A Moderate Energy Subsidy Shift Proposal For A Radical Energy Use Shift

By Patrick Leahy, Director (subdistrict #7), Papio-Missouri River Natural Resources District Board, NLC Omaha

If you were successful, somebody along the line gave you some help. There was a great teacher somewhere in your life. Somebody helped to create this unbelievable American system that we have that allowed you to thrive. Somebody invested in roads and bridges. If you’ve got a business — you didn’t build that.” — former U.S. President Barack Obama[i]

These words burn men and women from Wall Street to Main Street who fancy themselves frontier people of the highest order. The saying is used as evidence that there are those in the U.S. that believe government is the answer and source of individual prosperity and would hand enterprise over to government if given the choice. It throws sand in the face of those who believe they are the sole cause of their families’ prosperity.

When pressed to look closer in the meaning behind those words, even the proclaimed self-sufficient class cannot completely doubt that the government had some role in helping construct the roads, education system, social nets, even the market that allowed industrious people to build their fortune. The government builds the foundation in which structures stand…or fall. It creates the environment in which business breathes…or suffocates.

And why shouldn’t government do this? After all, the government in the U.S. is merely a social construct of ‘the people’, by ‘the people’ and for ‘the people.’ For the energy industry, the government has built the foundation and environment based on a variety of subsidies. These subsidies, government expenditures and investment, have driven the current energy portfolio of the country for a generation. To respond to ‘the peoples’ desires and drive the American economy forward for the coming generation, the U.S. government must help producers and consumers of new energy sources through adjustments in the structure of energy subsidies.

If the American people want to diversify the U.S. economy, enhance national security and move to cheaper, cleaner energy sources, they will have to demand that subsidies being handed out on their behalf be distributed differently.

A Brief Background

According to a seminal 2011 study, “What Would Jefferson Do? The Historical Role of Federal Subsidies in Shaping America’s Future” by Nancy Pfund and Ben Healy, energy subsidies have been around as long as the country. From coal tariffs to timber grants, a reliable source of energy for the nation has always and will always be a top strategic concern. Their paper examines and compares the start-up and historical aid for traditional energy sources (coal, oil, nuclear, gas) versus new energy sources (solar, wind, hydro). Per Pfund and Healy, the first 15 years are critical to developing new technologies. The report finds “oil and gas subsidies, including tax breaks and government spending, were about five times as much as aid to renewables during their first 15 years of development; nuclear received 10 times as much support”. Furthermore, the annualized average for oil and gas is nearly $5 billion per year, and it is $3.5 billion for nuclear. Compare that to $1 billion for biofuels and $300 million for renewables like solar and wind.[ii]

The Policy Problem:

The U.S. government has helped prop up large domestic oil, gas and coal suppliers and consumers going back generations. They have done so through energy subsidies. Energy subsidies can take many forms, including:

· Direct expenditures to producers or consumers,

· Tax expenditures,

· Research and development,

· Federal electricity programs supporting federal and rural utilities, and/or

· Loans and loan guarantees.[iii]

Subsidies allow their direct beneficiaries the ability to make long-term strategic investments and recoup capital outlays already invested. Indirect beneficiaries, the consumers, get cheaper gas/oil/coal/nuclear/wind/solar/etc. energy. The greater the subsidies, the greater the benefits. Should more subsidies flow to newer energy technologies, the greater the benefits would be to those companies who make longer-term investments in those sources and the consumers to buy their product.

Another benefit to the subsidies comes in terms of employment, people directly hired by the companies benefitting from the subsidies to do work they would not otherwise do. And that employment extends to those further down the supply and consumer chains in related industries that the energy source provides that it similarly wouldn’t otherwise. To stop subsidies to industries currently receiving them would most likely hurt employment in that sector. Conversely, if subsidies were to increase in another industry or be redirected to other companies, it would make sense that employment, up and down the supply chain, would increase.

However, all subsidies come at a cost. The U.S. government gives out energy subsidies while running steady annual deficits. The subsidies add to the interest costs the U.S. must eventually pay back to creditors, foreign or domestic. To be profitable, the net gain economic activity in the U.S. economy must be greater than the costs. To determine if this is an appropriate investment should be a matter of simple math. Is the benefit greater than the cost? If so, give the subsidy. If not, then stop it. Unfortunately, in today’s interest-driven world, any study ambitious enough to try to accurately calculate both sides of the equation will automatically be met with skepticism and partisanship.

Nothing groundbreaking thus far.

