By: Nancy Olewiler
If you took a poll of Canadians and asked: “Is it better to use subsidies or taxes to stimulate investment in clean energy technologies and reduce pollution from energy production?”, my expectation is that a majority would say—subsidies. Yet in theory, they should work identically—if they are set at the same level. Both policies should raise the cost of using pollution-intensive technologies. Using the example of electricity generation, the tax works as follows. For each kilowatt hour (kWh) of electricity produced using a technology that emits air contaminants and greenhouse gases, the producer pays a tax of say, 2 cents. If that same producer were to generate electricity using a technology that emits no contaminants, they would receive a payment of 2 cents for each kWh produced. The opportunity cost of the tax and subsidy are identical. “Dirty” generation pays 2 cents per kWh if there is no change in technology or foregoes the opportunity to receive 2 cents. Same goes for the “clean” producer: it gains 2 cents/kWh and doesn’t have to pay the tax. Thus, on the margin, for each kWh generated, the policies should have the same effect.
The trouble is, they don’t have the same effect when looking beyond the marginal impacts on individual producers. Taxes generate revenue; subsidies require governments to increase taxes, reduce expenditures on other programs, or increase debt to pay for them. What about raising taxes? Unless the tax is non-distortionary, an example is a head tax—you cannot avoid it except by leaving the country. For every dollar of a subsidy granted, there is what economists call a ‘dead weight loss’ to the economy. This is the inefficiency that is created from taxes that change the relative prices of inputs or outputs. For example, income or payroll taxes distort the choice between work and leisure for the household or between using capital and labour for firms. What about diverting funds from other government programs to energy subsidies? People might be happier because it doesn’t imply any new taxes, but less happy about the loss of say, money for health care or kids’ education. You’d have to argue that subsidizing energy is more in the public’s interest than hiring more teachers or doctors. This could be the case, but this question is rarely asked of the public in quite the same way. Do you want energy subsidies to eat your health care or education or—pick your program’s—lunch? What about increasing public sector debt? That mortgages future generations—our children and grandchildren have to pay higher taxes or have fewer public services. They may benefit from cleaner energy production, but at what price?
Subsidies to the energy economy take many forms and can be granted to producers or consumers, but all of them generate costs to society that can result in the public paying a lot more to reduce emissions. These costs includes over $300 billion a year in subsidies to ethanol and biodiesel fuels which translate into amounts of between 30 and 90 cents per litre of fuel. Subsidies to renewables such as wind allow them to ‘compete’ with fossil fuels, but a carbon tax would do the same thing more efficiently. Consumers face electricity prices that are lower than high cost of new renewables because prices reflect the average cost of historical sources of generation plus the new sources, which at present are a small share of the total. There is little incentive for consumers to reduce their electricity use, putting more pressure on the system to add capacity, and that capacity is the high cost (and subsidized) renewable. The investment in renewables may help bring their average costs down over time, but the ‘playing field’ could be levelled with environmental taxes instead of subsidies, and we’d mortgage less of our kids’ future.
Federal and provincial subsidies to the major oil producing provinces: Alberta, Saskatchewan, and Newfoundland/Labrador (who represent 97% of Canada’s oil production) cost governments $2.8 billion per year . This is $2.8 billion that could have funded better child care, more parks, or left more money in our and our kid’s pockets. What about the argument that these subsidies benefit the economy by stimulating investment and employment? Sawyer and Stiebert  estimate what happens if all subsidies are removed—the subsidies have no effect on aggregate Canadian GDP or employment. Looking at 2020, Alberta’s GDP is higher with the subsidies than without, but even without subsidies, output from oil production would grow over time. Oil subsidies reduce government balances (i.e., bigger deficits or smaller surpluses) by 1% for the federal government, 5% for Alberta. The subsidies stimulate oil production, thus emissions of GHGs also are 2% per year higher than they would be without the subsidy. Looking to the future, what is most concerning is that if these subsidies remain, increased output of oil will double the subsidy to this sector as a share of government revenue. In other words, oil subsidies will eat more and more of everyone’s lunch over the next 10 years. Adding in all the renewable energy subsidies would create well over an annual $3 billion hit to the budgets of governments.
Do we have a choice? Can we stimulate the production of energy from clean sources without falling into the subsidy trap? Sure. Tax the pollution-intensive energy production and remove the subsidies. A tax on a polluting activity improves the efficiency of the economy by changing relative prices, making it more expensive to generate the energy with a pollution-intensive fuel than a less pollution-intensive means, and provides the incentive to producers and consumers to invest in cleaner technologies and reduce emission-intensive energy use. Taxes generate revenue; they don’t require it. What to do with the tax revenue? If governments don’t want to increase the size of the public sector, they can return the tax revenue to the economy. This is exactly what British Columbia’s carbon tax does. The revenue from the carbon tax is recycled in the form of lower personal and corporate income tax rates, plus transfers to those least able to adjust their consumption of GHGs (low income and rural folks, farmers). The net effect of the tax can thus be doubly beneficial—the tax creates incentives to reduce pollution and the use of tax revenues to lower distorting taxes improves economic efficiency and people’s well being.
Do we want to sustain inefficient energy subsidies that worsen the fiscal balance, particularly now when governments are trying to eliminate deficits? Or, should we tell our governments to phase out energy subsidies and create incentives for cleaner energy by taxing emissions? Our kids might want to be consulted about this before energy subsidies eat their whole lunch.
1. Dave Sawyer and Seton Stiebert (2010) “Fossil Fuels – At What Cost? Government support for upstream oil activities in three Canadian provinces: Alberta, Saskatchewan, and Newfoundland and Labrador”, Global Subsidies Initiative for International Institute for Sustainable Development.
Nancy Olewiler is a Professor of Public Policy and the Director of the School of Public Policy, Simon Fraser University. She is Chair of the Board of Directors of TransLink and on the board of BC Hydro’s subsidiary, Powertech.
Prior to joining the Economics department at SFU in 1990, she was a professor in the Economics Department at Queen’s University. From 1990 to 1995 she was Managing Editor of Canadian Public Policy. Ms. Olewiler has a PhD is in economics with a specialization in Resource and Environmental Economics from the University of British Columbia. Nancy’s areas of research include natural resource economics including energy and environmental policy.
Nancy has published in academic journals, edited books, has written two widely used textbooks (The Economics of Natural Resource Use andEnvironmental Economics), and produced numerous reports for the Canadian federal and provincial governments on a wide range of environmental and natural resource issues, including studies in the energy field and federal business tax policy.