27 Sep 2012

Are subsidies more efficient than price signals?

Alex Trembath of the Breakthrough Institute sent this last week:
The lure of a carbon tax coming from several corners of Washington may be tempting, and the poor optics surrounding clean tech subsidies might make their forced expiry an attractive sweetener for lawmakers hoping to pass a carbon tax through Congress. But if advocates hope to sustain the remarkable progress the United States has made in deploying zero-carbon energy technologies in recent years, they should think twice before trading today's clean tech deployment subsidies for a carbon tax.

I recently co-authored a Breakthrough Institute analysis that found direct subsidies offer a stronger incentive for zero-carbon energy deployment than would a carbon tax alone. The methodology we used is simple: by multiplying the value of the subsidies for clean tech by the CO₂ emissions factor of competing fossil energy sources, we calculated the "implicit carbon price" of today's subsidies. And we found that subsidies like wind energy's production tax credit (PTC) and solar energy's investment tax credit (ITC) reliably offer higher implicit carbon prices than would current proposals for a carbon tax. For instance, while Rep. Jim McDermott (D-WA) recently proposed a carbon tax of $15/ton CO₂, the PTC imposes an implicit carbon price signal of $55/ton CO₂ when wind is competing against natural gas.
In other words, Alex and is colleagues are saying that a targeted subsidy for wind or solar will produce more wind or solar than a carbon tax. That makes sense, but it's not necessarily more efficient than a carbon tax, since a carbon tax -- in addition to encouraging the development of wind and solar technologies -- will ALSO:
  • Encourage people to use carbon-rich fuels more efficiently (techniques).
  • Encourage innovations that get more energy from carbon-rich fuels (technology)
  • Encourage innovations in non-wind and non-solar sources of energy
  • Raise revenue that can be used to reduce other taxes -- as in British Columbia
  • Provide a clear price signal in proportion to the carbon content of ALL energy sources
I think that those effects are pretty useful, but Alex appears to think that governments are better at choosing who and what to subsidize. I've seen many mistakes in that area (e.g., negative prices for wind power), so I do not share his faith.

We're going to debate these ideas -- and more -- next Tuesday (9am Pacific), so join us to hear his points, ask your questions and learn a little more about how ideas translate into policies.
Ed Dolan makes these points with characteristic clarity.


http://toenre.com/ said...

Many academicians in India blame energy subsidy as the culprit for groundwater overextraction. A simple arithmetic will demonstrate that, given the rising cost of well drilling and deep borewells, farmers incur more than 80 to 90 percent of the cost of groundwater. Public investment in agriculture is falling rapidly. There are no meters installed in borewells in India and hence groundwater extraction as well as electricity use are mere 'estimates'. In addition groundwater recharge is also an estimate. There are no precise or imprecise measures of electricity used to pump groundwater and at best is a residual estimate, which is fraught with mistakes. With siltation of irrigation tanks, lack of efforts to recharge, sand mining, initial and premature well failures and the probability of well failure are increasing. The negative externalities due to cumulative interference are prohibitive. The subsidy for energy is just the tip of the iceberg forming at best around 10 to 20 percent of the groundwater cost, while the rest is still borne by the farmers. Electricity subsidy is not a windfall gain as many academecians are writing.

David Zetland said...

Good point, except that subsidies are hardly a good way to "counter" other distortions that should be removed in their own right...

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