Recently, the people of the U.S. have begun to question if the benefits do outweigh the costs as traditional energy (oil, natural gas, coal and nuclear power) companies are recording huge profits.[iv] Nearly 2/3 taxpayers want to see the subsidies for traditional energy be curbed or stopped.[v] Because almost six out of ten polled did support subsidizing “new energy” sources (wind, solar, hydrogen) which receive sometimes higher subsidies, it can be assumed support or lack thereof is not purely economic based. Perhaps public opinion is related more to the negative consequences fossil fuels have on the natural environment and human health. The percentage of Americans asking for the government to prioritize renewable energy sources over old energy sources at an all-time high.[vi] Because the consumer, the tax-payer and the voter are nearly all one in the same, polls like this should not be ignored.

Policy Proposal: A Small Subsidy Shift

To address the swing in opinions, and the constant need for cheaper and cleaner energy, the U.S. government need not to drastically alter the tax subsidies it is currently providing in one fell swoop. It can do it slowly, allowing companies and the market time to plan and adjust. Doing so would give a strong indication of where the country would like to go into the future change the paradigm.

U.S. policymakers should structure subsidies to traditional energy industries to devolve consistently over 30 years or more. Moreover, U.S. should tie the old sources of energy to new sources on a one-by one basis. For example, as nuclear subsidies faded, they can be replaced by subsidies to wind. Oil could be tied to biomass energy sources, coal power to solar generations and natural gas to hydrogen energy companies. Starting in 2020, 1% of subsidies from old energy sources should by diverted to new energy sources, each subsequent year. This shift should be in addition to current subsidies received by new energy sources and should be planned to continue until at least 2050. Given the U.S. subsidized old energy with about $5.1 billion in 2013,[vii] this proposed policy would add up to a total of $19.1 billion in additional revenue for new energy industries during this time. The policy would eventually mean shifting 30% of subsidies from old energy sources. The policy ramifications will go farther than that even as the subsidies to new energy sources would begin to slow. Eventually devolving or slowing all subsidies would allow energy to be more tied to a freer market as consumers and producers trade more in line the true costs of the energy source rather than a subsidized cost.

Depending on one’s view, 30% can seem like a lot or a little. Again, this would not be all at once, but a percentage point per year on a rolling basis. That 1% annual loss may still seem like a lot to companies currently, but that is industry wide. And it doesn’t count for any new profits due to growing demand globally or more efficient production techniques. Additionally, it is a fraction of what they could stand to lose if the polity decides it is fed up with pollution and/or government deficits and enforces a more radical change like a broad elimination of subsidies. Think about it this way: the coal industry received $1.075 billion worth of various subsidies in 2013. Their loss in the first year of this plan would mean they would still receive over 1.064 billion in 2021. The second year, 2022, just under $1.043 billion. [See Example #1]

Losses to be sure, but nothing catastrophic that would ruin the industry too radically and too swiftly. And while the reduction in subsidies is relatively small, especially in the beginning years, the gain in subsidies for new energy sources is relatively large for about first ten years. In this example, the subsidies for solar would increase until 2029, to about $67.5 million in additional subsidy revenue that year, and then begin to be reduced.

After the 30 years pass, the solar industry would see an additional $1.07 billion. And even though it only meant a 1% decrease in funding per year for coal industry, at the end of 30 years the true reduction of their subsidies would be 99.5% to only $5,862,801 by 2049. In effect, this policy would ultimately end the artificial propping up of the market for old energy sources. And because the new energy sources would only be receiving 1% of the previous year from the old source, at the end of the 30 years the subsidy, in this example the solar subsidy, would come back down to near current levels after a surge of assistance (Example #1). The new energy sources would still in effect be propped up, but even their subsidy would relatively decrease given these numbers do not adjust for inflation.

Example #1 Coal Subsidies Shifting to Solar Subsidies:

The increasing 1% shift from old energy subsidies to new energy subsidies would be bring immense benefits. The projected change in subsidies would provide stability and a predictable environment for businesses, which are current beneficiaries of the subsidy. They would not have to worry about losing subsidies through drastic cuts, but instead would have a timeline on how the cuts would occur. Producers and consumers would be able to better plan what the future of energy subsidies will look like rather than guessing what policymakers may decide year to year. That should spark innovation and investment and hopefully, shift market choices in both the demand and supply side, to new energy sources even before 30 years is finished.

