Linking government support and what we value: The case of environmentally-harmful subsidies

Karen Hussey, The University of Queensland

Frans H. Oosterhuis and Patrick ten Brink (eds) Paying the Polluter: Environmentally Harmful Subsidies and their Reform, Cheltenham, Edward Elgar Publishing, 2014 (368 pp). ISBN 978-1-78254-530-9 (hard cover) RRP $180.00.

A subsidy is a form of financial aid or support extended to an economic sector, institution, business, or individual, usually with the aim of promoting a particular economic and/or social outcome. Subsidies work by providing an incentive to parties to behave in a certain way. For example, when governments offer subsidies for the purchase of roof-top solar installations, they hope this will encourage consumers to buy those installations (because they are cheaper than they would be otherwise), which in turn may reduce greenhouse emissions. A subsidy is not, therefore, an inherently terrible thing—governments are in the business of promoting desirable economic and/or social outcomes and thus it should be uncontroversial that financial aid or support should be extended in some cases. However, a subsidy should be well designed, such that its benefits exceed its costs, at the very least. Even so, problems arise because there are, inevitably, both winners and losers when decisions are made about what outcomes should be supported and to what extent. Whether subsidies are transparent, understood and debated by society is a similarly contentious and highly political business. The study of, and decisions about, subsidies can also be technically challenging because quantifying and comparing the relative benefits and costs of subsidies is often difficult.

In Paying the Polluter: Environmentally Harmful Subsidies and their Reform, Frans H. Oosterhuis and Patrick ten Brink bring together 21 researchers and policy analysts to consider the particular case of what the authors call ‘environmentally-harmful subsidies’ (EHS), namely those subsidies that encourage pollution or the inefficient use of natural resources. Some examples of EHS include:

  • payments to support domestic coal production, which encourage greater coal production than might otherwise occur;
  • road construction and maintenance costs that are not fully covered by excise taxes on fuel or road charging, which fail to account for the environmental costs of constructing and using those roads;
  • feed-in tariffs and price premiums for renewable electricity generated from waste incineration, which negate the benefits of generating the renewable electricity by encouraging air pollution through the burning of waste;
  • reduced fuel excise duty for diesel used in machinery or vehicles, which reduce the incentive to consume diesel judiciously;
  • reduced or no consumption taxes on domestic energy, water and/or food, which encourage inefficient use or consumption of these goods (for example, 30 per cent of food is thrown out in Australia, which suggests it is not priced appropriately);
  • tax-exemption for certain energy-intensive processes, which encourages their use and indirectly discourages the use of more energy-efficient processes;
  • selective exemptions for certain subjects or groups from specific regulations or standards, such as an Emissions Trading Scheme or the diesel fuel rebate for the agricultural and mining sectors, which mean those groups have no incentive to change behaviour and the environmentally-harmful activity can continue unabated; or
  • privileged access to government-owned or controlled natural resources, which removes competition for access to those resources, which in turn reduces the incentive for those seeking access to optimise their use of those resources.

Without exception, contributors to the collection are either European or based in Europe, and all are researchers or policy analysts in esteemed organisations such as the Institute for European Environmental Policy (IEEP), the Organisation for Economic Co-operation and Development (OECD), the European Commission or the United Nations Environment Programme (UNEP). This is significant because much of the pressure to identify and reform environmentally-harmful subsidies has been driven from Europe, and much of the pressure on the rest of the world will come from norm-setting organisations such as the OECD, the International Energy Agency (IEA), the International Monetary Fund (IMF) and the European Commission. The publication of the book is also very timely: with so many governments dealing with fiscal crises, well targeted reforms to subsidy regimes can reduce the burden on government budgets and free up funds for other, arguably more worthy—or at least less perverse—outcomes.

The motivation for the book is a desire to achieve policy coherence:

the ‘polluter pays’ and ‘user pays’ principles have become cornerstones of environmental policies, and using public money to support pollution and resource depletion is in flat contradiction with these principles – in other words: polluters should not be paid to pollute and users should not be paid to over-exploit or over-use resources. Likewise, the principle of fair competition requires that subsidies are used to correct market distortions and imperfections … not to exacerbate negative externalities such as pollution … Good governance principles imply that EHS should be disclosed, debated, and where appropriate reformed, taking into account the pros and cons of specific reform options (p. 8).

