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July 25, 2011

The Debt Ceiling, Subsidies and the Pain of Default

The debt ceiling debate will be with us for a long time, and (as I noted a couple 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 are simply a tax on political cowardice on the matter. 

I also want to point out 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 why 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 U.S. provides an incentive to oil and gas producers that is equal to about $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 about $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 between 9 percent and 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 U.S. 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 revenues.

In years past, U.S. Congresses 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 Laurel and Hardy movie if it wasn’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.

Link to this commentary: https://commentaries.cberdata.org/579/the-debt-ceiling-subsidies-and-the-pain-of-default

Tags: bailout and debt, budget and spending


About the Author

Michael Hicks cberdirector@bsu.edu

Michael J. Hicks, PhD, is the director of the Center for Business and Economic Research and the George and Frances Ball distinguished professor of economics in the Miller College of Business at Ball State University. Note: The views expressed here are solely those of the author, and do not represent those of funders, associations, any entity of Ball State University, or its governing body.

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