Welfare evaluation of subsidies to renewable energy in general equilibrium: Theory and application

Abstract

While support schemes to renewable energy are ubiquitous around the world today, there are few systematic welfare evaluations of their social benefits and costs in an economy-wide setting. We develop a general equilibrium cost–benefit rule to assess changes in quantity based subsidy schemes, “green” certificates, that support renewable electricity generation. An advantage to large-scale numerical models of the same issue is that we can go “into the black box” and uncover key economic mechanisms. We study a second-best economy with distorting taxes and pollution, so that a perturbation of the certificate scheme causes both benefits and costs; these items can be uncovered and estimated using our framework. To this end, we provide a user-friendly approximation for empirical implementation, which means that data requirement is modest relative to a typical computable general equilibrium model. We apply the theory to a currently existing scheme in Sweden taking into account “trickle-down” effects, including e.g. a loss of value-added tax income in the rest of the economy and environmental costs (i.e. externalities from electricity generation not currently internalized). We first present an ex post estimate, i.e. the welfare consequences of having scrapped the existing system 2003–2017 and then an ex ante analysis of extending the system to 2045. The latter includes a systematic sensitivity analysis based on Monte-Carlo simulation. Overall, we find net present value gains from removing the subsidy scheme, taking into account externalities, “trickle-down” and public finance repercussions.