Energy Subsidies: A Historical Perspective

12/12/11

As we turn the page on the year 2011, there is no shortage of topics about which the entire world seems to be debating. One that interests me the most is the renewed debate on the role of government in the energy sector, specifically in the United States. Budget shortages, deficit increases, front-page analysis of public-backed private enterprises, and a particularly bitter political climate have combined to push this topic to the forefront more so in 2011 than in recent years. It’s as though we are back in the smoky classrooms of the University of Chicago in the ‘50s and ‘60s where economists engaged in frequent Keynes Vs. Friedman (Milton not Thomas, mind you!) debates.

Energy is always a popular topic in the U.S., given its strategic importance to national security. All this recent debating has been interesting to follow but a bit confusing. Economists, reporters, business folk, and politicians do not seem to agree on what constitutes a government subsidy, let alone which sub-sector is the recipient of how much. While I do not want to take any sides, I thought it would be worthwhile to examine what constitutes a government subsidy, and what subsidies and how much were provided by the U.S. government historically.

As I began to think about what sectors to focus on, it made sense to examine those that have been of significant strategic importance to U.S. economic growth in the past. The rise of the U.S. to be the largest economy in the world was driven to a large extent by what some refer to as the second industrial revolution constituting the rise of the railroad, steel making, telecommunications, petroleum, and the automobile industries. This article attempts to capture the subsidies provided by the U.S. government to some of these industries at different stages of their growth cycle.

What is an energy subsidy?

I am no economist, but it seems to me that we can all agree on what constitutes a government subsidy without too much debate. Table 1 (below) attempts to summarize the different forms that energy subsidies can take. Most of these subsidy types are immediately recognizable. The “type” that has generated much debate so far is the “Failure to include Externality Costs.” No matter where you stand on the climate change debate, it is not that hard to see that pollution has at the very least caused smog and acid rain—ask the residents of the Los Angeles from the ‘80s and, more recently, those from Beijing. There has not been a worldwide accepted externality cost measure yet, but as we move forward the chances of that happening are higher.

Regardless, it is safe to say preferential tax treatments and price controls are as much a government subsidy as a cash grant or a low-interest loan. The U.S. government wallet is a bit lighter in both cases.

Historical U.S. government subsidies

The growth of the U.S. economy after the Civil War to become the world’s largest economy was driven by increasing commercialization of technologies including the railroad, iron and steel making, petroleum, and the internal combustion engine. Besides private capital and resources, an important catalyst behind the development and growth of these industries were U.S. government subsidies at different stages. Table 2 summarizes the amounts, types, time period, and stage at which government subsidies were provided to these industries.

Railroad and transportation

U.S. railroad companies laid more than 35,000 miles of track between 1867 and 1873—more than three times that laid in the previous 30 years. Congress gave the railroad companies more than $64 million ($8 billion in 2011 US$ at 3.5 percent inflation) in loans and tax breaks and more than 100 million acres of public land. The U.S. railroad industry flourished in the next few decades, acting as a leading catalyst of the economic boom.

Between 1921 and 1971 the U.S. Federal Transportation budget for highways totaled $122 billion, averaging a little over $2 billion a year. The U.S. Interstate system took shape in this time period and laid the foundation for population and worker mobility.

Iron and steel-making

U.S. steel makers have received a steady stream of taxpayer-funds subsidies throughout history. Ernst and Young estimated federal, state, and local government subsidies amounted to over $30 billion between 1959 and 1989. A more recent study, using more conservative assumptions and measurements, has calculated the combined total (through 1999) at over $16 billion.

The cost to U.S. taxpayers has come from special exemptions from federal environmental regulations granted specifically to the steel industry, largely from the Clean Air Acts of 1981 and 1990. Steel companies have also greatly benefited from various “Buy American” acts. Under the provisions of these acts, foreign steel companies are foreclosed from competing for contracts in a number of highway construction, mass transit, pollution abatement, state and local public works, and airport construction programs.

Petroleum

Tax breaks to the petroleum industry date back nearly a century, when they were intended to encourage exploration. The Tariff Act of 1913 allows oil companies to claim deductions for the lost value of tapped oil fields far beyond the amount the companies actually paid for the oil rights. In an attempt to deter Soviet influence in the Middle East in the 1950s, the State Department backed a Saudi Arabian accounting maneuver that reclassified the royalties charged by foreign governments to American oil drillers. Over the last 10 years, oil companies have also been aggressive in using foreign tax havens.

What does all this mean?

Industries at the core of U.S. national growth and security have historically benefited from subsidies—that is a fact. Some have benefitted in their early stages while others have needed that extra push to grow and mature. Some have utilized tax breaks while others have benefited from loans. The energy sector is no different. There appears to be a marked and acrimonious schism developing (if it has not already) between advocates of traditional (translation: fossil-fuel derived) energy and alternative energy (renewable) with arguments on erasing subsidies. This is not productive. Rather than arguing for eliminating subsidies for specific groups, let’s focus our attention on efficient and effective mechanisms for maintaining and developing a long-term energy strategy for the U.S. and the world. Subsidy is not a bad word. Used effectively, today’s subsidy is tomorrow’s tax revenue.

Mahesh Konduru is currently a Principal at the Potomac Energy Fund. He is an alumnus of the MIT Sloan School of Management. Follow @

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