Association for Public Policy Analysis & Management

Governments have a history of subsidizing clean energy technologies, including renewable electricity sources, biofuels, alternative vehicles, and efficient lighting and appliances. From an economic point of view, the subsidy for consumer use of clean energy technologies is primarily justified through two different conceptual arguments. First, a subsidy prompts consumer adoption of the technology, which yields direct environmental benefits in the form of reduced emissions. The second justification is that the subsidy, as a demand-pull policy tool, provides indirect innovation benefit through stimulation of technological progress and cost reductions. However, the two conceptual approaches are incomplete on their own and have not been combined in an analysis of clean energy subsidies.

In this research, we synthesize the two views and develop an integrated framework for analyzing the direct and indirect effects of government subsidy levels. We use this framework to estimate optimal subsidy schedules for residential solar photovoltaics. The framework integrates three types of techno-economic models: technology adoption, technological progress, and environmental emissions models. The adoption model quantifies expected technology adoption with and without a subsidy. The technological progress model estimates cost reductions driven by adoption and those attributable to the subsidy. Total environmental benefits from adoption in a given year are estimated with an emissions model that quantifies and monetizes emissions reductions.

We supplement our integrated framework with additional data on residential solar PV cost and energy prices across the U.S. to evaluate different levels of government support. We identify a socially optimal federal subsidy trajectory that maximizes the total net benefits (i.e. emission-reduction benefits minus the cost of government subsidies). Results indicate that subsidies that decline over time have greater net social benefits than flat subsidies, with the optimal trajectory dictated by the assumed social discount rate. At a 5% discount rate, optimal subsidy levels for residential solar start at $250/kW today and decline to $10/kW in 10 years, while a 3% discount rate suggests a subsidy that falls from $540/kW to $16/kW over 11 years. The model also demonstrates other important features of optimal subsidies. This includes the observation that greater heterogeneity in the private economics of a technology results in a lower level of optimal subsidies because of a stronger ability for early adopters to drive technological progress without intervention. The method we present can easily be extended to other technologies or integrated with more sophisticated modeling of system components, and offers a general framework for integrating direct and indirect benefits of government support for emerging energy technologies.