Subsidies, standards and energy efficiency

Abstract

Carbon taxes have been shown to be the most cost-effective instrument for carbon abatement in a second-best world characterized by non-energy-related market failures such as pre-existing taxes. We show, however, that both subsidies for energy efficiency improvements and fuel standards can be good policy instruments in a third-best world in which consumers underinvest in energy service capital. In this framework, subsidies and standards can both reduce emissions and increase welfare. We show additionally that still further emission reductions are attainable by combining these instruments with a CO2 tax. Two versions of a CGE model for Switzerland are used to compare five policy proposals. First, we examine the transitional impacts of the different policies using the dynamic CEPE model. The same policies are then implemented within a static representation of the model, which includes a bottom-up representation of light-duty vehicles and allows a more detailed examination of the role of fuel standards and subsidies for energy-efficient vehicles. Copyright ©2011 by the IAEE.