The Problem with Fossil Fuel ‘Subsidies’

Like all right-thinking people, I am passionately opposed to fossil fuel subsidies. What could be worse than paying people to accelerate the rate at which we are screwing the climate?

So I was shocked to discover – courtesy of Bloomberg’s coverage of the climate talks in Doha – that:

Rich countries spend five times more on fossil-fuel subsidies than on aid to help developing nations cut their emissions and protect against the effects of climate change.

Even worse, when I tracked down the report that Bloomberg had drawn their story from, I found that the UK is one of the worst offenders.  According to the campaigning group, Oil Change International, the British taxpayer shelled out $6.6 billion in fossil fuel subsidies in 2011, but pledged only $793 million in ‘fast-start climate finance” that year.

Outrageously, for the UK, subsidies are over eight times greater than climate finance. I simply had no idea that the government of my own country was pumping so much money into oil, gas, and coal. Quite embarrassing really.

So where does this money go? Margaret Thatcher shut down the UK’s coal industry, while I’d always assumed that North Sea Oil was profitable without subsidy. Motorists, meanwhile, are always complaining about how much additional tax they pay on petrol and diesel (Daily Mail: “We’re the fuel tax capital of Europe.”)

Who then is getting 6 billion dollars a year?

Oil Change International draws its figures from the OECD “inventory of estimated budgetary support and tax expenditures for fossil-fuels” – an authoritative source. It:

  • States that “there are no energy-price controls in the United Kingdom and all prices are set freely by the market.
  • Lists various taxes on oil and gas production, including the Petroleum Revenue Tax (50% of the profits from a given field), a strengthened form of corporation tax that stops companies writing off losses against their tax bill, and a Supplementary Charge which adds an additional 32% tax to the standard corporation tax.
  • Reports “very few measures other than tax exemptions or reductions that support energy consumption in the United Kingdom.”

So far, so good. A free market for energy, that is distorted mainly by additional taxes on fossil fuels. So, where are we going wrong? Burrow into the OECD numbers and the first thing you are presented with is a big fat caveat:

Caution is required… in interpreting the support amounts. This is particularly the case as the majority of support mechanisms identified in the inventory are tax expenditures. Tax expenditures are relative preferences within a country’s tax system that are measured with reference to a benchmark tax treatment set by that country. Since the benchmark or “normal” tax treatment varies considerably from country to country, the value of this type of support is not comparable across countries. Thus, for example, a country that applies high rates of taxation to fossil-fuel end products within the context of an excise-tax system with lower rates for some products than others may have higher measured support to fossil fuels than a country with lower but uniform excise-tax rates, even if the tax system of the former country has higher taxes than the latter country on each type of fuel.

To translate that into English:

  • Make very careful use of these figures.
  • For the most part, we’re not talking about subsidies but about tax breaks.
  • The size of these tax breaks is calculated through a comparison with taxes that are paid by/on comparable industries/products.
  • The calculation does not take into account additional taxes that are levied on fossil fuels, but not on other industries or products.

So how does this work out for the UK?

  • It hardly provides any direct subsidies for fossil fuels, bar a few million pounds spent on shoring up abandoned coal mines.
  • ‘Producer support’ accounts for around 6.5% of the total. This is mostly provided in the form of a relief to the 50% Petroleum Revenue Tax (itself a carbon tax) for small and marginal oil fields. PRT brings in £1.8bn ($2.9bn) in revenue to the Treasury, but the take from this ‘carbon tax’ would be 15% bigger if all fields were included. In this case, fossil fuels are ‘subsidised’ because some oil fields are taxed more punitively than other ones. By this logic, small companies are ‘subsidised’ because they pay lower rates of tax than big ones (or are supposed to, at least).
  • By far the biggest portion of the UK’s fossil fuel ‘subsidy’ (91%) goes to the consumer, meanwhile, via the tax treatment of domestic fuel, which is liable for VAT at a rate of 5%, rather than the 20% levied on most other products. In this case, fossil fuels are subsidised because all domestic energy, whether or not it comes from fossil fuels, is taxed at a lower rate than other products. By this logic, food is also subsidised – it is zero rated for VAT.
  • Petrol is very heavily taxed through fuel duty (around 60p per litre), which brought in £24.5bn ($39bn) in 2011-12 to the Treasury. However, full VAT on petrol is charged, so this fuel tax doesn’t figure anywhere in the OECD’s calculation.

My conclusions:

  • No significant subsidies for fossil fuels in the UK. NO SUBSIDIES. Anyone who says otherwise is pulling wool over your eyes.
  • We offer some tax breaks for fossil fuels, but only if you completely disregard all the additional taxes that are levied on oil producers and petrol consumers. The OECD is counting “relative preferences within a country’s tax system” but not accounting for “relative penalties,” even though the penalties are at least six times greater than the preferences.
  • Moreover, the OECD’s rules are fuzzy. Producers get a tax break because some oil producers pay more tax than others, although all pay higher rates than other types of company. For consumers, there’s a fossil fuel tax break, even though renewables receive the same tax treatment.
  • If you support the abolition of ‘subsidies’ in the UK, what you actually want is more VAT on domestic fuel bills – £200 per year for the average household – and, without a change to the tax regime, this would apply equally to renewables and nuclear. You should probably also support the imposition of VAT on food given its climate impact. (I’d actually be in favour of this, but I also support other measures, such as tiered pricing of energy, that deal with the regressive impact on the poor, and especially the elderly.)
  • The OECD’s estimate of “budgetary support and tax expenditures” is pretty meaningless for the UK and Oil Change International’s use of these figures is downright misleading. We could, for example, remove fossil fuel taxes and raise VAT. Energy would be cheaper, emissions higher, but the UK’s ‘subsidy’ problem would have disappeared. Same with North Sea Oil – abolish the additional taxes on oil and UK ‘subsidies’ go down.

All this has left me with hard questions about the campaign against subsidies. Is the OECD’s calculation really so badly distorted or am I missing something? And do the same problems apply to other countries?

If they do, it seems to me the ‘subsidy’ methodology needs substantial revision. The OECD is one of the main bodies advising G20 on its commitment to “the rationalization and phase out over the medium term of inefficient fossil fuel subsidies that encourage wasteful consumption.” If its figures don’t make sense, then nor does what the G20 is trying to do.