It is assumed that companies that currently benefit from the subsidy structure would use their vast and historical connections to policymakers to fight their reduction. However, the political clout these companies have built to keep their current subsidies should make them an odds-on favorite to receive some portion of the new subsidy. If they choose not (or cannot) make new, strategic investments to reap the new subsidies, then American entrepreneurs can fill the void and take advantage of the direction consumer preferences are heading. Proponents of a shift like this could also point out to policymakers that subsides are just another form of corporate welfare. And like individual welfare is a limited length of time the beneficiary can receive it, so to should these subsidies.[viii]

The subsidy shift would also slightly help the deficit. Currently, the subsidy schedule continues to increase[ix]. By implementing this approach, the initial subsidy today (2020) for old energy sources is about $5.1 billion per year. By 2050, under this policy, that would be reduced to roughly $24.5 million annually! The influx of subsidies to energy companies would increase in the first ten years of the policy, but then even those subsidies would begin to be reduced slowly. The percentage shift continues to increase by a percentage point each year, however the percent shifted will be on a smaller and smaller subsidy from the old energy source until eventually the new energy source subsidy is back to its 2020 levels by 2049 (Example #1).

Not eliminating the subsidies for old energy sources completely within even 30 years, acknowledges the continuing role these sources will probably still need to play for the foreseeable and unforeseeable future. However, policymakers shouldn’t fear any large spike in energy prices if the subsidies to those companies are significantly reduced. A study has predicted eliminating oil subsidies would cause a less than 1% increase in price.[x] And that is with a complete elimination in one year, not a 99% reduction over 30 years. Should old energy sources feel they need continued additional subsidy above what they receive via this shift, then they should seek to receive that from state sources. The national policy should continue to be providing the foundation and environment to promote the general interest of the American people, in this case moving to new energy sources.

How to Spend the Shifted Subsidy

Under this plan, eventually all subsidies will go away. For the traditional energy sources, this will happen sooner. Because subsidy dollars will become increasingly limited, there should be a political compromise with the individual energy industries to determine which of their subsidies their industry will want to continue the longest and which ones the public funds will be reduced from the quickest. However, if policymakers are looking to become involved, they should take the following into consideration.

When we wanted to improve literacy, we didn’t give tax credits but we built schools and hired teachers. When we wanted to stop houses from burning, it wasn’t government providing fire insurance but firefighters that helped solve the problem. These sayings provide a lesson that not all government intervention is created equal and can create the same success for a society’s goal. If the goal is to move the U.S. from old energy sources to new ones, for whichever reason (diversity for the economy, national security or environmental considerations), the increase in subsidy dollars that new energy industries would receive under the proposed shift needs to be invested in a manner which will maximize its effect.

Creating an ‘invisible hand’ of the market is more powerful and successful in changing behavior and demands than trying to force it with a ‘visible hand’. As mentioned earlier, subsidies can fall into one of five categories. Because the subsidy shift to new energy source surges in the first ten years and then dissipates based on the steady decline of the old energy subsidy, direct expenditures to producers or consumers is probably not the best way to use the shifted subsidy as the funding level is not constant for 30 years. Although tax expenditures like tax credits have proven useful to new energy companies thus far, for the same reason as direct expenditures, because the shifted money is not constant, using all the shifted funds on tax expenditures would also probably not be the best use. Of the three remaining ways to subsidize energy: research and development, federal electricity programs supporting federal and rural utilities, and/or loans and loan guarantees; a combination of the three may prove to be the best use of the windfall monies the shift in funds creates.

This type of investment has precedence by the government. Whether it was for the railroad during the late 19th century or the internet in the late 20th century, when government uses subsidies as investments rather than rebates to producers and consumers or tax credits, the resulting economic gain is still tremendously impactful and economy (and life) changing. Railroad companies were provided land grants to use for loans that banks wouldn’t otherwise give them as the payoff time to profitability was too long for a railroad.[xi] With the loan in effect guaranteed by the U.S. government, banks lent to firms, which were able to lay the tracks and expand settlements out west, building new communities and industries along the way which then needed the railroad to move products and people eventually making it a self-sufficient industry on its own.

Building up infrastructure to accommodate new energy technology could provide the investment injection needed to expedite changing the market dynamic. Couple infrastructure spending with the subsidy types that federal electricity programs supporting federal and rural utilities and it would give the subsidy shift a synergy of effort. While $10 — $60 million a year may not be much in infrastructure spending, it is relatively more impactful in more rural communities as the dollars ‘stretch farther’. And if the subsidy is structured through loans and loan guarantees, the money from the shift could back initial loans to companies seeking to store or transmit power form large solar or wind farms in rural America to city centers. As the government is repaid, the loan program becomes self-sufficient and increases the reach of what a program could do.

