The bankruptcy filing by solar-manufacturing firm Solyndra less than three months ago carried the debate about federal government investments in energy into the mainstream political conversation. What’s more, that debate now has moved from a relatively narrow argument about how government can most effectively intervene in energy to a much more fundamental and radical debate about whether or not government should even be involved in energy in the first place.
Case in point: The Heritage Foundation recently wrote, “Given the U.S. fiscal situation, this is a time to end all energy subsidies—not to extend wasteful, market-distorting policies. When the government decides to favor a technology with subsidies, it’s a good bet that subsidy ‘winner’ is a loser in the marketplace.”
While this is undeniably simple and may even sound sensible, it ignores the reasons why government invests in energy in the first place. Worse, this call for the government to get out of energy entirely—without acknowledging that there is sometimes a legitimate role for government to play—comes at a critical juncture for our energy future. Thinking ahead 20 years, to 2030, we know this about our country:
- We will either be powered by clean energy or we will be suffering the early effects of catastrophic climate change.
- We will have a vibrant clean energy manufacturing sector or our factories will have continued to close.
- We will control our own energy choices or we will continue to depend on entrenched fossil-fuel interests to meet our energy needs.
- We will either have moved beyond coal or our children will have even higher rates of asthma.
In short, we will thrive with clean energy or we will suffer without it.
But we know full well that just because it’s possible for the United States to achieve a prosperous future powered by clean energy, it is by no means certain that things will play out this way. In fact, as we look back over the past few years, it’s clear that despite the clean energy imperative being widely recognized across the country, there are forces holding back the clean energy economy. Some of these forces are well-funded fossil-fuel interests who mislead the public into thinking that we can’t afford to make this choice, but there are also real structural barriers that disadvantage clean energy.
The free market will address some of these barriers. For instance, new business models and new technologies are helping businesses save money by lowering their energy usage. Honeywell International Inc. and energy software company Opower are now partnering to deploy advanced thermostats in coordination with utilities’ energy-efficiency programs.
There are other barriers, though, that aren’t so easy. That’s why it’s important to understand the role that government can play in seizing the energy opportunity. The federal government not only can invest in clean energy but must—at least until the underlying market conditions in our energy markets change.
To fully understand why clean energy investment is so important, it is useful to start with the broader question of what role government investment should play in the energy economy as a whole. This is really three related questions:
- Is government intervention in the energy markets appropriate?
- If so, which investment tools, such as tax credits, loans, grants, or loan guarantees, are the best way for the government to intervene?
- Which of these types of investment are most suited to the particular problem at hand?
We’ll answer each of these questions in turn.
In their report “Government Spending Undercover,” the Urban Institute’s Eric Toder and New York University School of Law’s Lily Batchelder propose a methodology for determining when individuals or industries deserve tax breaks. We adopt and adapt that methodology here, to apply specifically to the energy context, omitting Toder and Batchelder’s discussion of the proper type of investment best suited to each particular situation. Matching investment type to the specific need of a technology or company is critically important, but is beyond the scope of this column.
The first important question in the Toder/Batchelder decision tree is whether there is a market failure, such as an “externality,” which in economics means an external impact with real economic cost that is not reflected in the price of a product. If so, then government intervention may be appropriate to help internalize the cost of that externality. Clean energy clearly meets this requirement.
Air pollution is a costly unpriced negative externality in the traditional energy sector. When a coal-fired power plant is allowed to spew dangerous pollution into the air, it is subjecting the entire surrounding community to ill health and other costs, and is contributing to global warming, which comes with enormous global costs. These costs aren’t captured on electricity bills, though. Instead, they’re registered in hospital bills and climate-adaptation expenses such as building levees to hold back stronger storm surges. These costs are not only real; they are significant. According to recent research published in the Annals of the New York Academy of Sciences, negative externalities related to burning coal cost our economy $345 billion per year. The federal government can help level the playing field by investing in clean energy, which reduces the need for traditional fossil-fuel energy, and reduces these negative externalities.
But let’s pretend for a moment that there is no market failure. The next Toder/Batchelder question is this: Does the energy resource produce important public benefits that the purchaser does not take into account? Consider this example: Clean energy technologies get cheaper as we build more of them. Society benefits from less expensive clean energy because the cheaper the alternative to fossil fuels, the more likely it is that we will build a lot of power generation using that alternative.
Yet someone still has to make the initial investments. If we buy solar panels today, society will benefit from cheaper solar panels tomorrow. But individuals are generally unwilling to pay for something that benefits other people and not themselves, so it falls to the government to intervene by providing some type of investment incentive—like a rebate for solar panel purchases—to those individuals.
Related to this, there is the chance that some energy resources provide private benefits that the purchaser does not take into account. In general, economists tend to think that if a purchaser is unwilling to pay for a benefit then that benefit does not have much value. This is largely correct. But there may be times when purchasers are unable to take certain benefits into account because they have insufficient information about those benefits.
If a utility bill is too confusing (as they often are) and if consumers have insufficient information about energy-saving actions, then consumers won’t be able to make effective energy-efficiency investments to bring down the costs of their next bill. In cases like this, government has several options to address the challenge. They could try to provide consumers with better information, or they can incentivize certain investments. Tax credits, for example, can be awarded to homeowners for installing the most effective energy-saving technologies, such as attic insulation.
Even if these other criteria aren’t met, there is another scenario where government intervention makes sense: if a society wants to assist a particular group, such as farmers, senior citizens, or others who seek government support. For instance, the Low Income Home Energy Assistance Program, or LIHEAP, which helps low-income households pay their utility bills to heat or cool their homes, is a good example of this type of intervention. On its face, the program is a direct benefit to utilities that already capture the value of their services through bills paid by ratepayers. That’s why the Environmental Law Institute classifies it as a subsidy to utilities. But LIHEAP plays a critical role in helping low-income ratepayers pay their bills so they can keep the lights and heat on, which we would argue is both an important benefit to low-income consumers and also meets the public good of providing more universal access to energy across America.
So now we know when intervention is appropriate. But when is investment the right government response? There are many tools that the federal government has at its disposal, including regulation (pollution standards), government provision of goods or services (generating electricity at the federally owned Hoover Dam), or investment in the private market (tax breaks for research and development expenses). Choosing the right tool requires an analysis of government’s capabilities, the type of problem that requires government intervention, and the desire to deliver the most cost-effective interventions.
Clearly, there are examples when investment is the right choice. But there are also times when investment may not be the most cost-effective solution. And there are times when investment should be paired with other interventions. Consider the primary way that the federal government currently incentivizes firms to invest in renewable-electricity generation such as wind power—by providing these firms with a tax credit. This strategy has been very effective, and the credit serves a legitimate function of addressing a market failure with a public-goods benefit tailored to the needs of the private marketplace.
But Congress should consider whether or not a complementary regulatory intervention like a clean energy standard would be a more efficient way of incentivizing these kinds of investments. With a clean energy standard that requires utilities to sell a certain amount of low-carbon electricity, it may be possible to reduce the tax incentives and get the same level of investment.
This simple example of how government can intervene in different ways points at just how complex our energy system is. It’s tempting to say that only the free market can effectively manage such a complex system, but our analysis shows that this is insufficient. Our current energy system not only allows government intervention, it demands it. As the year turns over to 2012, Congress should make a resolution to use every tool at its disposal, in the most efficient way possible, to make sure we get on the path to a more sustainable, equitable energy future.
Richard Caperton is a Senior Policy Analyst with the Energy Opportunity team at the Center for American Progress. Kate Gordon is Vice President for Energy Policy at the Center.