Maybe we should be giving rebates to installers rather than households.
People generally follow Newton’s first law of motion: they keep doing what they are doing unless acted upon by a force.
Unfortunately, to tackle climate change, we do need people to make some changes. If we want to follow the edict to “green the grid and electrify everything,” then one important change is a move away from natural gas, propane and fuel oil for home heating and cooking and toward electrification.
Around one-quarter of US homes are already fully electric, and Lucas has detailed how new homes are ready to go electric when the incentives are right. But, that leaves north of 80 million existing US homes that need to make a fuel switch retrofit.
What force can we muster to put momentum on the side of electrification at a national scale? A close look at the challenge reveals a role for subsidies for home electrification that are not just big, but smart.
The scale of the challenge
The electrification evangelists at Rewiring America have written extensively about this problem. Together with the Center for American Progress, they have a useful report calling for federal subsidies that average out to $5,000 per household and run as high as $14,000, or even $19,000 for low and middle-income households who get more generous rebates under the plan.
Some fancy multiplication shows that $5,000 per household scales to $5 billion in federal rebates for every one million retrofits. They sketch alternative roadmaps that pencil out to between $10 and $25 billion in subsidies per year, with a grand total north of a quarter-trillion in spending over a decade in their aggressive scenario.
Source: Center for American Progress
That’s a lot of cheese. For comparison, federal tax credits for residential rooftop solar and other energy technologies tallied around $2 billion in 2019, and investment and production tax credits for renewable energy summed to $8 billion.
But it’s not even clear that this is enough to motivate mass electrification. These subsidies are designed to bring the cost of the electric option into parity with the status quo technologies in terms of upfront purchase price and installation cost, with the goal of making electrification the default option.
But this upfront cost parity may not be enough to motivate people to overcome the hassle and information costs associated with making a switch. Here in Northern California, SMUD has generous subsidies under its Go Electric program, but only 6 or 7% of customers are going electric when they replace an old appliance.
To make electrification the default option, we probably need to combine customer rebates with policies that motivate the supply side of the market. That is, we need to get contractors and installers excited about electrification.
Some supply side considerations
I think contractors and installers are a big part of the solution because of my own mechanical incompetence. I have only the vaguest notions of the differences between an electric heat pump and my gas furnace, or the difference I’d experience cooking on an invection stove (convection? induction? what’s that word again?). I don’t even know how to figure out if I’d need an electric panel upgrade.
But the fact that I know I might need a panel upgrade, and that I’m close enough on the terms that Google can set me straight, puts me ahead of many millions of people who just want to take a hot shower, stay warm in the winter, and cook when it’s time for dinner without embarking on a research project.
When people like me need a new appliance, we end up working with a salesperson or installer who knows a lot more about the options and requirements than we do, and who can easily nudge us away from electrification if it’s in their interest–which it might be if they only have the fossil appliance in stock, they are less experienced at installing the electric version, fuel switching requires a permit or involves extra installation work, or because they have to coordinate with an electrician to get the job done.
Given these barriers, if we want contractors and installers to become the vanguard of electrification, we might want to offer them some cash courtesy of Uncle Sam. I conjecture that if we reduced the (proposed) customer rebate for a heat pump space heater by $1000, and instead gave installers a $1000 direct kickback for every installation that was a verified fuel switch, we would get more bang for the buck. Installers would find a new enthusiasm for retrofits, change their inventory, and figure out how to overcome the other associated hassles.
Conventional economic theory suggests that it shouldn’t matter if I give a $1000 subsidy to the customer or if I give the $1000 to the seller instead. According to this view (called the irrelevance of statutory incidence), if the customer is getting a rebate, the installer should know this and be able to raise prices, so my proposed shift is a red herring.
But this isn’t necessarily how the world works. In a classic paper on the car market, Meghan Busse, Jorge Silva-Risso and Florian Zettelmeyer show that when a manufacturer advertises a $1000 cash rebate to customers, customers end up with nearly all of that money–they strike a price with the dealer that is about the same as before the rebate was announced, but they get to keep the cash. But when the manufacturer gives a $1000 kickback to dealers for selling the same car, the dealers keep almost all of the subsidy.
The authors explain this as the result of asymmetric information–dealers facing a $1000 kickback for selling certain models redouble their effort to get customers interested in particular models and push extra hard to close sales. But consumers don’t know that the dealer has a discount on the backend and don’t negotiate down.
Something similar might happen with a fuel switching bonus. Installers might well continue charging the same hourly labor fees for installations of electric or fossil appliances, but they’d be keen to nudge customers to go electric if they got to pocket a bonus at the end of the day.
Another big challenge is that many appliances are replaced only after a failure, at which point speed is paramount. This heavily tips the scale toward the status quo fuel. But if the whole industry were facing lucrative bonuses for fuel switches, it might kickstart efforts to find customers ripe for an upgrade even before their equipment fails.
In the context of keeping the lights on, Severin recently asked, “Why don’t we do it with demand?” In the context of electric retrofits, I’m asking, “Why don’t we do it with installers?”
It would take more research to know how exactly to calibrate the right balance of subsidies on the supply and demand side for electric retrofits. (If there are any utilities or policymakers interested in getting these answers, give us a call–we’d love to design such a study.) And there is existing research showing that it can be hard to get salespeople interested in pushing energy efficient products.
Even so, I feel pretty confident asserting that a plan that is entirely focused on customer rebates is misguided. Yes, we need the economics to work for the customer, but I think we’ll get even more bang for our buck if we use some cash to help convert installers and contractors to the cause. After all, they follow Newton’s first law of motion, just like the rest of us.
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Suggested citation: Sallee, James. “The Supply-Side Economics of Residential Electrification” Energy Institute Blog, UC Berkeley, August 30, 2021, https://energyathaas.wordpress.com/2021/08/30/the-supply-side-economics-of-residential-electrification/
James M. Sallee is an Associate Professor in the Department of Agricultural and Resource Economics at UC Berkeley, a Research Associate of the Energy Institute at Haas, and a Faculty Research Fellow of the National Bureau of Economic Research. He is a public economist who studies topics related to energy, the environment and taxation. Much of his work evaluates policies aimed at mitigating greenhouse gas emissions related to the use of automobiles.