May 19, 2015

The $5.3 Trillion Energy Subsidy Problem

US$5.3 trillion; 6½ percent of global GDP—that is the IMFs latest reckoning of the cost of energy subsidies in 2015. The figure likely exceeds government health spending across the world, estimated by the World Health Organization at 6 percent of global GDP, but for the different year of 2013. They correspond to one of the largest negative externality ever estimated. They have global relevance. And that’s not all: earlier work by the IMF also shows that these subsidies have adverse effects on economic efficiency, growth, and inequality.

What are energy subsidies ?

We define energy subsidies as the difference between what consumers pay for energy and its “true costs,” plus a country’s normal value added or sales tax rate. These “true costs” of energy consumption include its supply costs and the damage that energy consumption inflicts on people and the environment. These damages, in turn, come from carbon emissions and hence global warming; the health effects of air pollution; and the effects on traffic congestion, traffic accidents, and road damage. Most of these externalities are borne by local populations, with the global warming component of energy subsidies only a fourth of the total.

Energy subsidies are both large and widespread. They are pervasive across advanced and developing countries. Emerging Asia accounts for about half of the total, while advanced economies account for about a quarter. The largest subsidies, in absolute terms, are in China (US$2.3 trillion), the United States (US$699 billion), Russia (US$335 billion), India (US$277 billion), and Japan (US$157 billion). For the European Union, subsidies are also substantial (US$330 billion).

Start the process now, at the national level

Even if motivated purely by national reasons, energy subsidy reform would have favorable effects globally. Take, for example, the case where countries raise prices purely with domestic considerations in mind, that is, without adding in a correction for global warming. This would nevertheless help reduce global C02 emissions by about 17 percent.

Conditions are ripe to decisively engage in energy taxation and energy subsidy reform, further favored by lower international oil prices and low inflation. Steps at the national level could hasten progress at the global level ahead of the Paris climate change summit in December.

The fiscal implications are mammoth: at US$5.3 trillion, energy subsidies exceed the estimated public health spending for the entire globe. It also exceeds the world’s total public investment spending. The resources freed from subsidy reform could be used to meet critical public spending needs or reduce taxes that are choking economic growth.


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