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Unequal playing field

by Discovery Newsletter 1/1/2012

Although the word “subsidy” is not in the United States Constitution, the federal budget is loaded with subsidy programs – more than 2,000 of them at last count.

Subsidies are also a major focus of the European Union, especially for agriculture. Out of the €57 billion the EU spent on agricultural development in 2010, direct subsidies accounted for €39 billion.

The Chinese government has created countless subsidies for state-owned enterprises. Many view this as much more damaging to the global economy than artificially low exchange rates.

Some subsidies seem to have no borders.

When Brazil complained about U.S. subsidies for domestic cotton production, the U.S. began paying subsidies to South American cotton producers, too.

In Britain, two-thirds of all wind turbines have foreign ownership. These nonresident owners receive more than half a billion pounds in annual subsidies, paid for by taxpayers in the U.K.

What is a subsidy?

In their simplest form, subsidies are cash payments made by a government to an individual organization, such as a farmer who is paid to grow (or not grow) certain crops or an airline that is paid to serve smaller communities.

Subsidies can also involve rebates and loans at below-market rates.

Examples of this in the U.S. have included student loans, home loans, the 2009 “cash for clunkers” program and homeowner tax credits for installing solar panels.

To an economist, a subsidy is something that distorts the market price of goods or services to the benefit of a special interest. Subsidies typically guarantee a profit to the recipient.

The sheer number of federal subsidies always seems to be increasing. In fact, the number of U.S. federal subsidy programs has more than doubled since 1980.

This has been true regardless of which political party was in the White House or had the majority in the U.S. Congress. The only notable exception to this trend was during the Reagan administration.

Doing without

Eliminating subsidies can be painful in the short run, but is almost always beneficial in the long run. However, reducing or taking away a subsidy is seldom popular and can even be dangerous.

“Rice riots” erupted in Liberia when the government’s rice subsidy changed and prices rose almost 20 percent. At least 40 rioters were killed and $40 million in damage done to private property.

More recently, the withdrawal of several subsidies in Europe has also provoked violent responses.

Last year, the cash-strapped British government decided to repeal a 1998 subsidy program that capped student tuition payments at £1,000 per year and allowed at least one-third of university students to pay no tuition at all.

When the change was announced, tens of thousands of students rioted, destroying or vandalizing landmarks and attacking a royal convoy.

Rioters began firebombing Athens, Greece, last October after the government announced new austerity proposals that included reductions in subsidies.

Small change

Forty-five cents may sound like pocket change, but paying that much for every gallon of ethanol produced in the U.S. added up to more than $6 billion in subsidy payments to the corn ethanol industry last year.

In Iowa, the epicenter of ethanol and biodiesel production, more than half of all state aid handed out since 2003 has gone to biofuel companies.

For decades, traditional fossil fuel production, nuclear energy plants and a wide variety of solar and wind energy projects have been subsidized with billions of taxpayer dollars. But much of that economic landscape is now changing.

Last October, the Department of Energy’s loan guarantee program for solar companies expired (although certain tax credits remain). Less than two months later, Congress allowed the Volumetric Ethanol Excise Tax Credit to expire.

Brad Razook, president of Flint Hills Resources, applauds those developments.

“Even though we own several ethanol plants, we believe allowing the ethanol subsidy to expire was a step in the right direction,” Razook said.

“We’re confident that our renewables businesses can compete in any market environment, subsidized or not, and that our base optimization and innovation efforts will continue to create long-term value in the marketplace.

“But to be clear, we think it’s best not to have any subsidies or mandates.”

Competitive disadvantages

If Koch opposes subsidies and mandates, why have several Koch companies – including FHR, INVISTA, Koch Minerals and Georgia-Pacific – accepted a variety of government subsidies?

The answer is simple: competition.

“We would be at a serious competitive disadvantage – and put thousands of jobs at risk – if we ignored the realities of today’s government-influenced marketplace,” Razook said.

“For example, the government’s ethanol mandate is a significant reason we’re in the ethanol business. We’re required by law to blend millions of gallons of ethanol at our refineries each year.

“In order to continue operating our refineries, it became a question of what is more cost-effective: buying the ethanol or producing it?

“So, for the sake of our business and our competitive position, we need to be involved in that industry at some point in the value chain.

“We will always follow the rules the government has established, but that doesn’t mean we have to like or approve of those policies. In fact, we oppose subsidies because we think they hurt the economy and our political system.

“This is why we continue to seek investments in assets that can create long-term value by economic, not political, means.”

A matter of principle

For decades, Koch leaders have consistently spoken out in opposition to subsidies, based on a belief in free markets.

As KII board member Richard Fink puts it: “We oppose subsidies because they distort markets. We maintain that the marketplace, while not perfect, is the best mechanism for allocating resources.

“Letting people, rather than the government, choose what to purchase is best for consumers and the country.”

Charles Koch, chairman and CEO of Koch Industries, has frequently commented on the problem of subsidies.

“Subsidies are usually promoted by those who seek to profit by political means,” Koch said, “rather than by fairly competing in a free market where consumers – not governments – choose the winners.”

As a recent example of this, he points to the proposed NAT GAS Act (H.R. 1330), currently awaiting action in the U.S. Congress.

This legislation would give billions of dollars in tax credits to those who buy natural gas-powered vehicles or invest in natural gas refueling stations. Its many supporters say it would be a boon to the economy and the environment.

“The NAT GAS Act may be well-intentioned,” Koch said, “but in essence it’s a misguided proposal. Passing it would give the natural-gas industry enormous new subsidies.”

“Think about it for a moment,” Fink said. “Instead of letting consumers choose what kind of fuel they want to use or vehicle they want to drive, the government would be dictating again, picking and choosing winners and losers, just like it did with ethanol.

“If natural gas vehicles are truly advantageous and economically efficient, producers already have the incentive to supply them without political mandates that exhaust more taxpayer dollars.”

Koch and Fink agree that subsidies do more than undermine economic well-being; they also corrupt culture in society and create a moral hazard.

“When our government guarantees profits for a select few and prolongs the benefits of political cronyism, we all suffer,” Koch said. “Entrepreneurship is stifled and American competitiveness and prosperity are undermined.

“In a profit-and-loss system, there is always the risk of downside, whether we realize it or not.

“If the government ensures that there’s no penalty for failure, why worry about succeeding or creating real value?”

Unreality

Dave Robertson, president and COO of Koch Industries, is especially concerned about the government’s tendency to make poor choices in the energy sector.

“The Obama Administration says it has spent $100 billion on renewable energy sources,” Robertson noted. “But these sources provide less than 3 percent of all U.S. energy. Is that really a wise policy?

“We should allow providers to compete on equal terms and encourage consumers to choose what works best for them, based on price, environmental standards or any other legitimate criteria.

“But that’s not a reality today. Government interventions are raising the cost of energy and taking us further in debt in the process.”

Robertson believes the government should eliminate all subsidies and preferential treatment, including credits, loans, mandates and favorable tax incentives.

“If you level the playing field and quit playing favorites,” Robertson said, “everyone has a chance to benefit – not just the chosen few.

“The very best thing Washington could do is take a big step back and allow the market to work.”

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