Inducing Renewable Energy Innovation Through Taxation

Renewable Energy Innovation’s Obstacles

As the Paris Conference approaches, policymakers will search for a practical means by which the United States can meet any potential voluntary commitments to reductions in greenhouse gas (GHG) emissions. Economists have suggested that an increase in the price of fossil fuels could “induce innovation,” as businesses are given an incentive to develop low carbon solutions to limit their costs.[1] To have a realistic chance of mitigating human contributions to climate change, it will be essential for countries to adopt policies designed to induce innovative technologies and techniques that will lessen economic reliance on fossil fuels.

The barriers to optimal incentives for research and development (R&D) in renewable energy and high efficiency technologies are widely understood—research produces positive externalities, which researchers are unable to capture the full benefit from, resulting in chronic underinvestment.[2] This underinvestment is particularly acute for R&D that may be sufficiently unproven in that researchers cannot be certain whether discoveries will ever be patentable or commercially viable, but findings may produce positive externalities in the form of knowledge that other researchers can later build upon.[3]

Meanwhile, fossil fuels produce externalities in the form of GHG emissions and other environmental impacts, which means that their users are not confronted with the full social cost of fossil fuels despite internalizing the benefit. Existing infrastructure also creates a lock-in effect that gives incumbent technologies a lower sticker price than innovative technologies that may actually be more beneficial in the long term.[4]

Opponents of extensive government intervention in private investment decisions through the use of incentives might note that the fossil industry’s dominance and lock-in are in part owed to the heavy subsidies that fossil fuel industries have enjoyed from the federal government for decades, achieved primarily through acceleration of deductions for exploration, drilling, and production costs.[5] These tax subsidies reduced the cost of the petroleum industry and gave it a competitive advantage, which in turn incentivized investment in technological innovation within that industry through much of the twentieth century.[6] The petroleum industry itself provides a model for how government intervention in financial incentives can lead to investment in otherwise risky R&D.[7]

Existing Alternatives and Counterparts

Federal subsidies, including direct research subsidies and tax-based subsidies, such as the research deduction and Production Tax Credits (PTCs) are important means for reducing the positive externalities of renewable energy R&D.

However, these research subsidies have several downsides in the renewable energy context. Political gamesmanship surrounding PTCs, which must be renewed every two years, has undermined the ability of businesses to fully invest with confidence in renewable energy projects in reliance on PTCs.[8] [9] In a Pew Center survey of business, 65% of respondents indicated that potential policy changes in regulation and subsidies represent the greatest uncertainty faced by businesses considering low carbon technologies, in contrast with less than 25% of surveyed businesses responding that market uncertainties were greatest.[10] Subsidies for renewable energy also incentivize an increase in energy consumption by lowering the overall cost of electricity, which undermines parallel efforts to promote energy efficiency for the sake of overall GHG emissions reductions.[11]

Existing fuel taxes are currently the most common form of energy tax, but they have many shortcomings as a measure to reduce GHG emissions. Taxes on fuel have been associated with pressures on the auto industry to develop fuel economy breakthroughs in vehicles, alongside direct regulation in the form of imposed standards. Yet given that transportation accounts for approximately 28% of GHG emissions, gasoline taxes are not effectively tailored to the goal of incentivizing innovation across a broader range of industries or forms of fossil fuel consumption. Fuel taxes may be partially justifiable as a coexisting supplement to carbon taxes in order to address other externalities, such as road accidents and other forms of air pollution, but they do not constitute a viable alternative.

Policymakers have also considered a broad energy tax, most notably including President Clinton’s proposal of a BTU tax in 1993. However, and quite intuitively, energy taxes do not tailor innovation incentives as closely to the goal of developing low carbon technologies as a tax on carbon. While an energy tax would create greater incentives for improving energy efficiency of all sorts, it does not tip the scales in favor of renewable energy over fossil fuels.