To help new energy sources, loans could be granted for infrastructure related to energy storage, conservation and transmission efficiencies. In rural America, this public investment can mean a huge increase in spending for a community and the resulting work would provide indirect benefits. As the country becomes more and more urbanized, rural investments will be needed to support communities and to provide a viable alternative to city-dwellers that are not reaping the benefits of urban living or just tire of congestion. The benefit is multi-fold, adding to the return on investment from the subsidy shift.

Also, much like the railroad industry, the U.S. should encourage loans to the companies and communities leading, not middling or failing. While the government does not have a great track record of picking winners and losers, broad grants disbursed on formulas do not create competition or ‘weed out the weak’. In the case of the railroads, the U.S. guaranteed the collateral (the land) for railroads to borrow against. But private lenders made the decisions on who to loan to. While the U.S. no longer has the abundance of land to dole out, it can use cash to similarly allow private lenders, not government bureaucrats, to make decisions on which projects and loans are worthy.

Likewise, as the Internet was helped along by government defense research into communications links and provided, through partnerships to the country’s universities that had the technical expertise.[xii] University grants for research and development in potentially paradigm changing technologies, such as a fusion reactor, also needs to be investigated where further increases in investments can be made. Research and development has the potential to create even more choices in the energy market for the U.S. consumer and the U.S. should leverage what universities are already doing through greater partnerships and sharing of technologies.

Moving Forward

Subsidizing energy choices is a choice the American people have and can implement through their elected representatives. In fact, it is a choice being made now as tens of billions are already being spent on subsidies annually. And with the consequences on inaction potentially being immense, action must be taken. And for action to happen, conversations in governments and communities need to start getting serious and proposals start to become concrete.

Policymakers should reach out to the firms receiving the current subsidies to a) inform them that public opinion is no longer on the side of continued subsidies at current levels and that changes will need to be made and b) determine if they can utilize the shift in subsidies to build new energy infrastructure or for new energy research and development. Getting buy-in from current receivers of subsidies is crucial to ensuring there is political support for any move, even if the proposed policy is relatively not radical or immediate. But hopefully slow, steady marginal change can lead to swift and major benefits for the U.S.

[i] http://www.factcheck.org/2012/07/you-didnt-build-that-uncut-and-unedited/

[ii] “What Would Jefferson Do?” Released September 2011. http://i.bnet.com/blogs/dbl_energy_subsidies_paper.pdf

[iii] “Direct Federal Financial Interventions and Subsidies in Energy in Fiscal Year 2013”. Released March 2015. https://www.eia.gov/analysis/requests/subsidy/

[iv] “The Most Profitable Industries In 2016”. Published December 2015. https://www.forbes.com/sites/liyanchen/2015/12/21/the-most-profitable-industries-in-2016/#68ceed6c5716

[v] “62 Percent Oppose Govt Subsidies to Oil but 58 Percent Favor Subsidies to Wind and Solar”. Published April 2014. Companieshttp://reason.com/poll/2014/04/17/62-oppose-govt-subsidies-to-oil-but-58-f

[vi] “Two-thirds of Americans give priority to developing alternative energy over fossil fuels”. Published January 2017. http://www.pewresearch.org/fact-tank/2017/01/23/two-thirds-of-americans-give-priority-to-developing-alternative-energy-over-fossil-fuels/

[vii] “Direct Federal Financial Interventions and Subsidies in Energy in Fiscal Year 2013”. Released March 2015. https://www.eia.gov/analysis/requests/subsidy/

[viii] “Welfare Time Limits: An Update on State Policies, Implementation, and Effects on Families”. Updated April 2008. https://www.acf.hhs.gov/opre/resource/welfare-time-limits-an-update-on-state-policies-implementation-and-effects

[ix] Direct Federal Financial Interventions and Subsidies in Energy in Fiscal Year 2013. Released March 2015. https://www.eia.gov/analysis/requests/subsidy/

[x] The Impact of Removing Tax Preferences for U.S. Oil and Gas Production. Released August 2016. http://www.cfr.org/energy-policy/impact-removing-tax-preferences-us-oil-gas-production/p38150?cid=otr-marketing_use-TaxPreferencesPaper/

[xi] Rise of Industrial America: Railroads in the late 19th Century”. Accessed April 2017. http://www.loc.gov/teachers/classroommaterials/presentationsandactivities/presentations/timeline/riseind/railroad/

[xii] A Brief History of the Internet & Related Networks. Accessed April 2017. http://www.internetsociety.org/internet/what-internet/history-internet/brief-history-internet-related-networks

[xiii] “Direct Federal Financial Interventions and Subsidies in Energy in Fiscal Year 2013”. Released March 2015. https://www.eia.gov/analysis/requests/subsidy/

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