Manifest Subsidy 

Governmental support for energy innovation is hardly the stuff of 20th century liberalism. A history lesson.

 

By Nancy Pfund and Ben Healy

 

From land grants for timber and coal in the 1800s to tax expenditures for oil and gas in the early 20th century, from federal investment in hydroelectric power to research and development funding for nuclear energy and today’s incentives for alternative energy sources, America’s support for energy innovation has helped drive our country’s growth for more than 200 years.

 

Using data culled from the academic literature, government documents, and NGO sources, the extent of federal support (as well as support from the various states in pre-Civil War America) for emerging energy technologies in their early days is clear. In discrete periods in history, the federal government enacted specific subsidies. While other scholars have suggested that the scope of earlier subsidies was quite large, we are—as far as we know—the first to quantify exactly how the current federal commitment to renewables compares to support for earlier energy transitions. Our findings suggest that current renewable energy subsidies do not constitute an over-subsidized outlier when compared to the historical norm for emerging sources of energy. For example:

- As a percentage of inflation-adjusted federal spending (eliminating increases in new programmatic spending since the introduction of early oil and gas subsidies in 1918), nuclear subsidies comprised more than 10 percent of this normalized federal budget over their first 15 years, and oil and gas subsidies constituted 5% percent of the total budget. Measured on a similar scale, renewables constituted only about one percent. That is to say, in an apples-to-apples comparison, the federal commitment to oil and gas was five times greater than the federal commitment to renewables during the first 15 years of each subsidies’ life, and it was more than ten times greater for nuclear.
- In inflation-adjusted dollars, nuclear spending averaged $3.3 billion over the first 15 years of subsidy life, and oil and gas subsidies averaged $1.8 billion, while renewables averaged less than $0.4 billion. The charts below clearly demonstrate that federal incentives for early fossil fuel production and the nascent nuclear industry were much more robust than the support provided to renewables today.

 

Click here for graphics. Historic Average of Annual Energy Subsidies, Competitive Energy Subsidy Trends, and Energy Subsidies Percent of Federal Budget.

 

Drilling Deeper Into the Past
Over the course of decades, contentious debates have raged in Washington, D.C., about the appropriate size and scope of federal subsidies to the energy sector, including support for both traditional fossil fuel industries and the emerging renewable energy sector. Certainly, a quick survey of existing subsidies demonstrates that critics have plenty of legitimate reasons to complain. Take the capital gains treatment of royalties on coal as an example. This subsidy allows owners of coal mining rights to reclassify income traditionally subject to the income tax as royalty payments, thereby allowing owners to pay a reduced tax rate:

 

 

Click here for graphic, Taxation and Subsidies

 

In 1950 and 1951, Congress increased a number of taxes to pay for the United States’ entry into the Korean War. With prevailing 1951 marginal income tax rates ranging up to a high of 91 percent and capital gains tax rates at 25 percent regardless of income, the reclassification was primarily adopted to insulate certain owners of coal mining rights from high marginal income tax rates—thus encouraging additional production. Since then, both income and capital gains tax rates for individuals have fallen, and the capital gains tax rate for individual owners currently stands at 15 percent. Yet the credit is still available to members of the coal industry.

 

 

Click here for graphic, US Growth and Energy Transitions

 

 

True, this Korean War-era tax break seems grossly out of place in the 21st century, but not all subsidies are created equal. Historically, as Mona Hymel summarized in a 2006 Arizona Legal Studies Discussion Paper, policymakers have justified intervention in energy markets “1) to promote a new technology during the early developmental stages and 2) to pay the difference between the value of an activity to the private sector and its value to the public sector.” Thus, it is worth evaluating our current energy subsidies through a longer historical lens, so that we can better understand how current incentives compare to past government support for the energy sector.

 

 

 

Fueling History
We can read the history of the United States—our country’s geographic and economic expansion—through the history of our energy production and consumption. Through war and peace, through westward expansion and our rise to economic and military superpower status, we find that energy transitions fueled it all. Wood and small hydro powered our country’s early, rural days. As cities expanded, railroads crisscrossed the nation, and the Industrial Revolution took hold, coal dominated. With the invention and improvement of the internal combustion engine, oil catapulted into our preeminent fuel. Large hydro became a reality thanks to Depression-era initiatives that have continued to drive economic development programs across the country decades later, followed by nuclear power on the heels of World War II. And today, in pursuit of greater energy security, enhanced environmental quality, and economic growth on a globalized playing field, renewable energy sources are transitioning from the margins to the mainstream. As the chart below starkly illuminates, our wealth and our energy usage are intimately intertwined.

