U.S. Pays a Heavy Cost for Energy Investments

H. Richard Heede is a research associate and Seth Zuckerman a contract consultant at the Rocky Mountain Institute.

As the U.S. imbalance of trade--a projected $142 billion this year--breeds talk of protectionism, it seems only right that America first set its own house in order. Should the United States impose trade barriers if the reasons for eroding U.S. competitiveness in world trade are domestic, not external?

The United States spends one-seventh of it gross national product on energy. Energy investments soaked up nearly 40% of the money spent on new factories and industrial equipment in 1982.

How efficiently is that money invested? Our studies show that federal policy encourages the least productive, most expensive forms of energy. They also show that Congress should start a gradual and orderly weaning of the entire energy sector from the subsidies to which it has become accustomed, as the Treasury's short-lived first tax-reform plan boldly proposed. This desubsidization must be ruthless, and it must be complete. Congress will have to bite the bullet and summon the courage to eliminate all special tax preferences, or special interests will whittle any proposal into insignificance, as they did to the Treasury Department's original tax proposal.

Figures from budget summaries and Administration and congressional reports reveal that in the 1984 fiscal year alone, $44 billion was funneled into the energy industry in the form of tax incentives, direct agency spending and cheap financing. That's equal to a quarter of the federal deficit.

Most of the subsidies ($30 billion) are special tax preferences passed by Congress to spur energy production and investment. For example, the depletion allowance and the write-offs of drilling and exploration costs--rules Congress enacted during World War I--lowered the tax payments of energy-extraction companies by $3.3 billion in 1984. Accelerated depreciation and the investment tax credit, passed in the Economic Recovery Act of 1981, liberalized cost recovery for a broad range of energy investments, particularly benefiting capital-intensive investments such as power plants, refineries and mining equipment. The taxpayers' tab: $17 billion in 1984 alone.

Several tax credits are more specifically targeted. Residential and business energy credits subsidized alternative energy investments for a 1984 revenue loss of $550 million; utility shareholders, who may reinvest their dividends in additional shares, tax-exempt, cost the Treasury $415 million, and tax-exempt bonds issued by publicly owned utilities resulted in a revenue loss of $2.2 billion.

Some of the subsidies would be funny if they weren't so expensive. The nuclear industry, for instance, has convinced the IRS that many parts of reactors are there to keep the radioactivity from getting out, and so should qualify for tax-free pollution-control bonds. As much as a quarter of a utility's nuclear investment capital can be raised by issuing pollution-control bonds. This favor--which cost the Treasury $730 million in lost 1984 revenue--is akin to General Motors' using such bonds to pay for crankcases and gas tanks, since those components keep the oil and gasoline from escaping.

These subsidies are weighted heavily in favor of certain energy options and against others, thus distorting consumer choices. For example, electric utilities of all sorts reaped some $14 billion in tax expenditures, nearly $5 billion in loans and loan guarantees and more than $3 billion in agency outlays last year. Nuclear energy support alone costs $15-plus billion per year. Oil and gas industry subsidies decreased to some $13 billion last year; coal received $3.4 billion and synthetic fuels development $640 million. In contrast, development of more efficient energy use, typically about 10 times cheaper than such new sources as nuclear electricity and offshore oil and gas, received only $860 million--mostly in the form of weatherization grants. Renewable energy technologies--such as wind and solar energy, biomass and geothermal--received $1.7 billion.

Nuclear energy, already dying of massive cost overruns and construction delays, received more than a third of the subsidies, even though it supplied less than 2% of the nation's delivered energy--as much as supplied by hydroelectric, but nearly seven times as much subsidy. Oil provided about a quarter of our energy services and received just under a fifth of the subsidies. Efficiency improvements, which over the past 10 years have cut by more than 25% the amount of energy needed to produce a real dollar of gross national product, received less than 2% of the support.

This yardstick of "bang per buck" is imperfect, since it looks at a one-year snapshot of subsidies without considering the support that some energy forms have received over the years. That is why oil, natural gas and coal show decreased support--they continue to benefit from subsidies that date back to the early part of the century. A Department of Energy study found that incentives to oil, gas, coal and electricity through 1978 totaled $346 billion in 1984 dollars. Besides wasting taxpayers' money, subsidies steer additional tens of billions of dollars of private capital into inefficient investments. Thus they drain available capital away from other, more productive investments and toward such capital-hungry projects as central power plants. In 1982, for example, we invested three times as much in nuclear plants as in automobile factories.

It's no wonder the country's infrastructure is crumbling and its factories rusting: Energy subsidies are cheerleading private capital toward expensive and increasingly uncompetitive power plants. These heavily subsidized energy sources also create far fewer jobs--per dollar invested or per unit of energy produced--than their competitors: renewables and efficiency improvements.

More directly, the $44-billion hemorrhaging each year from the Treasury contributes to the federal deficit, with all of the attendant dire effects: higher interest rates, a flocking of foreign capital to snap up the Treasury bonds, and an overvalued dollar, making U.S. exports even less competitive on the world market. Uneven subsidies lead Americans to overuse high-cost options, handicapping the U.S. economy against the more energy-efficient economies of Western Europe and Japan.

Investment in those uncompetitive options threatens to lock us into their high costs for decades to come, while setting the stage for increased imports of foreign renewable-energy and energy-saving technologies. Thus, well-intentioned energy subsidies are playing a strong role in America's becoming a debtor nation with burgeoning trade and budget deficits.

Other long-term prospects are also disquieting. Current subsidies discourage investments in efficiency and in least-cost new sources of domestic energy, eventually leading to increased oil imports and erosion of American security. As depletable energy sources inevitably become scarcer and more expensive, Americans are liable to find themselves unprepared to make a smooth transition from the fossil-fuel habit.

Certainly, some government expenditures are legitimate, such as high-risk research and development on very young technologies. However, energy firms should reimburse the federal goverment for services provided, such as the U.S. Geological Survey's mineral surveys and the EPA's research and regulatory activities. But the government must stop lining the pockets of ongoing, mature industries.

Failing that, Congress should at least try to maintain fair competition among all energy sources, as the House tax-reform package proposes. (While the tax-reform bill significantly levels the energy playing field by reducing tax breaks to conventional fuels and electricity, it falls short of treating all energy sources equitably, since it extends tax credits for solar technologies through 1988 but fails to do so for wind, biomass and efficiency improvements.)

To remove tax credits for renewable energy while most other subsidies continue (as the President's tax-reform proposed) would further handicap a form of energy already far less subsidized, yet often more successful, than its competitors. Perpetuating a swarm of special favors is only a second-best solution. If the U.S. economy is to regain its health and its competitive posture in world trade, we must take the free market seriously and let all energy sources compete on their merits--not on the basis of their lobbying strength.

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