By Cody Good
Governments often provide fossil fuel subsidies to, typically, make energy costs more affordable for consumers.
These subsidies are of two types: explicit and implicit. Explicit subsidies are direct financial supports, such as tax breaks or price controls, that reduce the cost of fossil fuels to consumers or producers. Implicit subsidies, on the other hand, arise when the environmental and social costs of fossil fuels, like air pollution and health impacts, are not reflected in their market price.
Source: The International Monetary Fund
Implicit Subsidies
Implicit subsidies arise from the failure to fully price the environmental, health, and social costs associated with fossil fuel consumption.
- Local air pollution:Â Health-related costs due to pollutants released by burning fossil fuels, such as particulate matter, nitrogen oxides, and sulfur dioxide, which can lead to respiratory diseases, heart conditions, and premature deaths.
- Global warming:Â The costs associated with greenhouse gas emissions, primarily carbon dioxide, which contribute to climate change. The costs are broad and include impacts like increased frequency of extreme weather events, sea-level rise, and changes in agricultural productivity.
- VAT underpricing:Â Failure to apply standard value-added tax (VAT) rates to fossil fuel products. When fossil fuels are taxed at rates lower than the standard VAT, it represents an implicit subsidy, as it reduces the price of these fuels compared to what it would be if standard VAT rates were applied.
- Driving externalities:Â Indirect costs associated with vehicle use, not covered by fuel prices. They include traffic congestion, road accidents, noise pollution, and wear and tear on infrastructure. By not accounting for these costs in fuel prices, an implicit subsidy is provided to road users.
Explicit Subsidies
Explicit subsidies are direct financial supports provided by governments to reduce the cost of fossil fuels or to support their production.
- Explicit Subsidies:Â Direct subsidies to reduce the cost of fossil fuel consumption. They occur when governments set fuel prices below market levels or provide direct financial support to lower the price of fossil fuels for consumers. This can include measures like fuel price caps, direct cash transfers, or tax exemptions on fuel purchases.
- Producer subsidies:Â Subsidies given directly to fossil fuel companies to lower the cost of production, exploration, or infrastructure development. They can take various forms, such as tax breaks, loans at favorable rates, or direct grants. Producer subsidies are aimed at promoting the fossil fuel industry, making it more competitive, or ensuring energy security.
Sources:
Black, Simon, Antung Liu, Ian Parry, and Nate Vernon, 2023. “IMF Fossil Fuel Subsidies Data: 2023 Update.” Working paper, IMF, Washngton, DC.
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