Time-Limited Subsidies: Optimal Taxation with Implications for Renewable Energy Subsidies
General Description of Research:
We study how policymakers should design subsidies that will or may eventually end. These considerations change what types of subsidy programs are most effective and how large the subsidies should be. We apply these insights to renewable energy subsidies for wind turbines.
Research Abstract:
Pigouvian subsidies are efficient, but output subsidies with uncertain or limited durations are not Pigouvian. We show that optimal time-limited policies must also subsidize investment to correct externalities generated after the output subsidy ends. Furthermore, an output subsidy’s optimal duration is characterized by the change in production when it ends. In the wind energy industry, we find that power generation decreases by 5%–10% after the end of facilities’ 10-year eligibility for the Renewable Energy Production Tax Credit. This behavioral response has implications for energy transitions and highlights how time limits could cause larger distortions in more elastic industries.