Finding a better target for energy efficiency subsidies

Energy efficiency subsidies are designed to encourage people to purchase items that use less energy, such as a hybrid car instead of a gas guzzler.

But new research from MIT Sloan applied economics professor Christopher Knittel, who also directs the MIT Center for Energy and Environmental Policy Research, with Hunt Allcott of New York University and Dmitry Taubinsky of Harvard University, suggests those financial enticements go mainly to the well-to-do and environmentalists who may not need encouragement to go green, raising questions about the way taxpayer money is spent.

Subsides come from the government. They help the government pursue a policy of reducing greenhouse gas emissions by making typically more expensive energy efficient products more attractive to purchase. For instance, Knittel said, on the high-end it might convince a person to purchase a battery-operated Tesla instead of a gasoline-hungry Hummer.

However, the government aid works only if the consumer didn’t intend to buy the Tesla without the subsidy, Knittel said, and his research reveals subsides may be winding up in the pockets of wealthy consumers and environmentalists who least need convincing.

“The optimal subsidy will depend on the correlation between consumers’ ‘mistakes’ and their sensitivity to the subsidy.” Knittel said. “That is, subsidies are most effective when they change the behavior of consumers that are making the largest mistakes; you change the decisions of those buying Hummers, but not necessarily consumers that are buying hybrids.”

The authors examined surveys of consumers of energy efficient products from compact fluorescent light bulbs to Energy Star water heaters. They also rely on data collected by a field experiment previously conducted by Allcott and Taubinsky which randomly offered subsidies for purchasing energy efficient products to customers.

The field experiment and other data sources provided a profile of subsidy recipients: high earners and environmentalists. These results suggest that these subsidy programs may be highly regressive—they disproportionately help high-income consumers relative to low-income consumers.

The MIT Center for Energy and Environmental Policy Research focuses on designing cost-efficient and effective policies to address environmental concerns. In this case, Knittel said the origins of his latest research can be traced to when he began thinking about buying his next car.

“I can imagine taking advantage of those subsidies,” Knittel said. “So it makes you think whether or not the subsidies are moving people’s behavior, or simply funding people who would have bought that vehicle anyway.”

What can be done?

Economists would prefer to correct behavior with a tax rather than to pay a subsidy, Knittel said. For example, a gasoline tax would force drivers to pay the full price of pollution. But policymakers find taxes unpopular, so they often use financial incentives such as subsidies to achieve the behavioral outcome they desire.

Subsides can work, though. Knittel and his colleagues suggest targeting the subsidies more narrowly. For instance, they can be devised so that only people of certain incomes can take advantage of them.

There’s a sound public policy rationale behind overhauling subsides so they target lower-income Americans.

“They don’t have access to cash to buy a more efficient hot water heater or car,” Knittel said. “So by targeting the subsidy so they’re only taken up by lower income consumers, you may be able to improve the cost-effectiveness of the program.”

And targeting subsidies to lower-income Americans wouldn’t be unusual. Knittel pointed out that many government benefits are already means tested.

In their paper, Tagging and Targeting of Energy Efficiency Subsidies [PDF], Knittel and his colleagues note that more research needs to be done in this area. And there is the question of whether narrowly targeting energy efficiency subsidies would improve conservation efforts. That, too, still needs to be studied, Knittel said.

“That’s the million-dollar question,” Knittel said.

More broadly, Knittel’s team is also concerned about Washington policymakers and how they view consumers’ purchasing decisions.

The government’s greenhouse gas emission reduction plans are influenced by the belief consumers make the wrong choice when weighing whether to buy the more expensive energy efficient product, which generally costs more upfront but saves money over time.

But Knittel said his research shows consumers do recognize the trade-off. He worries policymakers are understating the cost associated with convincing people to buy more energy efficient products, and are overstating the savings in greenhouse emissions from getting people to buy those products.

“As someone who cares very deeply about climate change [getting this wrong] would be a huge mistake,” Knittel said.