Signs of Hope for Reforming Energy, Ag Subsidies?

Rising commodity prices and tight government budgets are adding to pressures to reduce subsidies for energy and agriculture in many countries. Two new reports, including my recent paper on agricultural and biofuel subsidies, provide fodder for this debate by documenting the extent of subsidies in these sectors and analyzing their negative effects, particularly for developing countries and the poor.

On energy, the International Monetary Fund (IMF) launched a new report last week, “Energy Subsidies Reform: Lessons and Implications,” that includes a heroic effort to document subsidies in 176 countries. The paper highlights the broad negative consequences associated with energy subsidies—including a diversion of public funding in a time of tight budgets, negative impacts on private investment in the energy sector, and excessive energy use, which exacerbates local pollution and global climate change.  The report also emphasizes that energy subsidies tend to reinforce inequality because richer households usually capture most of the benefits.

The IMF report also analyzes several cases of energy subsidy reform and identifies key elements in implementing successful reform, including increased transparency and clearly communicated information about the magnitude and impacts of subsidies. The report also stresses the importance of phasing in price increases and targeting measures to mitigate the impact on the poor. The report identifies 28 reform episodes in 22 countries and concludes that 12 were successful, 11 eleven were only partly successful (perhaps because of reversals in reform), and 5 were unsuccessful.

CGD President Nancy Birdsall participated in the launch of the report and applauded the IMF for its work on subsidy reform, particularly the emphasis on how to do policy reform and on how energy subsidies exacerbate inequality. One of the key contributions of the new IMF report is the effort to quantify the far larger “post-tax subsidies” that occur when governments fail to tax or regulate the negative externalities associated with energy consumption. Nancy highlighted the fact that, while pretax subsidies in advanced countries are low relative to those in developing countries as a percent of GDP, they are considerable in absolute terms, and that US post-tax subsidies are the largest in the world, as shown in the slide below from her presentation. She called on the Fund to use more country-specific analysis to show the world the nature of the problem, especially in the biggest sinner, the United States,  and to put advanced country subsidies on the agenda in their Article IV discussions.  

Nancy also used my recent policy paper to point to some particularly development-unfriendly subsidies at the intersection of energy and agriculture. Agriculture in advanced countries tends to be quite energy-intensive in general, so subsidies to agriculture also encourage energy use—both directly in machinery and transportation, and indirectly through fertilizer use.

But it’s worse than that. On average each year between 2009 and 2011, the United States and European Union reported waiving or rebating $2.5 billion and $4.5 billion, respectively, in fuel taxes for farmers. At least that’s what they reported to the OECD, but neither reported these as trade-distorting subsidies under the World Trade Organization agricultural agreement. Moreover, the US-reported figure has been exactly the same since the OECD started collecting agricultural support data in the mid-1980s.  Clearly some additional transparency is needed here! The EU figure also stands out because it is higher than what they report as environmental payments. Just as with the other energy subsidies analyzed in the IMF report, these fuel subsidies for farmers divert public funds, are inequitable (larger producers get larger subsidies), encourage energy use, and increase greenhouse gas emissions.

In addition to the impact on climate change, ag subsidies are particularly development-unfriendly because, along with the biofuel policies discussed in a moment, they distort incentives to invest in developing-country agriculture and they contribute to price volatility, which is bad for poor producers and consumers alike. The European Union has been steadily reducing the trade-distorting share of its agricultural support, but the overall level remains quite high—higher than I would want to see if I were a European taxpayer! And, in the United States, subsidies payments are down sharply because prices are high; but reforms that would prevent subsidies automatically rising when prices dip are largely absent in the farm bills stalled in Congress. While the prospects for the farm bill remain unclear, one sign of hope is a letter from 20 US senators declaring their opposition to another extension of the current farm bill if it also extends $5 billion in direct payments that go to farmers every year, even when prices are sky-high. And, when the farm bill finally comes up again, maybe Congress will also take a look at the tax credits subsidizing on-farm fuel use.

Finally, biofuel mandates and subsidies are not necessarily much of a subsidy to energy—it depends on the relative costs of the inputs and outputs—but they are clearly a subsidy to agriculture. I analyze the problems with biofuel policies in the new policy paper and lamented the Environmental Protection Agency’s unwillingness to take action to mitigate the negative effects here. But there is hope for tackling subsidies here as well. The European Parliament recently voted to reduce the target for biofuels in transportation fuels there, and Congress allowed the blenders’ tax credit for ethanol to expire in 2011 when the cost to taxpayers reached $6 billion annually. And this year, because of a range of concerns about the negative effects of the policy, the House Energy and Commerce Committee has been reviewing the operation of the Renewable Fuel Standard and considering possible changes to make it more flexible. The Chicago Tribune argues eloquently that the biofuel mandate (along with “out-of-control” crop insurance) will even turn out badly for farmers because the incentives to plant nothing but corn will encourage disease.

So, with transparency, analysis, and growing evidence of the costs of subsidies, some progress is being made in reforming these distorting policies. Much remains to be done, but as Supreme Court Justice Louis Brandeis famously remarked, “sunlight is said to be the best of disinfectants.”

I would like to thank Albert Alwang for help in putting this post together, and Christian Meyer for sharing the slide.