Undermining Clean Air Objectives

We have covered carbon-offsetting and subsidies that provide misleading signals to consumers. But subsidies do far more damage than just misleading consumers; they undermine the very purpose of the Clean Energy and Security Act bill; which is to reduce greenhouse gas emissions.

By increasing the cost of bad energy goods (by internalizing the externality) then the overall cost of energy to the consumer is increased and this leads to a reduction of energy use. By subsidizing the good energy technologies we reduce the overall cost of energy to consumers thereby causing an increase in, or at the very least, static consumption of energy. The act of subsidizing energy to encourage consumption of clean energy goods over bad energy goods undermines the purpose of the bill in question.

Gilbert E. Metcalf explains the logic and economics of raising prices over subsidizing in his article “Tax Policies for Low-Carbon Energy.” He states that subsidies result in a relative price difference of the two types of goods to encourage consumption in the ‘right direction.’ “If fuel source X causes pollution that is equal to 10 percent of its cost then we can provide the right incentive to fuel users choosing between fuel sources X and Y by raising the price of X by 10% or by lowering the cost of fuel source Y by 1/(1.10) or 9.1%. Either way, the relative cost of fuel source X to Y is now 10% higher than it was prior to the implementation of new energy policy. Either a tax or a subsidy can be effective on the margin of choosing among fuel sources where some sources cause pollution.” Metcalf goes on to explain that the problem lies in the perceived information of the subsidy as explained the previous post. To achieve efficiency, consumers must have perfect information (normally achieved through prices) and by augmenting the prices in the wrong direction, consumers do not realize the true value of the good they are buying.

This is essentially the government playing favourites and losing sight of their true objective. This is exemplified in the subsidies on hybrid cars. Using two cars, the Mazda Tribute Hybrid and the Toyota Corolla, we can see how subsidies can create the wrong incentives for firms. The Mazda Hybrid gets 32 mpg while the Toyota Corolla gets 31. The Toyota Corolla has been engineered to have the highest mpg possible for a non-hybrid car but is not eligible for a subsidy from the government even though Toyota has spent time and energy into making it the most efficient it can be. The Mazda Hybrid is eligible for large subsidies from the government simply because it uses hybrid technology. Very little time and money have been put into making the rest of the car fuel-efficient and instead, has relied solely on the hybrid technology to increase mpg. The subsidy given to the Mazda Hybrid undermines any incentive the firm might have otherwise had to increase mpg through other means such as perfecting the internal combustion engine. Metcalf again argues that “Our tax policy should provide the same incentives to improve mileage regardless of the technology put in place.”

Why Taxes Trump Subsidies

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My last post explored the inefficiencies in the primary objective of the Clean Energy and Security Act bill, mainly carbon-offsetting. This post will focus on the other provisions in the bill, mainly, subsidies in the form of tax credits and business grants for those entities choosing to use clean energy technologies.

I must preface that though I am criticizing the abilities of this bill, it is a monumental legislative step in the right direction; though it must still pass in the senate. A friend of mine who does not believe in global warming has even expressed admiration for the bill and its intentions, though agrees with my assessment of its planned execution of those intentions.

The US government has long suffered from control issues. This bill provides subsidies and tax credits for those people who choose to use energy efficient technologies. To understand why this is not a great idea, we must look at the effect subsidies have on decision-making and rationality. In economics, we assume that people are rational agents acting on perfect information, among other things. If information is perfect, then prices represent the actual cost of the goods produced. By subsidizing clean energy technologies through business grants or tax credits the government is essentially creating prices that do not reflect the true social value of the good. Therefore, more is consumed of these goods than would otherwise be optimal and creates a higher social net cost without the same social net benefit that would have occurred if the prices were representative of the value of the good.

So what would be the solution? Instead of making it cheaper to consume certain energy sources, make it more expensive to consume the bad energy technologies. This may seem to achieve the same objective of having consumers substitute good energy with bad but this results in a more socially optimal solution.

Bad energy goods are labeled “bad” because they create an externality and further, this externality is not internalized in the price. This means that the cost to society of using this good is higher than the price being charged by firms because the firms are not held responsible for the negative effects the result from production and use of the good. By increasing the cost of these bad energy goods we can internalize the externality caused by the goods.

Why is this better? This gives consumers perfect information by way of prices so that they are able to choose the socially optimal level of consumption of both, or just one, good(s). The problem with subsidizing goods is that it gives signals to the consumer that the good creates a positive externality, i.e. it increases social welfare. While clean energy technologies trample less heavily on the earth, solar panels and wind turbines must still be produced by a firm using hazardous materials and non-renewable energy. One cannot argue that using such technologies reverse damage in the atmosphere, they only damage it less; therefore, they do not create a positive externality and should not be subsidized.