 

 

Energy innovation has driven America’s growth since before the 13 colonies came together to form the United States, and government support has driven that innovation for nearly as long. Although most of our quantitative analysis focuses on federal support, it is important to note that states have also contributed to the American energy narrative throughout our history, from the support of coal in the 19th century to incentives for renewable energy production 200 years later.

 

 

Click her for graphic, Primary US Energy Consumption vs GDP 

 

 

Overall, what we find, in contrast to much of today’s headline-grabbing rhetoric, is that today’s government incentives for renewable energy pale in comparison to the kind of support afforded emerging fuels during previous energy transitions.
In researching this paper, we took a very practical approach to data collection, asking ourselves four questions:
1. Was a given subsidy actually designed to increase domestic production of a given resource (or does it do so in practice, even if that was not its original intention)?
2. Was the data related to that particular subsidy available?
3. Did the subsidy exist during the early stages of a resource’s domestic production?
4. Did inclusion of that subsidy increase our ability to compare subsidy levels across resources and over time?

 

 

Those questions resulted in the exclusion of various subsidies from this analysis. But consider the major energy sources that have emerged over the last 100 years of American history:

 

 

Oil and Natural Gas
We looked solely at the subsidies embodied in the expensing of intangible drilling costs and the excess of percentage over cost depletion allowance.

 

 

From a 2011 report by Molly F. Sherlock for the Congressional Research Service:

“For more than half a century, federal energy tax policy focused almost exclusively on increasing domestic oil and gas reserves and production. There were no tax incentives promoting renewable energy or energy efficiency.

During that period, two major tax preferences were established for oil and gas. These two provisions speed up the capital cost recovery for investments in oil and gas exploration and production. First, the expensing of intangible drilling costs (IDCs) and dry hole costs was introduced in 1916. This provision allows IDCs to be fully deducted in the first year rather than being capitalized and depreciated over time. Second, the excess of percentage over cost depletion deferral was introduced in 1926. The percentage depletion provision allows a deduction of a fixed percentage of gross receipts rather than a deduction based on the actual value of the resources extracted. Through the mid-1980s, these tax preferences given to oil and gas remained the largest energy tax provisions in terms of estimated revenue loss.”

 

And from a 1990 report by Thomas J. McCool of the General Accounting Office: “... The marginal effective federal corporate tax rates—i.e., the tax rates on genuinely incremental investments—for domestic petroleum production are already among the lowest for a major industry, due to the effects of existing tax incentives. These analyses estimate marginal effective rates on petroleum production investments to be about half of the statutory rate for integrated producers (i.e., producers with significant refining or retail activity). Marginal effective rates can be near zero for independent (i.e., nonintegrated) producers eligible for percentage depletion, a favorable tax treatment for depletable costs. These relatively low marginal rates already provide incentives to make petroleum production investments that have pretax returns below those of investments in other industries—i.e., relatively inefficient investments. Some petroleum production investments face negative marginal effective rates. This means that such investments are actually more profitable after taxes than before taxes because they help reduce taxes on other income.

 

 

(Authors’ note: in 2009, domestic production of petroleum accounted for a little more than 40 percent of total U.S. consumption, and domestic production of natural gas accounted for more than 90 percent of total consumption.)

 

According to a 1987 analysis in The Energy Journal that considered the impact of Reagan era tax reform on the oil and gas industry, “Effective tax rates on other industries average[d] about 28 percent under pre-1986 law, compared to rates on oil investments ranging from 6 percent to 24 percent under pre-1986 law.” Given the high profile of these two major tax expenditures, we felt on firm ground basing our analysis of oil and gas subsidies on this pair of long-lived government incentives. As one early researcher wrote in 1975’s Studies in Energy Tax Policy, “Our findings reveal that several public policies significantly affected investment in crude petroleum reserves. . . . Our empirical estimates support the position that the special federal tax provisions . . . have induced the petroleum industry to maintain a larger investment in proved reserves than it would have in the absence of these policies.”