The motivation for the book is a desire to achieve policy coherence.

Certainly these intentions have been expressed over the last two decades by the international system of states at numerous conventions and fora, though the appetite for actual reform has been extremely mixed, depending on the country and sector in question. For example, there have been successful reforms to fuel subsidy regimes in Europe, Brazil, Turkey, Chile and South Africa, and similarly successful reforms to electricity subsidy regimes in Canada, Europe, The Philippines, Kenya and Uganda—but efforts to reform fuel and electricity subsidy regimes have largely failed in the United States, Indonesia, Mexico, Namibia, Nigeria and elsewhere. And while reforms to energy subsidies have occurred, their impact overall has been minimal: a report released by the International Monetary Fund in May 2015 estimates the global cost of energy subsidies to be $US5.3 trillion a year, or around $US10 million a minute every day (Coady et al. 2015, p. 5).

This book goes a long way to providing a ‘road map’ for further reform of EHS and there are three features that set it apart from, and which could certainly contribute to, the work being undertaken in Australia to establish where EHS exist and how they might usefully be reformed. The first is that the authors chart where EHS exist in a range of sectors, including but not limited to the use of fossil-fuels. The energy, agriculture, transport, food and water sectors are all examined and thus a comprehensive range of environmental impacts are considered, from the obvious impacts of fossil fuel use on climate change, through to the impacts on land and water resources from the agricultural and fishing industries, as well as the impacts of ‘urban sprawl and soil sealing’ on biodiversity. Importantly, in charting the full range of subsidies that could be environmentally harmful, the authors do not shy away from some of the more contentious—even counter-intuitive—examples that have conflicting economic or social goals. The complexities around subsidies for renewable energy generation, particularly biofuels, are discussed at length, and that discussion is prescient for other complex issues; that is, nuclear energy generation and large hydropower development.

Particular attention is paid in some chapters to those subsidies described as ‘hidden’ or ‘implicit’, because they are not immediately visible and are often ignored by policy analysts or commentators. Such subsidies include: (i) the lack of full-cost pricing for the provision of goods and services (ii) lack of resource pricing and (iii) the non-internalisation of environmental externalities. All three forms of subsidy have been the target of some reform in recent years, with more accurate pricing of water resources a case in point: the EU Water Framework Directive and Australia’s own National Water Initiative are explicit in their ambitions to cost fully the provision and consumption of water resources. Similarly, significant reform to property rights regimes has seen the uptake of market based mechanisms—such as tradeable fishing quotas and tradeable water rights—in a range of countries, all of which serve to remove financial support so as to increase efficiency in the use of natural resources.

It has traditionally been very difficult to quantify the negative impacts of subsidies.

To recall, the purpose of a subsidy is to produce an economic and/or social outcome. Conceptually and philosophically, then, the study of subsidies has tended to focus on their positive outcomes—normally expressed in terms of ‘jobs’ (keeping them) or ‘state revenue’ (ensuring it continues). Moreover, with the exception of subsidies for fossil fuels, it has traditionally been very difficult to quantify the negative impacts of subsidies and so the debate—at least in policy circles—has tended to focus on simply identifying subsidies and, where possible, quantifying their economic impact. However, Oosterhuis and ten Brink have gone to great lengths to ensure their book provides not only an overview of where the environmental harm exists, but also what the magnitude of that harm might be as a direct consequence of government subsidies. Thus, the second key feature of the book is that it demonstrates how to model both the economic impacts of EHS under different conditions, with the far more difficult challenge to assess the environmental impacts of those subsidies. In this way, the book goes a long way to quantifying the environmental harm done by some subsidies and, more importantly, to provide a ‘how to’ guide for policymakers in other jurisdictions to do the same.

