Everything You Need to Know About Fossil Fuel Subsidies

Colonel Mustard, with a subsidy

Debt subsidies did not cause the financial crisis. Corporate-tax rates in many countries fell in the run-up to the crash, lowering the potency of the tax perks. Most multinationals run solid balance-sheets. In America rich households get much of the benefit of the mortgage-interest relief—and few of those defaulted.

Yet a bias in the global tax system probably made the crisis worse, says Simon Johnson of the Massachusetts Institute of Technology. It boosted the overall level of debt and created pockets of distress. The Netherlands had the world’s most generous tax subsidies of mortgages, worth 2% of GDP a year, more than double the level in America. It built up one of the highest levels of mortgage debt, which still hangs over the economy. And many corners of the corporate world took lots of risk. Leveraged buy-outs and commercial real estate relied on heavy borrowing, made cheaper by tax breaks, and generated heavy losses. In the latest stress tests conducted by the Federal Reserve and European Central Bank, the corporate sector accounted for 30-40% of expected banking-system losses.

Banks, inevitably, took most advantage, gaming the tax rules with devastating results. Most issued “hybrid” securities that were treated as debt by the taxman but as capital by credulous regulators. In the crisis hybrids did not act as a buffer that absorbed losses. About a third of big Western banks’ capital was made up of these instruments. Had they raised equity instead, fewer banks would have wobbled, says Ruud de Mooij of the IMF. The resulting financial crisis left a debt burden that largely remains (see chart 1).

Is Farming a Booming Business?

But just because farming is difficult does not necessarily mean that it isn't profitable. Back in April 2011, when the number of farms was also decreasing, a Washington Post article stated:

"The Agriculture Department projects net farm income of $94.7 billion in 2011, up almost 20 percent over the previous year and the second-best year for farm income since 1976. Indeed, the department notes that the top five earnings years out of the past 30 have occurred since 2004," ("Federal Farm Subsidies Should Be Slashed").

And this data has continued to be encouraging to farmers. Net farm income in 2018 dipped to $66.3 billion, which was significantly below the average set by the years 2008 to 2018 but still managed to be well above what it used to be. Even more recently, though, this income is on an upward trend again. In 2020, net farm income was predicted to increase by $3.1 billion to $96.7 billion.

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Types of Subsidies

The U.S. has implemented many subsidies and in many forms, supporting everything from ethanol to used cars, but here are some of the major players.

Farm Subsidies

Agricultural subsidies were originally created to help farmers ravaged by the Dust Bowl and the Great Depression of 1929. The federal government guaranteed farmers a high enough price to remain profitable. How did it do this? It paid farmers to make sure supply did not exceed demand. The government subsidized farmers to keep croplands idle in order to prevent overproduction. It also bought excess crops. It then either stored them or gave them away to feed low-income people throughout the world.

Over time, the agricultural subsidy program grew massively, though its original intent may have been buried. Between 2013 and 2022 the average spending on farm subsidies was about 17.6 billion a year on average.

Here are some major touchpoints in subsidized farming in the U.S. in more recent history:

  • Between 2010 and 2019, farms received subsidies averaging more than $74,000 a year. During this time about 75% of subsidies went to medium or large farming operations, with the average small farm household receiving little or no payments, even though 89% of farms were small family farms.
  • By 2017, large farms dominated the industry. Farms generating $1 million or more in sales produced two-thirds of the nation’s agricultural output. Only 4% of farms were that large. Big farms gobbled up small ones that couldn’t compete. They relied on economies of scale to produce more food at a cheaper price. That sent prices down even more, putting more small farmers out of business.
  • In 2018 and 2019, the Trump administration increased farm subsidies by an additional $23 billion under the Market Facilitation Program.
  • In 2020 the U.S. Department of Agriculture announced two rounds of direct payments under the Coronavirus Food Assistance Program, valued at about $30 billion added to the existing farm subsidies.

Oil Subsidies

The oil industry subsidies have a long history in the United States. As early as World War I, the government stimulated oil and gas production in order to ensure a domestic supply.

In 1995, Congress established the Deep Water Royalty Relief Act. It allowed oil companies to drill on federal property without paying royalties. Ever since, the oil subsidy scene has been on a political yo-yo:

  • In March 2012, President Obama called for an end to the $4 billion in oil industry subsidies.
  • In 2018 President Trump's budget increased federal spending for the fossil fuel industry and created tax cuts to effectively eliminate taxes for coal and oil producers.
  • In January 2021 President Biden made a commitment to oil subsidy reform, but the follow-through is not guaranteed, and is difficult, as the subsidies are mainly embedded in the tax code.

Subsidies can often bring political and social critique. Greenpeace argues that the oil industry subsidies impede solutions to climate change and promote racist systems.

Export Subsidies

The WTO bans export subsidies. But it allows certain U.S. federal government export subsidy programs. They help U.S. farmers compete with other countries' subsidized exports. For example, the U.S. Department of Agriculture promotes the following programs:

  • The Export Credit Guarantee Program, which finances U.S. farm exports. The USDA guarantees the buyers' credit when they can't get credit approval locally.
  • The Facility Guarantee Program, which supports infrastructure improvements in countries that import U.S. agricultural goods, but not up to the full capacity due to inadequate facilities.