 

 

Take it from an even more storied source: “In 1937, President Franklin Roosevelt declared that percentage depletion was ‘perhaps the most glaring loophole in our present revenue law.’ ”

 

 

Coal

The Green Scissors Campaign is a 15-year old effort “to make environmental and fiscal responsibility a priority in Washington,” sponsored by a variety of D.C.-based public interest groups.

 

 

In their 2010 report, the Green Scissors analysts claimed that, “Subsidies to the coal industry began in 1932, when the federal government first began allowing companies to deduct a portion of their income to help recover initial capital investments (the percentage depletion allowance).” Of course, what they mean is that modern, income tax-based subsidies began in 1932. Both the federal government and the various states heavily subsidized coal in the 19th century. But since we do not have access to data quantifying the coal subsidies that go back to the fuel’s true origins in the early 1800s, we have chosen not to include coal subsidies in our comparative quantitative analysis.

 

 

Nuclear
In considering how best to quantify nuclear data, we considered multiple sources and decided to use the analysis conducted by lifelong energy analyst and consultant Marshall Goldberg, a resource planner with a broad background in resource and land use policy and impact analysis. In his work, Goldberg includes principally the costs of regulation, civilian R&D, and liability risk-shifting (the Price-Anderson Act), while also taking into account both payments from the government to industry and government receipts from industry— thus coming up with a net annual figure for every year from 1947 to 1990. Although “on-budget” expenditures for the nuclear industry have been enormous, we especially value Goldberg’s analysis because he attempts a rigorous quantification of the “off-budget” value of the Price-Anderson Act of 1957, which “provided federal indemnification of utilities in the event of nuclear accidents, thus removing a substantial (and perhaps insurmountable) barrier to nuclear power plant develop- ment.”

 

Congressional testimony at the time of passage confirms the importance of Price-Anderson: For instance, the Edison Electric Institute noted “We would . . . like to state unequivocally that in our opinion, no utility company or group of companies will build or operate a reactor until the risk of nuclear accidents is minimized.”

 

 

Hydro
Measuring subsidies to big hydro is a beast of a task, and there is broad disagreement about what analysts should and should not include as a subsidy. Management Information Services estimates about $80 billion in historical federal subsidies to hydroelectric power, with nearly three quarters of that total coming from their “market activity” category: “Market activity incentives for hydroelectric energy include federal construction and operation of dams and transmission facilities—estimated as the portion of the net investment in construction and operation of dams allocated to power development and the relevant transmission facilities—and the net expenditures of the power marketing administrations.”

 

 

On the other hand, stresses Goldberg, data on early expenditures for hydropower are incomplete. This reflects both the scarcity of archived generation and investment data on hydropower—the development of which began in the 1890s—and the complex historical context of federal hydropower development. In particular, federal hydropower facilities often formed part of larger projects with multiple goals, including flood control, river navigability, regional development, and stimulation of the local and national economies. For instance, most of the spending on hydropower projects undertaken by the U.S. Army Corps of Engineers and the Bureau of Reclamation in the 1930s and 1940s was considered supplemental to the primary purpose of building dams for irrigation, flood control, and public water supply, among other uses. . . . For this reason, it is difficult to attribute a specific portion of federal investment for power generation. Nevertheless, to assist in further investigations, the figure of $1.6 billion can be given for a set of straightforward subsidies to hydropower.

 

This $1.6 billion figure ($2.7 billion in 2010 dol- lars) comes from a 1993 analysis by Doug Koplow of Earth Track, a respected think tank that works to consolidate and standardize energy subsidy data and present a comprehensive view of such subsidies so that we can better evaluate them. Koplow arrives at his $1.6 billion figure by analyzing the implicit borrowing subsidies provided to the Tennessee Valley Authority, the Bonneville Power Administration, and the other Power Marketing Administrations by the federal government over an 80-year period, thanks to their ability to access capital at lower-than-market rates.

