May 15, 2011
Oil Subsidies
The U.S. Tax Subsidies for Oil Companies—Posner
My focus is somewhat narrower than Becker's; it will be on subsidizing the U.S. oil industry by means of tax breaks.
The current and I think healthy concern with the growing gap between federal revenue and federal spending has focused attention on all sorts of questionable fiscal arrangements. One of these is tax subsidies. Conservatives have managed to make tax increases seem un-American, yet it is obvious that the few politically feasible spending cuts, both present and future, that are under discussion cannot begin to close the revenue-expenditure gap. Hence the attention to tax subsidies. The term is misleading. A tax subsidy is not an expenditure, but a selective tax reduction, as distinct from some general or uniform reduction. Hence to eliminate a tax subsidy is to raise taxes. But eliminating a tax "subsidy" sounds like reducing wasteful government spending rather than raising taxes, so it has more popular appeal than an explicit tax increase.
But that doesn't mean that it's any more feasible politically. The American political system is not that democratic, or at least not that populist. The fact that tax subsidies tend to be targeted on particular activities means that a proposal to eliminate a tax subsidy catalyzes interest-group opposition, often formidable since if the interest group were weak, the tax subsidy would not have been legislated in the first place. Tax subsidies are eliminated from time to time, and it would be interesting to speculate on the conditions that make that possible, but I will not attempt that here.
Not all subsidies are bad; not all tax subsidies are bad, for there is no economic reason for thinking that all activities should be taxed at the same rate. A subsidy is defensible on economic grounds if it encourages the production of benefits that would be underproduced from an overall social-welfare standpoint were it not for subsidy. That is the argument for allowing expenditures for research and development to be written off (deducted from taxable income) on an accelerated schedule; R&D is underproduced from an overall social-welfare standpoint because even with a patent system one firm's R&D is quite likely to confer benefits on other firms for which the firm conducting the R&D will not be compensated; note in this connection that one requirement for a patent is that the applicant disclose the invention, and that disclosure may convey valuable information to competitors even though they cannot practice the patented invention without the patentee's authorization.
Is there a similar case for giving oil producers subsidies? The principal tax subsidies for the oil industry are as follows: a "domestic manufacturing deduction" that allows oil and gas companies to deduct an extra 6 percent of their taxable income; a deduction for "intangible costs," which are costs for investments in oil exploration or production that have no salvage value, such as clearing land to enable an oil well to be drilled—the oil companies are not required to amortize these costs over the entire expected life of the oil well—and last the companies are permitted to deduct royalties they pay to foreign government, on the ground that royalties paid to a government are really a tax.
The aggregate values of these subsidies to the U.S. oil industry is approximately $5 billion a year, almost as much as the industry pays in federal income tax ($5.7 billion). The industry's total profits exceed $30 billion, so it would not be facing a crushing burden if the subsidies were to be eliminated; the Obama Administration proposes to eliminate only $2 billion of the subsidies.
The first two types of subsidy (the domestic manufacturing and intangible costs deductions) are likely to increase domestic oil production, and the industry argues that expanded domestic production creates external benefits (that is, benefits not reaped by the oil companiess) by reducing our dependence on foreign oil, much of it produced by hostile or unstable countries. (The third subsidy, treating royalties paid to foreign governments as deductible taxes, can't be defended on this ground—it encourages American oil companies to increase their production abroad.) This is true, but the effect is probably small, especially relative to imposing a stiff tariff on oil imports (as suggested by Becker). The tariff would actually generate revenue for the federal government without being called a tax (though that is what a tariff is), reduce the income of foreign oil-producing countries, and increase domestic production by making foreign oil more costly. In addition, as Becker also mentions, more U.S. public lands, and more territorial waters of the Gulf, Atlantic, and Pacific coasts, could be opened to drilling for oil.
The advocates of eliminating the tax subsidies for the oil companies argue that the oil industry's profits are excessive in relation to the high prices of gasoline at the point, but eliminating the subsidies would result in higher, rather than lower, gasoline prices because it would reduce overall production of oil.
But that wouldn't be a bad thing! Our problems with oil are not limited to oil imports, but include the environmental damage (particularly the effect on climate) caused by the burning of oil, oil spills, and traffic congestion. High prices for gasoline, which reduce demand and therefore consumption, are the equivalent of a pollution tax, and should be encouraged. They would also reduce imports.
So both the advocacy of the tax subsidies for the oil industry and the advocacy for eliminating them are unsound, but the case for eliminating them is strong. Oil is not our future, and the expansion of the industry should not be encouraged. The oil companies even acknowledge, or at least pretend to acknowledge, a willingness to give up their subsidies if subsidies to other industries are likewise abolished. This is not a good argument either, because those subsidies, though most of them are no more justifible than the tax subsidies for the oil industry, do not impose costs on that industry. The argument amounts to saying that since the world is imperfect, I should be free to cheat and steal.
