The Tricky Art of Measuring Fossil Fuel Subsidies: A Critique of Existing Studies

Fossil fuel subsidies are of enormous import to policy-makers and public opinion, making it critical to properly define them. However, traditional methodologies tend to place subsidies in the realm of tax expenditure analysis, presenting a flawed picture. A recent report on government subsidies to the Canadian energy sector prepared for the International Institute for Sustainable Development exemplifies this flawed approach along several dimensions: it is not based on a robust underlying economic framework, it fails to account for complex interactions between tax and royalty systems in existing fiscal policy, and it uses a definition of subsidies that was created for a different purpose. The authors of this paper propose an alternative “economic view”, based on economic rents, which provides a neutral benchmark against which subsidies, royalties and other energy-focused fiscal measures can be measured. Using marginal effective tax rate (METR) analysis, the authors show that it is possible to obtain a more accurate picture of energy subsidies and their impact on resource allocation and economic activity. This improved schema will ideally allow governments to better understand subsidies and devise sound policies, leading to less waste and distorted investment choices.