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Bad Incentives For Green Choices

Sure, I’d like to see a tax on gasoline that reflects its greenhouse gases emissions.  If we can’t or won’t do that, then maybe subsidies for electric vehicles can imperfectly address some of the same goals.  If not that, how about free EV charging?  Free parking? Higher speed limits for EVs? Discount air travel for EV owners?  Complimentary massages?

By the time you got to the last couple ideas, you probably said “well that’s ridiculous.”  At least I hope so.  But where do you draw the “ridiculous” line?

The near-unanimous view of economists is that the best way to deal with pollution externalities is by pricing them, generally through a pollution tax or cap and trade program.  Yet, policy makers still prefer to reward “good” behavior rather than impose costs on bad behavior.  Economists grumble, but policy makers respond that we mustn’t let the perfect be the enemy of good steps in the right direction.  There’s something to that, but a number of recent debates illustrate how these substitutes for pricing pollution can go off the rails, often doing much less good or even overall harm.[1]

Even if a reward is narrowly targeted — such as a subsidy for using or generating energy that is truly zero-GHG —  it still doesn’t give consumers incentives that match the underlying problem.  When we subsidize cleaner electricity, we may get the relative price of green versus brown electricity right, but we get the relative price of electricity versus everything else in the economy wrong.

The fundamental problem is not that green energy has positive spillovers — running your A/C on solar power doesn’t make others better off — but that brown energy has negative spillovers.  Thus, when we subsidize green instead of taxing brown, we end up making electricity too cheap overall.[2]    Green electricity subsidies also fail to account for how much GHG emissions they actually prevent.  Is that wind turbine crowding out coal-fired generation, a gas-fired plant, or another wind turbine?  The answer determines the value of the green power, but is not reflected in today’s subsidies.

While renewable electricity standards and subsidies are the big gorillas of green behavior rewards, there is a plethora of smaller reward systems that create further problems.  They offer some indirect benefit that creates a new set of distortionary incentives.  A perfect example was in the news earlier this year when Los Angeles International Airport (LAX) cancelled its free parking for electric vehicles — which began in the 1990s when EVs were as rare as $4 gas  — because the program had become “too successful.”

The advantage of electric vehicles is that they put out less pollution (yes, even counting the electricity generation process), but only when they are moving.  Why would anyone think that subsidizing EV parking at LAX gives the appropriate incentive to buy and drive an EV?  In fact, it lowers the overall cost of travelling by air, which is itself a GHG-intensive activity.  Complimentary massages for EV owners would probably make more sense.


But this reward turned out to have many other flaws.  Free parking was especially attractive to people going on long trips, who left their EVs sitting for weeks at charging stations, blocking other EVs from getting a charge and actually reducing the effectiveness of the free charging reward that LAX also offers.  On March 1, LAX discontinued the free parking, but continued to offer free charging (at least when you can find a charging station available).  The change was deplored by some EV advocates who instead wanted LAX to offer still more EV-dedicated spots with charging stations.  For every subsidy there is a beneficiary who believes it is now their God-given right, whether free parking for EVs or free polluting for old cars and power plants. (This post is already too long, so I’ll have to defer comments on HOV lane access for EVs, another indirect subsidy.)

A number of recent stories about taxing hybrids and EVs have raised a similar issue.  In Massachusetts, New Jersey, North Carolina, Virginia, Washington, and many other states improved vehicle fuel economy is reducing gasoline sales, which is lowering gas tax revenues that are dedicated to road maintenance and improvement.   The owner of an EV or plug-in hybrid does about as much road damage per mile driven — and gets about the same value of using the road — as a similar-sized car with an internal combustion engine, but the electric car doesn’t pay those gas taxes.

Advocates of a tax on EVs say high-fuel-economy cars should pay their fair share for road use, but defenders of electrics say that we need strong incentives to recognize the environmental and other advantages of reducing gasoline consumption.  They’re both right.  Taxes for road use should reflect the cost imposed by the user — road damage, congestion, safety, and other externalities – regardless of the type of engine used.  But those should be coupled with charges that accurately reflect the environmental damage of each type of vehicle.  These are separate costs that need separate, and transparent, fees.

Exempting EVs from paying for road use is like giving them free parking at LAX, an indirect reward for good behavior that will be less equitable and efficient than taxing the negative externalities directly.  Using gas taxes to reflect road use may have once been the best we could do, but technology now allows easy pricing of vehicle miles traveled – such as a mileage component to the annual registration fee — as well as the vehicle’s impact on congestion.

