Phasing Out Fossil Fuel Subsidies for the Green Transition: Financing and Distributional Prospects

Watch Robert Pollin’s INET interview on a global green energy transition

Abstract

Despite this near-universal global recognition that consuming fossil fuels to produce energy must be phased out by 2050 as the centerpiece of a global climate stabilization project, governments throughout the world continue to subsidize both the consumption and production of oil, coal, and natural gas. Fossil fuel subsidies clearly constitute an obstacle to advancing a viable global climate stabilization program. This is because they create perverse incentives, encouraging both consumers to continue purchasing fossil fuel energy and producers to continue producing it. They also represent a huge financial resource that could be mobilized to help finance the transition to a clean energy-dominant energy infrastructure. At the same time, in many countries, fossil fuel subsidies provide critical support to low-income people, by reducing the costs they must pay to meet their energy needs. Fossil fuel subsidies also support business activity in many countries, by lowering their energy input costs. Any workable program to eliminate fossil fuel subsidies must also establish alternative measures to maintain support for consumers and businesses that are justifiable independent of whether fossil fuel subsidies are the policy instrument used to provide such support.

This study presents an approach through which fossil fuel subsidies can be phased out altogether while still protecting, and indeed, enhancing, the well-being of the poor and affected communities. Moreover, the approach we develop will help undergird the transition to a high-efficiency and renewable energy dominant infrastructure. Section 2 reviews the range of issues involved in defining and measuring fossil fuel subsidies. Section 3 tracks the movements of global fossil fuel subsidies between 2010–2023. We show that, over this period, fluctuations in the fossil fuel subsidy/GDP ratio closely track those of global crude oil prices. This demonstrates that, on a global basis, the extent of subsidies is driven primarily by movements of crude oil prices rather than changes in governments’ fossil fuel subsidy policies.

Section 4 reviews the extensive literature on fossil fuel subsidies. The benefits of fossil fuel subsidies are spread widely across all segments of society—households at all income levels, businesses within all sectors of the economy, and, not least, the fossil fuel corporations themselves. With respect to households specifically, fossil fuel subsidies are a critical resource in supporting lower-income households’ efforts to meet their basic needs. This is true, even while, in terms of absolute amounts of money, the benefits of fossil fuel subsidies flow overwhelmingly to high-income consumers and fossil fuel corporations and ancillary businesses. Section 5 presents case studies on fossil fuel subsidy policies in India and Indonesia. For both countries, fluctuations in subsidy levels closely follow the patterns for the global economy. For both countries, we provide brief summaries of their fossil fuel subsidy policies since they achieved independence—in 1947 for India and 1949 for Indonesia. In particular, policymakers in both countries have at times undertaken significant initiatives to phase down the subsidies. At times, both countries have also introduced alternative forms of cash or in-kind support for low-income groups to protect them against sharp fossil fuel price increases resulting from the subsidy phase downs. For both countries, we work through some simple examples to illustrate ways through which alternatives to fossil fuel subsidy programs that are distributionally progressive can be implemented to protect living standards of lower- and middle-income households. We show that, even under assumptions of generous cash or in-kind alternative subsidy programs to support lower- and middle-income households, the Indian and Indonesian governments will still be able to capture large-scale savings by phasing out fossil fuel subsidies. These large-scale savings can then be rechanneled into financing these countries’ respective clean energy transitions. Section 6 offers brief concluding perspectives for both the Indian and Indonesian economies, as well as more generally.