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Redirecting oil dollars not like rewriting a cheque

Large machinery at the oil sands north of Fort McMurray, Alta.

Kevin Van Paassen/Kevin Van Paassen/The Globe and Mail

NDP leader Jack Layton pulled no punches Thursday when he told a crowd in a Bloc stronghold that he would, "immediately eliminate all …subsidies to fossil-fuel producers," and thus "stop the flow to the tar sands, every single penny." He went on to promise to "redirect the savings into Canada's most promising clean energy."

The subsidies, which Mr. Layton values at $75 a person, or $2.5-billion, likely refer to figures published by the International Institute for Sustainable Development (IISD) in a November report, although Mr. Layton did not directly provide a source for his numbers.

The IISD's analysis was based not only on oil sands but on the value of all tax deductions and royalty relief programs for oil production across the country from both federal and provincial governments.

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The IISD estimates that federal government support of $1.3-billion annually is mostly allocated to defray exploration and development expenses for conventional oil production. Only a fraction was directed to oil sands operations, mostly through the $300-million-a-year accelerated capital cost allowance program that is now being phased out.

This $1.3-billion federal subsidy is almost entirely made up of what economists call tax expenditure, or the value of taxes not collected. Think about all the deductions on your tax return, and you'll get the idea. The government supports many different businesses and charitable organizations through tax expenditures via individual or corporate tax deductions. You can see the tax expenditures associated with some tax deductions here. Tax expenditures are very different from direct expenditures because you can't simply change the name on a cheque and spend the money elsewhere.

In order to redirect tax expenditures, the government must collect the additional taxes once the deductions are removed. It's easy to assume that exploration and production activities would go on as before if the subsidies were eliminated. If this were true, tax revenues would increase. Some will also raise the possibility that all oil and gas activity currently making use of these deductions would cease, leading to large drops in income tax revenues flowing to Ottawa. The truth will lie somewhere in the middle; it's simple economics.

Oil exploration and drilling are risky ventures, like research and development, and so companies will invest only where the payoffs are high. Even with the advanced technology in play in the oil and gas sector today, only a small majority of drilled wells end up producing commercial quantities. Removing the deductions will, without question, reduce exploration and development activities, which will reduce production. The key question is how reduced income taxes from overall lower production compare to the extra revenue from eliminating the exploration and drilling incentives. The Canadian Energy Research Institute estimates that the federal government took in more than $144-billion in income tax revenue related to the oil and gas sector in 2006. Using this number, a 1.5 per cent drop in oil and gas activity as a result of removing the subsidies would mean that the federal government would lose revenue overall from the policy change.

If there is no additional income, there will be no savings to invest in renewable energy or anywhere else. People should not assume that Mr. Layton's promise to remove $75/person worth of subsidies is as simple as changing the name on a cheque. We need to know exactly which programs Mr. Layton plans to eliminate, and how he plans to convert a maximum of $1.3-billion worth of federal tax expenditure into $2-billion worth of funding for renewable energy sources.

Andrew Leach is an assistant professor at the Alberta School of Business. He blogs on energy, environment, and oil sands issues at http://www.andrewleach.ca and is on Twitter @andrew_leach

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About the Author

Andrew Leach is an energy and environmental economist and is Associate Professor at the Alberta School of Business at the University of Alberta. He has a Ph.D. in Economics from Queen's University, and a B.Sc (Environmental Sciences) and M.A. (Economics) from the University of Guelph. Dr. Leach was previously Assistant Professor at HEC Montreal. Dr. More

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