 

However, even with a rigorous analysis such as Koplow’s, hydro data remains unsatisfying. For example, consider the fact that large hydroelectric facilities are essentially wholly owned subsidiaries of the federal government: thus, they do not need to earn private sector rates of return and can price electricity more cheaply than they otherwise would. This is clearly an important subsidy, but it is also an incredibly challenging one to measure. In the end, then, since hydro does not lend itself to facile comparisons with privately owned energy resources, we decided to exclude historical hydro data from our quantitative subsidy analysis. (For those who want to dig more deeply into the subject, we recommend the analyses by both Koplow and Management Information Services, since the two follow vastly different approaches to calculating federal support for hydroelectric power.)

 

 

Biofuels
Often, when comparing current energy subsidies, the conversation breaks down into a “fossil fuels vs. renewables” debate, with little thought given to the diversity of energy sources contained within each of those categories. Thus, using data from the Joint Committee on Taxation, the Treasury, and annual Office of Management and Budget analytical reports, we have broken out federal support for biofuels from those incentives designed to support increased wind, solar, and geothermal energy production. Our comparison takes into account both the income tax credit for alcohol fuels and the excise tax exemption for alcohol fuels, including that exemption’s more recent transition to a credit. As Sherlock notes, beginning in 2005, the volumetric ethanol excise tax credit (VEETC) was introduced to replace the previously available excise tax exemption for ethanol. Since excise tax credits are deductible, replacing the excise tax exemption with an excise tax credit has additional federal revenue consequences, above and beyond payouts for the excise tax credit. Specifically, income tax receipts decrease due to the higher excise tax deduction.

 

 

Some biofuels subsidy analyses have also included Department of Agriculture support for farmers that has incented the growing of corn for ethanol. As the Environmental Law Institute points out, “A substantial portion of USDA’s corn production subsidy payments are received by farmers who use their corn to produce ethanol. Even though these subsidies are not directed at corn growers specifically for the purpose of producing ethanol, they represent a government expenditure that benefits energy and that supports a specific fuel (and Congress has not acted to restrict the use of these subsidies in order to prevent them from supporting corn ethanol production).

 

 

Although this argument certainly has merit, the fact remains that these USDA subsidies are designed to stimulate the growing of corn, not the creation of fuel. The fact that some of this corn ends up as fuel is driven by the various alcohol tax incentives, federal blending requirements, and the price of traditional fossil fuels at any given moment in time, not by USDA grants. We have not included these USDA grants in our biofuels accounting.

 

 

Renewables
Finally, we categorize renewables subsidies as those tax subsidies—principally, the production tax credit, as well as the investment tax credit—that incent power generation from wind, solar, and geothermal sources. Although some minor incentives became law in the late 1970s, significant federal support did not take hold until after the Energy Policy Act of 1992. Thus, we begin our accounting of renewables subsidies in 1994, when the first firms really took advantage of that 1992 law, as summarized in 2007 by Gilber Metcalf: “Section 45 of the IRS code, enacted in the Energy Policy Act of 1992, provided for a production tax credit of 1.5 cent per killowat hour (indexed) of electricity generated from wind and closed loop biomass systems. The tax credit has been extended and expanded over time and currently is available for wind, closed- loop biomass, poultry waste, solar, geothermal and other renewable sources. Firms may take the credit for 10 years.

 

 

“Nonrefundable investment tax credits for alternative energy were initially put in place in the Energy Tax Act of 1978 at a rate of 10 percent for solar and geothermal property. That law provided a number of investment tax credits including a credit for residential energy conservation investments. This latter credit expired in 1982. [The Energy Policy Act of 2005] increased the investment tax credit for solar to 30 percent [extended through 2016 as part of the Energy Improvement and Extension Act of 2008].3”

It is worth noting that the American Recovery and Reinvestment Act of 2009 included a host of temporary clean energy subsidies (many focused on energy efficiency and research and development, although some specifically targeted towards increasing renewable energy production). These temporary provisions do not fall within the scope of this paper, but we do recommend their inclusion in future longitudinal analyses.

 

 

The quantitative analyses presented in the previous section, along with the qualitative discussion of 19th century energy subsidies, demonstrate that not only are incentives a tried and true American approach to driving energy innovation, but also that current subsides for renewable technologies make up a much smaller federal commitment than was made during previous transitions. Looking at the history of American energy subsidies, a strong case can be made that in order to drive the next generation of energy technology, the federal government needs to continue its support for renewables, in line with hour historical commitments to innovation.