Marshall Kaplan: Reduced energy subsidies will increase efficiency

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Economist Dr. David Lipton's recent paper, "Energy Subsidy Reform: The Way Forward," is necessary reading if you want to know why the global economy is a mess and why the U.S. economy – while improving – is recovering very slowly.

I believe Lipton's conclusions, based on his and International Money Fund's research, can be fairly summarized and interpreted as follows:

1. Energy subsidies create significant economic, environmental and social welfare problems, whether they are given to producers, suppliers or consumers and whether they are provided by the U.S., other developed nations, or developing nations.

2. Pre-tax subsidies, that is, when energy consumers pay less than the supply cost of energy, are bad for developing or emerging countries. They are costly and limit economic growth and the social welfare of their populations.

3. Pre-tax subsidies are not significant enough to cause extensive economic difficulties in developed nations. But advanced nations provide extensive post-tax subsidies that cause problems. Taxes are not large enough to account for adverse effects of energy consumption.

4. Subsidized prices crowd out investment, including investment with respect to economic growth, infrastructure, education, health care and social welfare

5. Subsidies result in skewed resource allocation and an overuse of subsidized technologies. The post-tax subsidy for petroleum products in the U.S. totals 2.42 percent of GNP. It is only .27 percent for natural gas and .64 percent for coal and, I believe, much, much less for other alternative fuels.

6. Subsidies increase energy consumption and as a result, pollutants and GHG emissions. For example, 70-80 percent of the oil used in the U.S. is used for transportation fuel. Gasoline derived from oil spews far more total GHG emissions and other pollutants than other alternative fuels – even coal. Neither coal nor gasoline ranks high as a clean energy source. Coal is dirtier, but its use as a fuel is relatively small compared to gasoline.

7. Subsidies provide far more monetary benefits to the affluent among us than they do to low-income groups. Higher-income groups use more energy per capita. They drive bigger cars, drive more miles and buy more air conditioners for larger houses. Presently in the U.S., the cost of gasoline at the pump accounts for somewhere between 12 percent to 17 percent of low and moderate household incomes – far more than for higher-income households.

In light of IMF's and Lipton's work, where do we go from here? Both suggest we eliminate subsidies – not instantly, but gradually – to better absorb possible related political, economic and social welfare problems.

Lipton emphasizes the need for transparency, public involvement and clear information as well as solid analysis concerning the effect of reducing subsidies, particularly on the "winners and losers."

He and the IMF are particularly concerned about the probable harm to the poor, if energy prices, including the price of fuel, continue to rise because of the devolution of subsidies. Both suggest targeted cash or near-cash transfers, such as vouchers, as the best approach to avoid harm to low-income budgets.

I am not sure that the energy markets, particularly the present highly restrictive, almost-monopolistic transportation fuel market will respond with significant price increases, assuming a slow reduction of subsidies.

Other factors will likely have a more important impact, such as financial sector speculation, tension in the Middle East and the health of the global economy.

While, over time, reduced subsidies will create a more efficient, and ultimately, fairer and transparent energy market, I am not as sanguine as IMF and Lipton concerning the global and, indeed, America's willingness to strategically lower subsidies.

A reduction in subsidies will help make energy markets, including transportation fuel markets, more efficient. They will become more equitable, if, as suggested by IMF and Lipton, the possible advent of higher gas prices occurs parallel with support for the poor. If implemented simultaneously with initiation of a more open, competitive, fuel market, the U.S. and other developed nations would level the playing field for transportation fuel and illustrate healthier economies, lower transportation fuel prices, cleaner environments and increased security.

Lipton and his IMF colleagues deserve commendation for taking us to a road less traveled.

Marshall Kaplan is an adviser to Fuel Freedom Foundation.


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