economic policy, said in a briefing with reporters Monday, adding that the industry's reinvestment drives "economic progress and translates to billions of jobs supported, vast amounts of retirement income protected and billions in government revenue generated."

So I guess we should give them more money?  Isakower's linkage of oil subsidies to "retirement income protected" is a new one to me, and among the most absurd of the claims I've seen put forth by industries trying to defend their continued access to the federal trough.  Subsidy elimination would have very little impact on oil company share prices, which aggregate production from multiple business lines in many countries of the world.  Further, it is quite clear that fiscal default and ballooning deficits even without short-term default will have a far more detrimental impact on retirement funds and funding than stripping the favorable tax rules that have fed the fossil fuels industry for more than eight decades.

Last week, the National Academy of Sciences (NAS) launched an important project to assess the impact of the federal tax code on greenhouse gas emissions (ghg).  Tax expenditures now total more than $1 trillion per year, and trigger a wide variety of changes in the level and distribution of economic activity relative to a more neutral tax baseline.  Understanding whether these subsidies also exacerbate (or in some cases lessen) ghg emissions is increasingly important. 

The NAS has engaged a highly skilled panel for this initiative, and launched a website on which project information will be posted. 

Earth Track submitted written comments to the panel last week.  These comments summarize many of the issues that have come up in my work on environmentally-harmful subsidies over the two decades, and provides recommendations on how to address them.

I am anxious to see NAS' work successful.  Back in 2000, I was paired with a tax specialist to work on a similar research task for a large foundation.  The objective of that effort was to examine the tax code well beyond the energy tax breaks that had been examined to date, including policies in the areas of forestry and agriculture, transport, and housing. 

Unfortunately, there were early conflicts among contributors on how to view tax expenditures within the research scope.  This conflict slowed, and ultimately derailed, the project.  The specific disagreement:  should tax provisions that diverge from our existing tax system be treated as subsidies (my position) or ignored on the grounds that under other tax bases (e.g., a consumption rather than an income tax) those provisions would not be subsidies (my co-author's position). 

One of my current recommendations to NAS is that they address this issue quickly upfront -- such that a review of alternative tax systems and how they could help or hinder the challenges of climate change is considered, but as a standalone research task.  The core review and modeling of tax expenditure reforms should be based on the tax system we have now, and are likely to retain in most of its forms for many years to come.

There was very promising motion on subsidy reform contained in this March 2011 letter to Congress signed by a large number of conservative organizations (as well as others).  Since structural reform of subsidies will require a broad political coalition, the variety of groups signing on to this letter is a positive step.  Elements of their letter that I found particularly important are:

1)  Use of an appropriately broad definition of subsidies

"From direct payments and loan guarantees to mandates neither the environment nor the American economy can afford to be hampered by these anti-growth, anti-competitive policies." The inclusion of this mix of instruments is quite important, as it illustrates their understanding that subsidies go well beyond cash transfers, and that no matter the exact form, all can affect market positioning and competitiveness of beneficiary industries. 

Contrast this statement with the position taken by the Nuclear Energy Institute's Marvin Fertel in a recent presentation to Wall Street (page 13).  Fertel stated that "nuclear loan guarantees are actually a revenue generator for the government,"  knowingly glossing over two important facts.  First, revenues and long-term credit performance are quite distinct issues.  After all, mortgage closing fees made lots of money for loan originators until that little problem with borrowers not paying back their loans began to crop up.  Second, even without a default, the politically-selected access to Uncle Sam's line of credit greatly reduces borrowing costs for a lucky few, undermining the market position of competitors (see item 2, below).  The signatories to this letter have steered clear of these types of evasive definitions.

2)  Recognition that political selection of winners via subsidies favors established industries

Such policies provide unfair advantages for some producers, typically the more politically astute, while creating competitive disadvantages to other, often more promising and more nascent technologies. Centrally controlled energy policy has not worked, Washington does not know best, and the law of unintended consequences cannot be vitiated.

3)  Phased approach to level the energy playing field

The Coalition proposes four stages to their reform effort.  They begin with a cessation both of new subsidy creation and of the expansion of existing subsidies (in terms of scope or time frame).  They propose instead that any fiscal savings from eliminating subsidies be redeployed to the general economy through broad-based reductions in the tax rate.  Given that tax expenditures overall are in excess of $1 trillion per year, broad-based reform of tax expenditures alone could provide material reductions in general tax burdens.  The final stage of their plan is to dismantle the existing system of subsidies.

Additional work needed

There are some important limitations to this proposal that need to be addressed to make subsidy reform equitable and effective.  For example, most subsidies to renewable energy include sunset provisions already.  In contrast, many of the core subsidies to conventional fossil fuels are much older, and do not automatically expire.  Thus, unless dismantling of existing subsidies comes very close in time to allowing existing ones to expire, the proposed action plan will generate its own distortions.  A related issue involves externalities such as pollution.  To the extent fiscal subsidies are addressed, but emissions from coal or oil remain unchecked, the playing field will remain skewed.  Finally, the Coalition cites Pew's numbers for the scale of energy subsidies.  This is a good starting point, but even Pew does not believe they have systematically characterized the problem.  The subsidy reform "net" will need to grow wider over time if the the problem is to be fully solved.