The third admirable feature of the volume is that it systematically demonstrates how EHS can be reformed or removed with due consideration of the distributional impacts as well as with an eye to broader, overarching sustainability objectives. They identify three kinds of subsidies (p. 193):

  • The‘good’: still relevant, targeted, effective with positive impacts, few negative effects. In short, good subsidies continue to give value for money in meeting important policy priorities.
  • The‘bad’: whose objectives are no longer relevant, that lead to important negative effects and are inefficient; that is, subsidies which are, in their current form, a waste of public money.
  • The‘ugly’: badly designed subsidies that are inefficient, badly targeted, with potential negative effects. While the objectives may still be relevant and important, the instrument is not offering due added value and could be reformed to improve delivery.

In pursuing a reform agenda, then, a policy-maker has to reconsider:

the original purpose of the subsidy, to ask if this original purpose is still valid and to what extent the subsidy is actually contributing to its achievement. Next, if it is concluded that the subsidy indeed plays a relevant role, the question should be addressed of whether there are other ways to achieve the objective, which are less likely to be environmentally harmful and perhaps even more (cost-) effective (p. 119).

The last four chapters consider these design questions, and the discussion reaffirms what is little-appreciated in most work on subsidies—largely because it is undertaken by economists. This is that, like all public policy, a subsidy is an instrument that gives effect to a decision based on values and ideology: a government chooses to subsidise (that is, support) one industry over another; so too it can choose not to subsidise any industry at all.

How the debate about subsidies is framed naturally influences how the public responds.

The book is arguably the most comprehensive assessment to-date of where subsidies exist, their impact on the environment, and crucially, how they might be reformed. But where the ideas and analysis in the book are largely economic in nature, the extent to which their proposed reform agenda will be pursued is inherently social, which demands rigorous, informed and extensive debate by the those who pay for these subsidies and who suffer the long term consequences of them: people. However, to the extent that government subsidies are ever publicly debated in Australia, the debate is inevitably depressingly binary. In one scenario, the subsidy is portrayed as a ‘hand out’ of some description, with the inference being that the recipient of the ‘hand out’ couldn’t quite manage their own affairs properly and they are therefore highly irresponsible. In the other scenario, the subsidy is portrayed as a necessary ‘helping hand’ to secure ‘jobs’ in an industry that would otherwise thrive if it weren’t for the exogenous factors that are out of the industry’s control (that is, policies of other countries, conditions in the international market, or of the climate, in the case of ‘exceptional circumstances’ payments to farmers). How the debate is framed naturally influences how the public responds to it. For example, upon reading this book, it struck this Australian reader that even the term ‘environmentally-harmful subsidies’ is a term rarely used in Australia.

Nevertheless, occasionally the debate in Australia gets wedged between the ‘helping hand’ vs. ‘hand out’ models and we find ourselves debating the merit of government support, as has happened recently in the case of the Australian car manufacturing industry. On the one hand the Australian public are wary of supporting an industry that seems to be hanging on by their proverbial fingernails, but on the other hand, that same public finds it hard to imagine a future without Ford, Holden or Toyota having a home in the outskirts of Melbourne. The reasons behind the demise of Australia’s manufacturing sector are complex, centred largely on a lack of competitiveness vis-à-vis industries in other countries, which in turn is a function of high wages and conditions and the relatively high regulatory burden in this country. But these issues are rarely discussed in such debates, nor is the relative magnitude of government support to, say, the manufacturing sector as opposed to the resources sector. In fact, by international standards, annual assistance to the Australian automotive industry is relatively modest (for an excellent analysis of the subject, see Davison 2013).

Nevertheless, while the public might not fully comprehend the reasons behind an industry’s demise, they will very quickly assess who the winners and losers will be from any given decision on government support and emotion plays an important role in the public’s assessment—the car manufacturing example above is a case in point. It is recognition of this emotional dimension to public subsidies that Oosterhuis and ten Brink’s book is particularly valuable. The authors argue that not only must policy-makers identify and quantify EHS, they must also make public the link between those subsidies and the environmental harm they cause. In this way, policy-makers with a reform agenda can invoke an emotional reaction from the public in support of that reform.

