Banking & Finance and Opinion and Economic Analysis

HICKS: Ending subsidies good, but won't solve debt

July 23, 2011

Mike HicksThe debt ceiling debate will be with us for a long time, and (as I noted a couple of weeks ago) it is worth remembering that, unless significant budget cuts occur, the federal government faces higher borrowing costs with or without a change to the debt ceiling.

We currently have an unsustainable budget, and the inevitable increase in borrowing costs is simply a tax on political cowardice on the matter.

I also want to point out that I have never been, and am not now, a foe of federal government debt. A $2 trillion or $3 trillion debt could well enable thoughtful investment in infrastructure construction, research and human capital. That is one of many reasons a balanced budget amendment is a bad idea. Today, our debt is not merely five times $3 trillion, but it also has not (for the most part) been allocated to investments.

To understand why an agreement on the way forward is so difficult, it is useful to place in context President Obama’s quite sensible recommendation to eliminate tax subsidies for the oil and gas industry.

Through a combination of special tax cuts, depreciation rules for capital and the like, the United States provides an incentive to oil and gas producers that is equal to $39 billion annually. This is a big number. It would keep a lean and efficient Indiana government operating for almost exactly three years.

But Americans buy roughly 19.6 million barrels of petroleum daily. At current prices, that is $715 billion annually. So, the federal subsidy on oil and gas is about 5 percent of the industry’s annual production. Profit rates for these companies ran 9 percent to 10 percent last year, so the subsidy represents about half the profits of the industry in a good year. We should end oil subsidies, but this would allow the United States to pay off its debt in only 371 more years (if we could stop interest payments).

Subsidies for oil are big and fall upon an industry few love, but there are other industries to consider. Farming receives subsidies worth more than $16 billion annually. Indiana alone received $222 million in subsidies last year, and nationwide subsidies amount to about 2.6 percent of total farm revenue.

In years past, U.S. lawmakers decided unwisely that these and thousands of other industries required something special to stay in business. This has created a crazy web of fiscal catatonia. We subsidize oil companies to drill for oil, but we want less oil production because oil is a pollutant, so we subsidize wind and ethanol production. This increases the price of agricultural goods for which we were already paying farmers to limit production to keep prices down.

This would make a Laurel and Hardy movie if it weren’t robbing our children of an economic future. Obama is correct in stating that oil subsidies are a great place to start cutting. But without profound cuts in ways that really, really hurt, we will suffer all the pain of default no matter what happens to the debt limit.•

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Hicks is director of the Center for Business and Economic Research at Ball State University. His column appears weekly. He can be reached at cber@bsu.edu.

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