Doug Koplow founded Earth Track in 1999 to more effectively integrate information on energy subsidies. Over the past 17 years, Mr. Koplow has written extensively on natural resource subsidies for organizations such as the National Commission on Energy Policy, the Organisation for Economic Cooperation and Development (OECD) and the United Nations Environment Programme (UNEP)

Introduction

Tax subsidies are the result of selective tax legislation that benefit particular groups of people or industries in the economy. In effect, they share the costs of certain actions between the private sector and the government and impact investment decisions by increasing the expected returns associated with a particular pattern of economic activity. Tax subsidies may be applied in a number of ways to any one or a combination of economic variables (land, labor, capital).

While some provisions (e.g., the general investment tax credits) may be available to an entire class of economic activity, such provisions may still be viewed as subsidies because other classes of economic activity are placed at a relative economic disadvantage. In this case, for example, the government has made a decision to favor capital-based productive methods rather than alternatives (such as labor). Similarly, subsidies to new investment favor supply expansions (such as new power plants) over improved efficiency in the use of existing capacity (such as many demand-side management approaches) and constitute a de facto governmental choice of the method by which to meet market demand.

Tax subsidies are generally measured in reference to a normative or baseline tax system, and estimates assume no other changes in the tax code. Each tax expenditure is calculated assuming that there is no interaction with other provisions. As a result, the estimates can’t be added directly together without errors. As it is very difficult to estimate the potential interactions from simultaneous removal of multiple subsidies, though, most analyses do add the tax expenditure values together anyway.

Since the government forgoes revenue that would have been collected had there been no special legislation and must make up those revenues through higher taxes on other economic activities, these policies have real costs. These costs are classified as “tax expenditures.” Within the United States, we are lucky in that two separate groups (the U.S. Treasury and the Joint Committee on Taxation) both independently estimate tax expenditures associate with current and proposed legislation. Many states and countries have no information at all about these special tax rulings. As a general rule of thumb, where there is no light the largest mushrooms grow. However, even within the U.S., the estimates for tax losses for the same provision by the two bodies can differ by hundreds of millions of dollars. The estimation methods or assumptions are not made public, so improving the accuracy of these estimates is not clear-cut.

The stated goal of tax subsidies, according to the U.S. General Accounting Office, is to promote some policy objective such as “economic growth or a desirable expenditure pattern by taxpayers.” However, there is a great deal of disagreement over whether particular tax benefits typically encourage “socially desirable” economic behavior. Further, even if the policies are effective, they are static and may become ineffective or counterproductive as circumstances (be they demographic, technological, or economic) change. For example, percentage depletion allowances were significantly expanded when crucial minerals were needed for war efforts. As these initial conditions changed, the policies did not necessarily evolve with them.

In summary, tax subsidies are neither inherently right or wrong. They are inherently distortionary, however, in that they alter patterns of economic activity to promote particular areas (targeted by Congress) that would not necessarily have received investment or consumer demand in the absence of the government intervention. The subsidies need to be considered as a real cost when evaluating alternative long-term energy options. These costs include the direct cost of increased taxes in other areas to individual taxpayers, and the indirect costs to the economy as a whole through the distortionary effect of the subsidies on R&D, investment, and consumption patterns.

There are a few issues to keep in mind regarding our net tax expenditure estimates. First, special taxes on energy have been treated as negative subsidies if they are used for general revenue purposes. If they are earmarked for specific energy-related uses, such as oil spill cleanup, they are considered user fees and are netted from the total government cost of dealing with the particular energy-related problem. Second, energy-payments such as royalties reflect a return to the resource-owner for selling the oil or minerals in question, and are not a tax. Finally, given the fact that the data regarding Treasury losses from tax provisions are somewhat crude and that interactions between the various tax preferences are not incorporated into these data, our quantification of the tax subsidy magnitude should be viewed as an estimate.

How tax subsidies work

Tax subsidies increase expected returns by decreasing the costs associated with taxation. This is accomplished in four main ways: providing tax credits; altering the statutory tax rate; altering the taxable basis (i.e., the activities and expenses which are or are not included in the calculation of the tax base); and altering the taxable entity (such as by allowing losses from one corporation to off-set profits of another). Each of these methods of subsidizing private activity via the tax code has additional variants as well, which are described in more detail below.

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