Are Australian tax-payers aware of the trade-offs that are routinely made in their name?

Inherent in decisions about what and what not to subsidise are the trade-offs between economic and/or social outcomes. For example, following intense debate about ‘trade liberalisation’ in the 1980s and 1990s, the Australian government withdrew considerable economic support from a range of sectors, most notably the agricultural sector. The consequence of those reforms is that the Australian agricultural sector is now second only to New Zealand’s as being the ‘least protected’ in the world, and, admirably, it is now also one of the most efficient and respected agricultural sectors in the world. The withdrawal of that support reflected successive Australian governments’ belief in the benefits of free trade to Australia’s economy and, in the main, the public agreed with the logic provided at the time and they have continued to accept it since. Indeed contemporary negotiations over bi-lateral and regional free trade agreements are an excellent example of governments exercising their decision-making power to reflect underlying values. Interestingly, the pursuit of FTAs has continued unabated in recent years, despite analysis by the Productivity Commission (2015) suggesting there is sometimes little benefit for Australia from such agreements and that in toto the losers may outnumber the winners. For example, in the context of the Trans-Pacific Partnership (TPP), concessions made in relation to (i) investor-state dispute resolution arrangements and (ii) compliance and enforcement mechanisms for environmental regulations suggests that one of the biggest ‘losers’ from that agreement is likely to be the environment. While the detail and implications of the TPP have been debated intensely in policy and academic circles, the absence of any significant debate amongst the general public about which sectors, standards and regulations should be ‘protected’ in FTAs begs the question of whether Australian tax-payers are aware that these trade-offs are routinely being made in their name.

At the moment debates about subsidies in Australia are framed in terms of ‘jobs’, ‘business’, and ‘the economy’ at the expense of more nuanced discussions about the relationship between those issues and the environmental harm they cause. Arguably, as a consequence, the government has implicitly made a ‘decision’ about what ‘we’ do and don’t value, and this is reflected in international perceptions of Australia as one of the ‘laggards’ in climate change mitigation. Before any of the reform processes outlined in Oosterhuis and ten Brink’s excellent volume can be pursued in Australia, we must first ask ourselves: what do we value in Australia, now, and for the future? And do existing subsidy regimes accurately reflect those values? Only once we have answered those questions, can we systematically analyse our system of subsidies and tax breaks to figure out which ones are ‘good’, which are ‘bad’, and which are downright ‘ugly’. And ideally that debate would be far removed from the politicking of annual budgets, and would involve an economy wide analysis, well beyond the big ticket items such as negative gearing, the diesel fuel subsidy, and exemptions in the Goods and Services Tax (GST).

REFERENCES

Coady, D., Parry, I., Sears, L. & Shang, B. 2015, How large are global energy subsidies?, IMF Working Paper WP/15/105, Fiscal Affairs Department, International Monetary Fund, Washington [Online], Available: http://www.imf.org/external/pubs/ft/wp/2015/wp15105.pdf [2015, Jul 30].

Davison, R. 2013, ‘FactCheck: Do other countries subsidise their car industry more than we do?’, The Conversation, July 26 [Online], Available: https://theconversation.com/factcheck-do-other-countries-subsidise-their-car-industry-more-than-we-do-16308 [2015, Jul 30].

Productivity Commission 2015, Trade and Assistance Review 2013–14, Productivity Commission, Canberra [Online], Available: http://www.pc.gov.au/research/recurring/trade-assistance/2013-14/trade-assistance-review-2013-14.pdf [2015, Jul 30].

Dr Karen Hussey is an Associate Professor and Public Policy Fellow at the Fenner School of Environment and Society, at the Australian National University, where she undertakes research on policies, institutions and governance arrangements relating to sustainable development. Karen has a PhD in Political Science from the University of Melbourne, an M.Econ.Sc from University College Dublin, Ireland, and a B.A (Economics and Politics) from the University of Melbourne. From October 2015 Karen will be Professor and Deputy Director of the Global Change Institute at the University of Queensland.