Studies in Policy Choices and Interactions
Critical Issues in Environmental Taxation series
Edited by Larry Kreiser, Mikael S. Andersen, Birgitte E. Olsen, Stefan Speck, Janet E. Milne and Hope Ashiabor
Chapter 6: Reforming fossil fuel subsidies: will it make a difference?
Environmentally harmful subsidies (EHS) occur across different sectors and take different forms. The most obvious ones are direct budgetary grants and tax reductions or exemptions, but there also exist more indirect ones, such as: concessionary loans at reduced interest rates; state guarantees below costs; lack of full cost pricing; indirect support by for example financing infrastructure; or reducing liability for environmental disasters. They lead to a double damage: environmental and economic. They induce inefficient production and consumption choices resulting in higher levels of waste, emissions, resource extraction, or negative impacts on biodiversity. Economic theory states that providing a subsidy to any product on the market will have a distorting effect, unless it is introduced to correct an externality. Beneficiaries of the subsidy will increase their demand for the product, other sectors of the economy will face a lower demand and the overall efficiency will fall. With producer subsidies, costs of production are lowered, production is increased or sustained for those who produce ‘on the margin’ and the companies have fewer incentives to innovate. An additional distortion will occur through the government’s need to finance the subsidy, which it can do by increasing taxes or social security contributions. The former will reduce households’ purchasing power or the ability of companies to invest, the latter will result in lower incentive to work or to hire labour.
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