Deception vs Reality: The Misleading Debate About Energy “Subsidies”

Contributed by Robert Lyman © 2022. Robert Lyman’s bio can be read here.

In 2019, the International Monetary Fund published a working paper that concluded governments around the world were subsidizing fossil fuels by US $5.2 trillion annually.

The purpose of this paper is to reveal the misleading language and failed logic behind the IMF’s analysis and claims that environmental campaigners have made based on that analysis.

Much confusion surrounds the definition of a subsidy. The simplest is a form of financial aid or support to an economic sector or business that is intended to promote economic and social policy. The World Trade Organization (WTO) has developed a different definition to be used in settling disputes about the use of subsidies to distort trade. The IMF adopted the WTO terminology but tried to lump together a wide range of different types of subsidies allegedly to determine their impact on investment, output and emissions. It added together the effects of different types of financial measures, such as tax expenditures and royalty relief measures, without accounting for important interactions among these and the broader fiscal/tax system. This approach does not examine the impacts of taxes, royalties and subsidies on investment at the margin, which is the basis upon which investment decisions are made. Further, it is not based on economically meaningful benchmarks, which are the bases for comparison between the actual taxes paid and what would have been paid in the absence of a subsidy.

The IMF divided the alleged subsidies to fossil fuels into different categories, including producer subsidies and consumer subsidies. Environmental campaigners present the subsidies as entirely benefitting the energy producers. In fact, the IMF’s estimate of producer subsidies amounts to just 6% of the $5.2 trillion figure, with 94% going to consumers. In turn, most of the subsidies that allegedly go to consumers reflect the difference between end-use prices and what consumers would pay if the price of “negative externalities” were included: local air pollution, alleged effects of climate change, traffic congestion and road accidents, and health impacts. It is called a subsidy based on economic theory, which states that when the consumption of a good results in an external cost to society, then “efficient” pricing requires that consumers face a price that reflects these costs. However, deciding not to price an externality differs from granting a subsidy. Nowhere does anyone actually plan to impose on any product, let alone fuels, taxes allegedly representing the costs of environmental externalities.

The International Institute for Sustainable Development (IISD) issued a report in 2010 that claimed that federal and provincial governments in Canada subsidized the oil industry by $2.8 billion in 2009, with about half of that coming from the federal government. This study is the main source of the claim that the Canadian oil industry is heavily subsidized. According to the IISD, almost 84% of the subsidies identified were “tax expenditures: associated with fast write-offs and other tax breaks in the corporate income tax system, as well as royalty reductions associated with various royalty programs”.

Finance Canada annually reports on the value of the federal government’s tax expenditures. The most recent (2021) report notes instead that almost all of the tax expenditures formerly in place (i.e., before 2014) have been phased out. The only item left to report on is flow-through share deductions against Corporate Income Tax and Personal Income Tax for oil and gas and coal mining. These declined from $20 million in 2018 to a projected $8 million in 2022.

The claims about large subsidies to the Canadian oil and gas industry ignore other important considerations. First, oil and natural gas consumers in Canada are already heavily taxed; the total revenues to governments annually from the excise taxes and HST on motor fuels are about $25 billion. Second, the “subsidies” granted to oil and gas producers are far outweighed by the revenues that these producers provide to governments in corporate income taxes, royalties and land bonus payments, which are about $10 billion per year. Third, any subsidies to oil and gas producers are small by comparison with the dozens of subsidies and other market advantages provided to renewable energy and electric vehicle industries. In Ontario alone, the cost of subsidies to wind and solar electricity generation provided through favourable rates exceeds $4 billion per year.

We may all have questions about the benefits of governments handing taxpayers’ dollars out in subsidies to various industries, but one thing is clear. As we search for ways to reduce government subsidies, the largest scope for reductions is definitely not in the oil and gas industry.