How Much Does the Federal Government Support the Development and Production of Fuels and Energy Technologies?

March 6, 2012

The federal government has used both tax preferences and spending programs to provide financial support for the development and production of fuels and energy technologies in recent decades. At the request of Senate Energy and Natural Resources Committee, CBO released a brief addressing the following questions:

  • How much has the federal government provided in support for developing and producing fuel and energy technologies?
  • What types of energy-related tax preferences does the government provide, and how has the value and composition of that financial support changed over time?
  • What is the status of energy-related tax preferences under current law?
  • In what ways does the Department of Energy (DOE) spend funds to support energy technologies?
  • When is it beneficial for the government to intervene in energy markets and what are the most cost-effective methods?

How Much Has the Federal Government Provided in Support for Developing and Producing Fuel and Energy Technologies?

In 2011, federal support totaled an estimated $24 billion, which was provided in the following ways:

  • Tax preferences—such as special deductions, special tax rates, tax credits, and grants in lieu of tax credits—which totaled $20.5 billion, or about 85 percent of the total.
  • The Department of Energy’s spending programs, which received funding totaling $3.5 billion, or about 15 percent of the total.

Energy-related tax preferences account for a small percentage of the cost of all federal tax preferences, which totals hundreds of billions of dollars per year.

What Types of Energy-Related Tax Preferences Does the Government Provide, and How Has the Value and Composition of that Financial Support Changed Over Time?

Tax preferences for energy production were first established in 1916, and until 2005, they were primarily intended to stimulate domestic production of oil and natural gas. With the enactment of the Energy Policy Act of 2005, energy-related tax preferences grew substantially, and an increasing share of them were aimed at encouraging energy efficiency and energy produced from renewable sources, such as wind and the sun. Although tax preferences for fossil fuels continued to make up the bulk of all energy-related tax incentives through 2007, by the end of 2008, fossil fuels accounted for only a third of the total cost of energy-related tax incentives (see the figure below).

Energy-Related Tax Preferences, by Type of Fuel or Technology

The Emergency Economic Stabilization Act of 2008 expanded and extended provisions related to energy efficiency and renewable energy. The American Recovery and Reinvestment Act of 2009, or ARRA, further expanded tax preferences for energy efficiency, renewable energy, and alternative vehicles. As a result, in 2011, provisions aimed at energy efficiency and renewable energy accounted for 78 percent—or about $16 billion—of the estimated budgetary cost of federal energy-related tax preferences.

What Is the Status of Energy-Related Tax Preferences Under Current Law?

Four provisions expired at the end of December 2011; together those provisions accounted for a little over $12 billion, or 60 percent, of the budgetary impact in 2011 of the energy-related tax preferences. One expired provision—a renewable energy tax credit for the use of alcohol fuels—accounted for about half that amount. Another expired provision—a credit for energy efficiency improvements to existing homes—cost $1.5 billion and was the only tax preference that provided support for energy efficiency improvements.

Only four of the major tax preferences are permanent, three of which are directed toward fossil fuels and one which is directed towards nuclear energy. Those four cost about $3.4 billion in 2011. (Table 1 in the brief shows all of the tax preferences.)

In What Ways Does DOE Spend Funds to Support Energy Technologies?

The Department of Energy supports energy technologies through direct investments (primarily for research and development, or R&D) and by providing loans or loan guarantees. That support has varied over time, but, with the exception of the substantial funding provided in ARRA, it has generally declined in recent years—from $10 billion (in 2011 dollars) in 1980 to $3.5 billion in 2011 and $3.4 billion in 2012. More than half of that support in both 2011 and 2012 was directed toward energy efficiency and renewable energy.

DOE received roughly $10 billion in 2009 to cover the net cost to the government of its subsidized credit programs but has received only limited additional subsidy funding for those programs since then: $170 million in 2011 and no new funding in either 2010 or 2012. Between 2009 and 2012, DOE provided an estimated $4.0 billion in subsidies for about $25 billion in loans, primarily to producers of advanced vehicles, generators of solar power, and manufacturers of solar equipment.

When Is It Beneficial for the Government to Intervene in Energy Markets and What Are the Most Cost-Effective Methods?

Generally, households and businesses do not have a financial incentive to take into account the environmental damage or other such “external” costs to the nation as a whole that are associated with their decisions about energy production and consumption. The federal government’s intervention in energy markets can be beneficial if it leads to a more efficient use of resources than would result from the outcomes in a purely private market.

Reducing External Costs Through the Tax System. Despite the fact that tax preferences have accounted for a large share of federal support for energy, they are generally an inefficient way to reduce environmental and other external costs of energy. They often reward businesses for investments and actions they intended to take anyway. Also, they target only specific technologies, which may not be the least expensive technology. The most direct and cost-effective method to reduce external costs would be to levy a tax on energy sources that reflects the amount of such costs associated with their production and use.

Increasing Spillover Benefits Through Support for R&D. The amount of R&D that the private sector undertakes is likely to be inefficiently low from society’s perspective because firms cannot easily capture the “spillover benefits” for society as a whole that result from it. That is particularly true for R&D at the early stages of development. Such research can create fundamental knowledge that can lead to numerous benefits for society but not necessarily for the firms that funded that research; thus government funding can be beneficial. By contrast, DOE’s funding of energy technology demonstration projects at later stages in the development process has been far less cost-effective, and the Government Accountability Office, among others, has criticized DOE’s management of such projects.

This brief was prepared by Terry Dinan and Philip Webre of CBO’s Microeconomic Studies Division.