Would a Carbon Tax Be a Sensible Alternative to Subsidies?


Governments around the world stimulate the development of renewables by offering subsidies. But fossil fuels are subsidized too. Given the realities of climate change and increasing global energy demand, a better option could be a carbon tax – which might promote renewables better than any set of policies. 



Governments around the world stimulate the development of renewables by offering subsidies. Unfortunately, fossil fuels are subsidized too. However, climate change and increasing global energy demand require changing the status quo. A better option could be a carbon tax – which might promote renewables better than any set of policies. 


Subsidies are a factor in solar’s current competitiveness, often allowing its price to be just low enough to justify investing in it. But what role do fossil fuel subsidies play?


Fossil fuel versus renewable energy subsidies


The comparison between fossil fuel and renewable subsidies vary with the scope of the data. For example, OPEC nations heavily subsidize oil, which skews global numbers. Venezuelans apparently enjoy 6 cents/gallon gasoline prices. 

The U.S. Energy Information Administration (EIA) publishes U.S. federal support data for select years (pages xiii and xiv). It’s worth pointing out that of the roughly $14 billion of support to “renewables” in 2010, almost half of this is tax relief for biofuels. Often these breaks for farmers are not carefully distinguished from sincere investment in clean energy. It’s only very recently that renewables have received more support than fossil fuels in the U.S. DBL Investors report that, historically, fossil fuel subsidies dwarfed support to renewables.

Fossil fuels comprise a very large market, so the effect of their subsidization on prices is small. But it is enough to marginally affect solar investment decisions. I recently did a panel data regression comparing 17 developed, non-OPEC countries from 2005-2011. I found a significant negative correlation between coal / natural gas subsidies and solar installed capacity. 

Since coal and natural gas are competitors with solar for electricity generation, this isn’t too surprising. It’s like saying that when Coke gets a bunch of tax breaks and subsidies it’s bad for Pepsi’s business. 


Many wonder why fossil fuels are subsidized at all. There are some dubious justifications for these policies, such as jobs and energy independence. In the best cases, fossil fuel subsidies seem to have to do with politics. In the worst cases, they are pure anachronisms that remain on the books. 


In light of the threat of climate change, public support of renewable energy, and the increasing efficiency of renewable energy technologies, it’s unfortunate that wealthy nations subsidize fossil fuels at all.


Benefits of a carbon tax


In contrast, a carbon tax policy would reduce emissions more efficiently and could promote renewables better than today’s subsidy environment. The debate turns to the consequences and fairness of such a tax, notwithstanding the political barriers to enacting it.  


There’s a catch-22 here: a carbon tax would have to be large enough to actually change people’s behavior, but this change would disrupt the economy in the short run and impact the poorest people the hardest. 


One way out of this dilemma is to use the revenue generated by a carbon tax to offset the regressive effects, by rebating electricity bills or reducing income taxes for qualifying households (with clean energy requirements). Replacing sales tax with a carbon tax is another option, at the state level. Carbon tax revenues are likely to be substantial.


Renewable energy would enjoy a boom as home- and business owners shift away from costly carbon-taxed electricity. Economists like such a tax because it allows market forces to choose the most successful clean energy innovations, meaning that even the fossil fuel industry will invest seriously in reducing emissions. Subsidies would still be useful for funding R&D, but would no longer be necessary for renewables as industry-wide support. 


The EPA will announce new regulations on existing power plants next year, and hasn’t ruled out a (modest) carbon tax. Politically, however, it’s more likely that we’ll see tradable permits or technology standards than taxes. And any of these options would have to be enacted by state legislatures (see this Washington Post article). Still, an important policy decision is on the horizon.