With fluctuating oil prices and intermittent global shortages, governments use fossil fuel subsidies to keep fuel prices low for consumers, usually through investment in fossil fuel production and tax deductions to oil companies. But subsidies create a host of problems, including inefficient government spending, corruption, fuel smuggling, social inequity, and contribution to global emissions. The calls for fuel subsidy reform are reflected in UN SDG target 12.c, which aims for the removal of harmful subsidies in a manner that protects the poor, who can be hit hardest by subsidy removal. Member states committed to phasing out inefficient fuel subsidies at the Pittsburgh G20 summit in 2009, but many of these states struggled to navigate the political and social barriers to subsidy reform in the decade since. Simply withdrawing subsidies is not practical – a strategy is needed. A carbon dividend system, whether administered by governments, corporations, or a public trust, addresses the problems with fuel subsidies while keeping fuel prices affordable.
A carbon dividend system is a variant on current emissions trading systems. Fee-and-dividend sets a fee on fossil fuel extraction and import, while cap-and-dividend sets a science-based cap on emissions, under which permits on fuel extraction and import are created. All net revenue generated from fees or sale of carbon permits to fossil fuel producers is then returned to people as dividends. Either system would ideally include a border adjustment tariff on imported fuels and goods to prevent emissions leakage to neighboring states or countries, preserve domestic competitiveness, and encourage other countries to adopt a carbon pricing system.
Withdrawing fuel subsidies quickly can cause a sharp increase in fuel prices and spark social unrest (e.g., Nigeria in 2012, Mexico in 2017, Ecuador in 2019), so a gradual approach is needed. Fuel subsidies tend to follow the volatility of global oil prices, often increasing or being quickly reintroduced during global price hikes. A cap-and-dividend system starts with a cap on emissions that gradually tightens over time, sending a predictable price signal for business to shift to alternative energy sources. A pricing mechanism can also help keep domestic fuel prices stable as they rise – for example, a “price collar” involving both a floor and a ceiling that rises with fuel prices would create a reserve of funds (when global market prices fall below the floor) that can offset the need for subsidies when market prices exceed the ceiling. A carbon dividend system would allow for gradual withdrawal of fuel subsidies while keeping fuel prices stable.
It’s a win for economies
A dividend system, particularly cap-and-dividend, is not simply another regulation or tax on carbon – it uses market economics to make renewable energy and low-carbon goods more appealing than fossil fuels and carbon-intensive goods, all while generating income for most households. While a fee or emissions cap would increase the price of fuel and carbon-intensive goods, dividends would be more than enough to offset these increased prices for most people. In the U.S., for example, a REMI economic impact analysis indicates that a fee-and-dividend system beginning in 2016 would give extra cash to most households, in turn stimulating the U.S. economy over a decade through consumer spending and creation of 2.1 million jobs in sectors like healthcare and retail. Fuel subsidies only have a direct impact on the energy sector, while dividends benefit everyone.
Governments spend substantially on fuel subsidies (e.g., equivalent to 6.3% of global GDP in 2015). In several developing and emerging economies, it is estimated that governments have spent between 10-50% of their revenue on fuel subsidies. Dividends don’t require government budget spending, and they don’t generate additional revenue for governments – instead, they can free up hundreds of millions in government spending on fuel subsidies, which can be saved for other purposes or partially reallocated to higher-return public investments like health, education, and energy access.
Fuel subsidies are often obscure to the public due to their complexity, enabling potential for corruption and leakage. Subsidy funds may be misused by oil companies, as in the case of Nigeria, and fuel smuggling to neighboring countries with higher prices is a major problem globally. Thus, part of what is spent on subsidies never reaches energy consumers as intended. Dividends are a simple, transparent mechanism that directly benefits the public – unlike reduced fuel prices, which fluctuate, vary by region, and are driven by opaque and somewhat discretionary market forces. A similar system, ‘classic’ Cap & Share, can be used when there is concern that the government will not distribute dividends. In this system, carbon permits are distributed to the population, who can then sell them to fossil fuel companies via banks and post offices.
Fuel subsidies – intended to keep fuel prices affordable – are a socially regressive welfare policy. In countries with high fuel subsidies and large energy access deficits, it was estimated (2018) that fuel subsidy spending amounts to about $573 USD per household without access to electricity. Often, this share goes to wealthier households instead: in developing countries, the wealthiest quintile of households have received an average of 43% of subsidy benefits – compared to 7% for the poorest quintile. Under dividends, fee or permit revenue is shared equally among the population to benefit everyone, but low-income individuals can benefit the most as they tend to consume far less fuel than the wealthy. Direct payments to households, rather than lower fuel prices, are a more effective means of reducing poverty – Iran succeeded in its 2010 fuel subsidy reform by replacing subsidies with cash transfers to household bank accounts, in the process reducing inequality by 10% and poverty by 64%. Other countries, such as India and Saudi Arabia, have successfully taken similar ‘oil-to-cash’ measures to reform fuel subsidies. Case studies of cash transfer programs suggest that such transfers do not discourage work and are not misused by the poor on “temptation goods” like alcohol and tobacco, as is often assumed.
Fuel subsidies contribute substantially to global emissions (~28% in 2015) and air pollution deaths (~46% in 2015), and reduce incentive to invest in renewable energy. The REMI analysis above also found that a 2016 U.S. fee-and-dividend system would reduce emissions by 33% by 2025 and 52% by 2035. Subsidies encourage increased fossil fuel consumption by keeping prices for fuel and carbon-intensive goods low, while a cap-and-dividend system encourages fuel conservation and a shift to renewable energy and low-carbon goods as fossil fuel prices gradually surpass those of renewable energy sources.
Variants on a carbon dividend system are already happening in Canada, California, Switzerland, and Alaska. In the U.S., dividends can receive bipartisan support – for progressives, dividends are equitable and sustainable; for conservatives, they are revenue-neutral and are a less regulatory and more market-based approach to reducing emissions; and for independents, they are gradual, transparent, and economically favorable. A carbon dividend system is a win-win solution and can be a keystone of successful global fuel subsidy reform.
Mohammad is a junior at Vanderbilt University interning with Feasta for the summer of 2021. He is part of Feasta’s CapGlobalCarbon efforts and is based in Texas, USA.
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