Housing Subsidies

Housing subsidies promote homeownership and support the construction industry. Housing subsidies come in two forms: interest rate subsidies and down-payment assistance. The biggest interest rate subsidy is the mortgage interest deduction on the federal income tax. There are also some smaller interest subsidies that reduce mortgage costs for low-income families.

These direct homeowner subsidies paled in comparison to what the federal government spent to support its Federal Housing Authority mortgage loan guarantee program.

The real trouble started when it created two government-sponsored enterprises. Fannie Mae and Freddie Mac provided a secondary market to buy these mortgages from banks. But they bought too many. That forced the government to spend up to $154 billion to bail out Fannie and Freddie.

Was the bailout a subsidy? Yes, in a sense. Without it, there would have been no housing activity whatsoever after the subprime mortgage crisis. Fannie, Freddie, and the Federal Home Loan Guaranty Corporation were behind 90% of all home loans in the year following the housing crisis. The agencies replaced the private sector’s role in the home mortgage market in the United States.

Health Care Subsidies

The most notable example of a healthcare subsidy came in 2010 with the Affordable Care Act (ACA), or more colloquially known as “Obamacare.” It aimed to provide access to healthcare for those who could not afford it, primarily low- and middle-income families, and those who work in jobs that don’t provide health insurance. The subsidy portion of the plan is delivered directly to eligible citizens in the form of a tax credit.

In spite of a number of judicial challenges and political criticism, the ACA is still in effect through December 2022.

Automobile Subsidies

Another example of a less direct subsidy can be found in the changing automobile industry through the promotion of electric vehicles, though this can be thought of as an environmental subsidy as well. Starting in 2010 the Federal government began offering tax credits upwards of $2,500 for the purchase of plug-in electric vehicles. The credit increases for higher kilowatts, maxing out at $7,500. The tax perk incentivizes consumers and businesses to purchase electric vehicles, and as a result manufacturers have greater incentive to produce them.

Key Takeaways Any financial benefit, whether cash or tax cuts, given by the government to businesses or government organizations is considered a subsidy. Subsidies are given to help companies reduce their costs of doing business.The U.S. government grants subsidies to many industries including oil, agriculture, housing, farm exports, automobiles, and health care. Some economists are opposed to government subsidies, believing they end up doing more harm than good in the long run.

Who Benefits Most From Farm Subsidies?

Farm subsidies don't benefit all farms equally. According to the Cato Institute, farmers of corn, soybeans, and wheat receive more than 70% of farm subsidies. These are also usually the largest farms.

While the general public may believe that the majority of subsidies go to helping small family operations, the primary beneficiaries are instead the largest producers of certain commodities:

"Despite the rhetoric of 'preserving the family farm,' the vast majority of farmers do not benefit from federal farm subsidy programs and most of the subsidies go to the largest and most financially secure farm operations. Small commodity farmers qualify for a mere pittance, while producers of meat, fruits, and vegetables are almost completely left out of the subsidy game."

According to the Environmental Working Group, from 1995 through 2016, reports the seven states received the majority of subsidies, nearly 45% of all benefits paid to farmers. Those states and their respective shares of total U.S. farm subsidies were:

  • Texas – 9.6%
  • Iowa – 8.4%
  • Illinois – 6.9%
  • Minnesota – 5.8%
  • Nebraska – 5.7%
  • Kansas – 5.5%
  • North Dakota – 5.3%

What effect would reducing subsidies have on climate change?

Removing consumption subsidies in 32 countries would cut their greenhouse-gas emissions by an average of 6% by 2025, according to an IISD July report7. This chimes with a 2018 United Nations report8 suggesting that phasing out fossil-fuel support could reduce global emissions by between 1% and 11% from 2020 to 2030, with the largest effect occurring in the Middle East and North Africa (see ‘Carbon cuts’). That reduction could be amplified if the money that would have subsidized fossil fuels was instead used to support renewable energy.

Source: Ref. 7

A 2020 report by IRENA9 tracked some $634 billion in energy-sector subsidies in 2020, and found that around 70% went to fossil fuels. Only 20% went to renewable power generation, 6% to biofuels and just over 3% to nuclear. “This overwhelming imbalance of subsidies between fossil fuels and clean energy is a drag on us achieving the Paris climate goals,” says Taylor, who wrote the report. The balance of these numbers varies from year to year, because fossil-fuel subsidies swing around depending largely on the price of oil, he adds.

The IRENA report also mapped out a scenario of how global energy subsidies might change by 2050 to help limit global temperature rises to below 2 °C, compared with pre-industrial levels. It sees subsidies for fossil fuels and renewable electricity falling and moving to renewable energy in transport and buildings, and to energy-efficiency measures (see ‘Changing future’). However, some fossil-fuel support is retained, almost all of which would bolster carbon capture and storage for industrial processes such as cement and steel production.

Source: Ref. 9

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