Monday, June 16, 2008

Energy policy: taxing or subsidizing?

How should one encourage to use of alternative energy sources? There are essentially two market based means: subsidizing the good sources, and taxing the bad ones. So what would be optimal to do?

Essentially, the goal is to create a price wedge between good and bad, so that consumers are encouraged to choose more frequently good energy sources. So at first sight, taxing or subsidizing does not make a difference. However, subsidizing has several drawbacks. First, as the average price of energy decreases, the overall use of energy increases, which may be an unintended consequence. Second, the subsidy must be financed with some other revenue, which is typically through some distortionary taxation that generates a deadweight loss.

Thus: tax fossil fuels, do not subsidize renewable energies. Use the revenue to offset distortionary taxes.


T-Bone said...

Agreed. Yes a subsidy encourages overall increased energy use and requires revenue from somewhere else.

But I think there's another reason to penalize/tax fossil fuels. The reason is that the pollution and carbon are externalities, and a tax internalizes those external costs.

On the other side of the coin, some actions have external benefits, and not subsidizing those actions appropriately would actually be a distortion.

Using clean energy doesn't have an external benefit. It just lacks external costs. No subsidy needed.

VIlfredo said...

Sins are not taxed enough. I wish governments had the guts to tax externalities all the way where they should be, introduce value added tax where it is not yet in place, and reduce with the revenue the distorting taxes, like the income tax. Use subsidies sparingly.

PaulHunt said...

I think that the public will go for whatever is cheaper for them immediately. So I think subsidizing is a good idea. But I'm not sure if it will happen because we seem to be approaching a energy crisis. I read this article called, Energy Recession or Energy Depression.... And it talks about the implications of expensive energy and what we can expect. Its interesting. Thanks.

Economic Logician said...

Paulhunt, if the public understands that an increase in tax here means a decrease in tax there, it will accept it.