Ah, Those Subsidies (Re-Run)

Reading a couple of comments on last week's postings, specifically on the question of whether today's fuels are over- or under-priced, reminded me of a piece I wrote on the subject of fossil fuel subsidies and externalities at the end of 2004. Since fuel prices are higher today, the amount of tax revenue generated by their sales is now significantly higher than the figures I cited:

Ah, Those Subsidies (November 5, 2004)
Periodically I'll run across an article on renewable energy, whether solar, or wind, or something more exotic, in which the author will downplay the importance of government subsidies in making them more competitive with traditional energy by citing the "hidden subsidies" that fossil fuels enjoy. They then go on to assert that if fossil fuels had to carry the full burden of those hidden subsidies, renewables would either compete now, or be on the verge of being fully competitive. This kind of thinking holds back the development of renewable energy, rather than advancing it.

Let's start by considering what might be included in such subsidies. Given current events, some sort of security subsidy seems like an obvious and important component. A lot of oil comes from a part of the world where the US has to maintain a big military presence to ensure continued access, the Middle East. By comparison, renewables are mostly homegrown, so they impose no such burden.

The other major category of subsidy usually cited is environmental. The use of fossil fuels emits oxides of sulfur and nitrogen into the atmosphere, along with a bit of heavy metals and gobs of carbon dioxide. In addition to the high cost of mitigating these at the source, which is paid directly by the producer or user, this pollution imposes costs on society via effects such as smog, acid rain, and their consequences.

All of this can be estimated and quantified, and a number of academic studies have done so. The resulting value of the "hidden subsidies" for fossil fuels ranges from fractions of a cent to roughly 12 cents per gallon. (This figure could be even higher, depending on how much of the annual defense budget you want to attribute to oil security.) Even if you quibble with some of the methodologies in question, it's pretty obvious that the figure isn't zero, and that economic decisions about our energy systems ought to take this into account.

But if we're going to look at the full economic cost of using fossil fuels, we should also consider the offsetting penalties built into the current system. Most of these penalties come in the form of taxes, and they are significant.

Consider the taxes on road fuels. In the US these include both federal and state excise taxes, and state sales taxes. In theory the revenue from these taxes is meant to fund highways and roads, though in reality it often disappears into general funds. Federal tax collections from road fuels totaled $32.4 billion in 2001. States collect anywhere from 8 cents to 26 cents per gallon (yielding another $30.3 billion in 2001), plus sales taxes, which go up with rising fuel prices. So even in the US, with much lower fuel taxes than Europe, we're in roughly the same ballpark as some aggressive estimates of the hidden subsidies.

So what is the point of all this? I assure you it's not just another argument for the status quo, although I suppose some might see it that way. After all, gasoline is cheaper than bottled water, and it will be a while before any practical alternative can make the same claim. My point is that the whole argument about hidden subsidies is a red herring, because the case is highly debatable, at best.

If we decide that it is worthwhile to subsidize alternative and renewable energy, then we should just get on with it, rather than rationalizing that the competitive bar is kept higher than it might otherwise be, because of some sneaky subsidy for fossil fuels. You're not going to displace fossil fuels on economics alone, no matter how many "externalities" you include; what is needed is something that is at least as practical and convenient, but that also supports our other, non-economic values.