Innovation-Spurring Benefits of a Carbon Tax

A carbon tax can induce innovation in renewable energy by making byproducts of this research more commercially competitive with existing fossil fuel technologies. Both carbon pricing and renewable energy and energy efficiency research subsidies are necessary to internalize both the negative externalities of greenhouse gases and the positive externalities of R&D. If the long-term cost of GHG emissions can be at least roughly accounted for in the price of fossil fuels, renewable energy technologies that currently suffer from underinvestment may become commercially worth pursuing.[12]

A carbon tax gives inventors and businesses a free hand in deciding which renewable energy and efficiency projects constitute the best investment of time and resources.[13] Unlike direct regulation or targeted grants and subsidies, innovators can respond to incentives and decide which efforts are worth pursuing without needing to convince a regulator or lobby a legislator—innovative success can be decided on the free market. Additionally, unlike a system involving a fixed number of cap and trade permits, socially optimal GHG emissions need not be predetermined by government officials attempting to balance uncertainties in both economic impact and climate science.[14]

An upstream carbon tax could be placed on a relatively small number of businesses which serve as entry points for a commodity into the market through a supply chain. This would be more cost effective to implement than a direct tax on millions of consumers, such as a ‘tailpipe tax.’ An upstream tax on fossil fuel producers or refiners would also be capable of establishing a large tax base while utilizing administrative economies of scale, covering an estimated 80-90% of GHG emissions, which could then be priced into downstream consumption incentives.[15] The most important uncertainty would be the tax rate itself, which may have to evolve with the consensus on socially and environmentally optimal GHG emissions.[16]

The major downside of a carbon tax for manufacturing industries is the potential loss of economic competitiveness for adopting countries. Because carbon pricing results in a net increase in energy costs, a carbon tax would create a danger of “carbon leakage,” whereby elastic forms of manufacturing could be moved to countries without a similar tax, resulting in no net reduction in GHG emissions with respect to manufacturing.[17]

Much of this carbon leakage might be alleviated with a border tax on imported goods accompanied by tax rebates on exports.[18] However, this would require either extensive maneuvering around existing WTO commitments or renegotiation with individual countries.[19] Each tax rate would also have to be based on industry averages in the importing country or within the US, and importers would need an opportunity to prove lower GHG emissions in their production process in order to retain the desired incentive effects of the tax.[20]

Overall, some combination of a carbon tax and broad renewable research subsidies may be capable of overcoming many of the positive externalities of innovative yet unproven research, while still increasing the commercial competitiveness of renewable energy R&D in comparison with fossil fuels.

 

[1] Richard G. Newell, Adam B. Jaffe & Robert N. Stavins, The Induced Innovation Hypothesis and Energy-Saving Technological Change, 114 Q.J. Econ. 941 (1999)

[2] Shaun P. Mahaffy, The Case for Tax: A Comparative Approach to Innovation Policy, 123 Yale L.J. 812, 819-21 (2013)

[3] Id.

[4] Joshua Meltzer, A Carbon Tax as a Driver of Green Technology Innovation and the Implications for International Trade, 35 Energy L.J. 45, 50 (2014)

[5] Mona Hymel, The United States’ Experience with Energy-Based Tax Incentives: The Evidence Supporting Tax Incentives for Renewable Energy, 38 Loy. U. Chi. L.J. 43, 64-66 (2006)

[6] Id. at 65-69

[7] Id. at 67-68

[8] Weisbach & Gilbert E. Metcalf, The Design of a Carbon Tax, 33 Harv. Envtl. L.R. 499, 553 (2009)

[9] Joshua Meltzer, A Carbon Tax as a Driver of Green Technology Innovation and the Implications for International Trade, 35 Energy L.J. 45, 50 (2014)

[10] Pew Center on Global Climate Change, A Survey of Company Perspectives on Low-Carbon Business Innovation, 3 (May, 2011), http://www.webcitation.org/6cZXm9OPn

[11] Weisbach & Gilbert E. Metcalf, The Design of a Carbon Tax, 33 Harv. Envtl. L.R. 499, 553 (2009)

[12] Id.

[13] Joshua Meltzer, A Carbon Tax as a Driver of Green Technology Innovation and the Implications for International Trade, 35 Energy L.J. 45, 58 (2014)

[14] Id. at 51

[15] Weisbach & Gilbert E. Metcalf, The Design of a Carbon Tax, 33 Harv. Envtl. L.R. 499, 501, 523 (2009)

[16] Id. at 511-13

[17] Joshua Meltzer, A Carbon Tax as a Driver of Green Technology Innovation and the Implications for International Trade, 35 Energy L.J. 45, 63-64 (2014)

[18] Weisbach & Gilbert E. Metcalf, The Design of a Carbon Tax, 33 Harv. Envtl. L.R. 499, 540 (2009)

[19] Joshua Meltzer, A Carbon Tax as a Driver of Green Technology Innovation and the Implications for International Trade, 35 Energy L.J. 45, 64-67 (2014)

[20] Weisbach & Gilbert E. Metcalf, The Design of a Carbon Tax, 33 Harv. Envtl. L.R. 499, 550-51 (2009)

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