Tackling the folly of fossil fuel subsidies

OECD Trade and Agriculture Directorate

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There is a growing awareness that mitigating greenhouse-gas emissions is not only about introducing new climate policies, but also making sure that existing measures and regulations do not run counter to climate goals. In other words, governments should not undermine with one hand what they are seeking to achieve with the other. There is no better example of this problem than fossil fuel subsidies.

The OECD’s Inventory of Support Measures for Fossil Fuels released in September found that governments in the OECD and the emerging BRIICS countries (Brazil, the Russian Federation, India, Indonesia, the People’s Republic of China and South Africa) collectively support the production and consumption of fossil fuels to the tune of US$160-200 billion a year. With most of that support coming in the form of budgetary transfers and tax breaks–the OECD inventory identifies about 800 such measures– this effectively means that governments today still spend billions to encourage the extraction and burning of fossil fuels at taxpayers’ expense. Adding in the consumer price subsidies measured by the International Energy Agency, this makes total subsidies and other forms of support for fossil fuels in the vicinity of US$500-600 billion a year.

The problems with fossil fuel subsidies are by now well-known. They are distortive and costly, directing investment towards carbon-intensive sectors and activities with public funds that could be put to better use, such as in the education, skills and physical infrastructure that people most need and value in the 21st century. And because energy investment is often long-term, they lock societies into carbon-intensive pathways for decades to come at the expense of cleaner alternatives. But first and foremost, fossil fuel subsidies are evidently harmful to human health and the environment as they exacerbate global warming, local air pollution, and the damage to ecosystems caused by drilling and mining activities.

While the solution may seem obvious in today’s context, it often proves very hard to eliminate fossil fuel subsidies. One difficulty stems from the effects of higher energy prices on poorer households, for whom energy can represent a large share of total spending. So while subsidies often benefit the rich disproportionately, such as those who can afford cars, the impacts of reform on vulnerable segments of society cannot be overlooked. It is therefore essential that some portion of the fiscal resources saved through subsidy reform be redistributed to households by way of direct cash transfers or improved access to basic services.

A number of countries are already moving in the right direction, with examples found across the Americas, Europe and Asia. For the first time in years, Mexico started charging positive rates of excise taxes on sales of motor fuels after having subsidised their consumption for years. In 2013 Austria and the Netherlands both removed tax concessions for diesel used in farming. In 2014, India completely eliminated its subsidies for diesel fuel. More needs to be done though, and the OECD stands ready to help by further improving transparency on all measures that sustain our dependence on fossil fuels.

OECD (2015), OECD Companion to the Inventory of Support Measures for Fossil Fuels 2015, OECD Publishing.

OECD/IEA/Nuclear Energy Agency/International Transport Forum (2015), Aligning Policies for a Low-Carbon Economy, OECD Publishing, http://oe.cd/lowcarbon

©OECD Observer No 304, November 2015

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