I support gas taxes to address GHG emissions (that’s my generic-gray Prius with the “TAX GAS” license plate), but vehicles that put out little or no GHGs shouldn’t be exempted from covering all the other costs they impose.  There’s really no reason to think that exemption from road taxes creates the right level of incentives for reducing GHGs.

We will never get to a pricing system that exactly reflects all the negative and positive externalities that our actions create.  But that shouldn’t be used as an excuse to adopt indirect — and opaque — subsidies without a careful analysis of how well they address the basic market failure, and what other perverse incentives they create.

[1] And this doesn’t even include the additional concern that pollution taxes can raise revenues that allow reductions in other distorting taxes – such as on wages — while subsidies often increase the need for those other distorting taxes.

[2] This is mitigated to some extent when we pay for the subsidies through increased electricity prices (though very imperfectly it turns out), but the U.S. relies heavily on green energy subsidies from the federal government, paid for through income taxes and other revenue sources that do not impact the price of electricity.  For more discussion of green power subsidies, see my recent paper on renewable electricity generation.

Severin Borenstein View All

Severin Borenstein is E.T. Grether Professor of Business Administration and Public Policy at the Haas School of Business. He has published extensively on the oil and gasoline industries, electricity markets and pricing greenhouse gases. His current research projects include the economics of renewable energy, economic policies for reducing greenhouse gases, and alternative models of retail electricity pricing. In 2012-13, he served on the Emissions Market Assessment Committee that advised the California Air Resources Board on the operation of California’s Cap and Trade market for greenhouse gases. Currently, he chairs the California Energy Commission's Petroleum Market Advisory Committee and is a member of the Bay Area Air Quality Management District's Advisory Council.

18 thoughts on “Bad Incentives For Green Choices Leave a comment

  1. “Thus, when we subsidize green instead of taxing brown, we end up making electricity too cheap overall.” Not necessarily. First of all, it depends on the form of the subsidy. If it’s a feed in tariff, the subsidy will most likely increase rates. Secondly, it depends on the nature of regulation. Hawaii and the Philippines have the most aggressive renewable subsidy programs in the U.S. and SE Asia, but their prices are the highest in those places by far. Casual empiricism suggests that utility stockholders were primary beneficiaries of subsidies and mandates.

  2. Are there any recent studies (within the past few months) on the impact (or lack thereof) of renewable standards and subsidies on the continuing decline in prices (according to the EIA, 35% drop in the levelized cost of solar in the last two years)?

  3. Why the worry about making electricity too cheap, setting aside the pollution from fossil generation and the risks from nuclear? I suggest taking a long view on this. A 100% renewable electricity system, which we must get to over the next few decades to prevent climate catastrophe, will have a marginal production cost of zero most of the time, because you need a large reserve to cover peak loads and outages. So we will have to pay for electricity almost entirely by capacity charges. Nobody will worry about the marginal kwh. Under plenty – and economists might remember that plenty is desirable if you can have it, even if it makes them redundant – the problem of misallocation disappears. A temporary misallocation en route to early plenty isn’t that important.

  4. Subsidies are insidious, I have done some work in Saudi Arabia. Their electricity is highly subsidized. Their water (desalinated) is highly subsidized. The citizens of that country have no reason to buy an efficient air conditioner or to turn it off. I don’t see any way out for them. To change that situation might cause a revolution.

  5. I guess the problem is still that it is difficult to draw the “ridiculous” line and whether we need smaller actions like these stated in the article. When we consider these small incentives/actions, the logic of “big problems — small actions” is helpful for us to understand why they exist. In economics, when there are big market failure problems, big actions such as tax and CAT are obviously the best options. However, what can small bodies like an airport do when facing big problems? Purely nothing and unnecessary? I don’t think so. It is exactly because the problem is so prevalent that everybody wants to contribute in his/her own way. Maybe their policies/approaches are not perfect, but when they see a potential problem of it, they will react to that. This is a practical, gradual and ‘imperfect’ approach, but a worthwhile one. Most of these small actions just cannot be perfect in economics sense, since they are partial and cannot consider the full impact they have on the economy. But they are voices from various small parties, who can then converge and add up to the momentum, before we have a once-for-all best policy.

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