Executive summary
Reforming fossil-fuel subsidies is crucial to reducing greenhouse gas emissions and hence meeting climate change goals. Since 2009, G20 leaders have regularly affirmed their joint commitment to rationalise and phase out “inefficient fossil-fuel subsidies that encourage wasteful consumption” over the medium term, while ensuring targeted support for the poorest. The 2020 OECD Inventory of Support Measures for Fossil Fuels documents over 1 300 government budgetary transfers and tax expenditures that support the production and consumption of fossil fuels. This Companion draws on the Inventory’s findings to provide insights on progress in reform.
The 2020 Inventory records fossil-fuel support in 50 OECD, G20 and European Union Eastern Partnership economies. Total support rose by 5% year-on-year to USD 178 billion in 2019, reversing a five-year downward trend. The increase was driven by a 30% rise in direct and indirect support for the production of fossil fuels, primarily in OECD countries, as governments provided additional funding and preferential tax treatment to help alleviate corporate debt and encourage fossil-fuel infrastructure investment. The massive upheaval to the global energy system caused by the COVID-19 crisis – both in terms of fuel prices and consumption – is set to enhance this trend, with many countries using COVID-19 recovery aid to shore up fossil-fuel and related industries.
Conversely, the crisis is enhancing 2019 reductions in support for fossil-fuel consumption due principally to the mechanical effect on consumption subsidies of the drop in average fuel prices, as governments continue to spend less subsidising energy costs for end users. The OECD-IEA combined estimates of government support for fossil fuels in 81 economies, which include fossil-fuel support provided through induced transfers (i.e. price regulation), fell by 19% year-on-year in 2019, to USD 468 billion. Support for consumption represented 89% of the overall figure. Policy changes played a limited role in the reduced estimates, with few positive reforms announced in the period. Similarly, government focus on providing immediate support to economies, firms and households in response to the COVID-19 pandemic does not appear to have translated into widespread, additional momentum to use low fuel prices to carry our pricing reform. Many governments have ignored or made only partial use of the major opportunity to prioritise sustainable investments and broader well-being objectives as they design and implement stimulus measures for economies battered by the COVID-19 crisis. Governments need to place further conditions on support and focus on “green” recovery measures to reorient their economies in the right direction.
Indonesia and Italy completed peer reviews of fossil-fuel support under the auspices of the G20 in 2019, chaired by the OECD. Reviews for Argentina and Canada are under way, and France and India committed in August 2019 to follow suit as the next review pair. Defining what constitutes an “inefficient fossil-fuel subsidy that encourages wasteful consumption” for the purposes of the overarching G20 commitment remains a challenge, but the growing body of peer reviews is helping to draw out differences in interpretation, providing an important first step towards a possible future common definition. Peer reviews are also providing insight into how countries might go about the reform process, and the potential vulnerability of reform to the prevailing political environment – underscoring the need for ongoing efforts to improve transparency of support and continued monitoring by the G20 and other organisations. Examples of good practice include efforts to reform the solid fossil-fuel industry in Germany, “pro-poor” reform efforts in Indonesia through better targeting of electricity subsidies, Italy’s use of model-based macroeconomic assessment to assess the possible impact of phase-out of support measures on economic activity, and fuel pricing and taxation reform in Mexico.
Country reporting against SDG indicator 12.c.1, “Amount of fossil-fuel subsidies per unit of GDP (production and consumption)”, is due to commence soon. UN Environment’s methodology to help guide country reporting and underpin national and global measurement of support – developed with the OECD and the International Institute of Sustainable Development – invites countries to report disaggregated information on individual support measures, adopting the Inventory approach. Countries are to report on direct transfers, induced transfers, and – as an optional sub-indicator for countries that do not yet have the information or resources available – tax expenditures, other revenue forgone and under-pricing of goods and services. Particularly for OECD countries, which deliver most (or all) support to fossil fuels through tax expenditures, tax expenditure data is intrinsic to establishing an accurate picture of progress towards the SDG indicator. The same can be said for at least the partner economies included in the Inventory, in which 43% of the total value of support is provided by tax expenditures.
The OECD is considering how the interpretation of tax expenditure data might be enriched, prompted by ongoing exchanges with member countries on their measurement and comparability. Using an external rather than domestic benchmark – such as an internationally agreed reference carbon price – is one option, although the resulting calculation of revenue reveals less about countries’ domestic contexts. Ireland and Sweden are considering how effective carbon price analysis might complement national tax reference rates, together with an expert sub-group of the London group on environmental accounts. Two further avenues for research are growth decomposition analysis, to help assess whether changes in support arise from explicit reform or simply structural changes to the underlying domestic benchmark tax regime; and effective tax rate analysis for production of fossil fuels (i.e. corporate effective rates), to show the extent to which tax expenditures provide investment incentives in upstream fossil-fuel industry segments.
The trends highlighted in this report illuminate the challenges that governments face in gaining traction for reform. To help spur enduring change, this report offers a sequential framework to assist OECD and G20 governments assess and address the effects of fossil-fuel support measures and their reform. Each step can be tailored to fit countries’ contexts and underpin individual reform processes. The framework proposes several analytical tools to facilitate each step, from identifying the most distorting government support measures, to crafting alternative or complementary policies to mitigate any adverse impacts of reform. Including a full suite of assessments in designing reform measures should minimise the risk of political backlash and backsliding that too often accompanies reform. Being modular by construction, the sequential approach also enables different steps to be undertaken in isolation as countries identify specific needs, and as capacity to conduct analysis becomes available. Enhancing transparency on the ways governments deliver support to fossil-fuel users and producers remains an essential first step towards reform, underscoring the ongoing relevance of the Inventory’s primary mission to provide comprehensive information on policies that support fossil fuels and shed light on how public resources are used.