Subsidies to Oil and Other Energy Sources-Becker
President Obama and members of Congress are calling for a sharp reduction in the substantial direct subsidies to American oil companies. Many countries also give an indirect subsidy to oil producers and refiners by subsidizing the purchase of gasoline. In Saudi Arabia, for example, subsidies have reduced the price of a liter of gasoline (1 gallon equals about 3 ¾ liters) to 12 cents, which had made gasoline there cheaper than bottled water. The largest subsidies to gasoline are usually found in oil producing countries: Saudi Arabia, Iran (although the Iranian government greatly reduced gasoline subsidies in 2010), Russia, Venezuela, Indonesia, and the UAE. Yet, the economic case for either direct or indirect subsidies to the production and refining of oil is quite weak.
One argument commonly made for subsidizing gasoline prices, especially when, as at present, oil prices are rising rapidly, is that this helps the poor. Yet these subsidies disproportionately favor the middle classes and the rich since poor families in general, and especially those in developing countries like Indonesia, Egypt, and Iran, are much less likely to own cars, and the poor drive fewer miles with the cars they do own.
Since subsidies lower the retail price of gasoline, this increases the demand for gasoline. Especially after subsidies have been in place for a number of years, the response of demand to lower gasoline prices is substantial as consumers drive more miles, shift consumption toward gas-guzzlers, keep older cars on the road longer, and make other adjustments that increase the consumption of gasoline. Government-owned oil producers in countries that subsidize the purchase of gasoline must divert more of their production to domestic use, and hence are prevented from getting the world price for this oil used domestically. Subsides obviously harm poor countries like Egypt that have subsidized gasoline so much that it has gone from being self-sufficient in oil to becoming an importer of oil.
The United States and other developed countries like Japan and those in Europe tax rather than subsidize gasoline consumption. The US is also a large producer of oil, and as I indicated at the beginning, the US does directly subsidize oil producers. Although estimates of the exact value of these subsidies vary, most analysts put them at several billion dollars per year. One justification frequently given for subsidizing domestic producers of oil is that this increases domestic oil production at the expense of imports. Greater domestic production is considered valuable because of national security concerns about the availability of imported oil during world crises, especially oil from the unstable Middle East and from Russia.
However, a fiscally better way to meet national security concerns would be to tax oil imports rather than subsidize domestic producers since an import tax would bring in additional tax revenue, whereas subsidies to oil companies are financed by tax revenue. Also better than subsidies to oil producers would be for the US to encourage rather than discourage offshore drilling for oil, and greater drilling on government-owned lands. President Obama has just indicated that he is taking steps to allow greater oil and gas drilling offshore and on public lands.
From an American national security point of view, the development of effective hydraulic fracturing, or "fracking", methods to recover natural gas from rocks deep underground is a godsend since the US has enormous reserves of such gas-among the two or three largest in the world. Some states are encouraging greater natural gas production through fracking, although others have severely restricted the use of this procedure because of environmental concerns. Fracking pumps enormous amounts of water deep underground, and this could contaminate water supplies, although the level of this risk is still controversial.
As this discussion indicates, energy policy depends on more than national security concerns since global warming and local pollution caused by fossil fuels are also important. Domestic oil may be better than imported oil from a national security viewpoint, but it is worse from a pollution perspective since producing and refining oil causes local pollution. Domestic natural gas produced through fracking methods directly causes some local pollution, but it is less harmful to the environment than domestic coal, which is the main alternative to natural gas for electricity generation.
A potential alternative to greater domestic production of fossil fuels is much greater output from other sources of energy, like nuclear power, wind, and solar power, which all cause little pollution and are domestically produced. The governments of the US and of many other countries already heavily subsidize wind power and solar energy. Nuclear was making a return to popularity, but the disaster in Japan has as least temporarily greatly stalled its return. Some subsidy may be justified for these alternatives, but energy from either wind or solar is unlikely ever to be produced at a reasonable cost on a large enough scale to replace fossil fuels as the major source of energy. I still support expansion of nuclear power, but the safety issue clearly needs further attention.
It would be preferable to limit subsidies to wind and solar, and increase government support of basic research on various alternative ways to either produce energy, such as with batteries, or contain the pollution from oil, coal, and natural gas. The private sector generally has weak incentives to work on basic research since the results of such research are not patentable. Clearly, governments have very imperfect incentives as well, but still some government help to the private sector seems warranted for basic research in the energy field that is looking for effective ways to reduce pollution and find alternative sources of energy.