Subsidies vs. Carbon Taxation
Extensive studies on the tangible effects of green energy subsidies have consistently shown that they often result in miniscule reduction of emissions. For instance, renewable electricity provisions in the US have been found to lower annual CO₂ emissions by merely 0.3 percent; the impact of biofuel provisions proves to be even more negligible—in fact, removing tax code provisions and import tariffs reduced overall emissions (Murray et al. 2014). What explains the lackluster performance of subsidies? In the case of biofuels, lower prices have increased the consumption of motor fuels, offsetting many reductions in emissions during fuel production (National Research Council 2013). This pattern is also observed in other areas, such as the production of EVs (Miron 2024). On the other hand, carbon taxation has achieved resounding success in reducing emissions. In Britain, the Carbon Price Support (CPS) policy that placed a tax on the power sector resulted in a 55% decrease in emissions (Gugler, Haxhimusa, and Liebensteiner 2021), whereas in Sweden, carbon and transport fuel taxes reduced carbon emissions from transport by 11% (Andersson 2019). While subsidies often fail to reduce emissions due to increased consumption from lower prices, carbon taxation, as seen in Britain and Sweden, has proven more effective in driving significant emissions reductions.
In terms of cost-effectiveness, the two policies also differ greatly. Consistently, studies have shown that carbon taxation requires a lower marginal abatement cost (i.e., the cost of reducing emissions by one unit). For instance, in Germany, where subsidies are the primary policy mechanism, the marginal abatement costs for wind and solar energy are €206 and €978 per ton, respectively. Britain, on the other hand, achieved significantly lower abatement costs of €36 and €55 owing to its carbon tax. Though Britain’s geography comparatively favors the utilization of green energy, this alone would not explain such a substantial disparity in cost (Gugler, Haxhimusa, and Liebensteiner 2021). Similarly, while in the US, the marginal abatement cost of subsidies introduced with recent legislation is $83, a potential carbon tax would reduce this to roughly $14 (Bistline, Mehrotra, and Wolfram 2023). Not only do carbon taxes lower costs, but they also increase revenues—a U.S. carbon tax of $20 per ton of CO₂ could generate over $100 billion annually (Aldy and Stavins 2012). A revenue-neutral carbon tax would even reduce taxes in other areas, with all revenue rebated to individuals. Carbon taxation’s lower abatement costs and potential for generating substantial revenue underscore its cost-effectiveness over green energy subsidies.
Finally, one must consider the feasibility of climate policies, with subsidies proving more practical than taxes in this context. In general, taxes are far less popular than subsidies as consumers are required to pay more for products; the same logic applies to taxes on carbon emissions (Bernton 2018; Jabakhanji 2024; Rubin and Sengupta 2018; Taylor and Hoyle 2014). Despite a negative response towards their implementation, many are taking initiatives to revamp public perceptions of carbon taxation to promote their wider adoption.
Figure 1: Effectiveness of Carbon Pricing Compared to Energy Subsidies
Overall, despite the greater political feasibility of subsidies, carbon taxes are a much better option; not only do they result in greater emission reductions, but they also do so at a lower economic cost, making them a highly effective and efficient approach to combating climate change. While political challenges remain a barrier to widespread implementation, attempts to improve public awareness and acceptance of carbon taxation are ongoing and could help overcome public resistance towards carbon taxation (Carattini, Carvalho, and Fankhauser 2018).
Policy Alternatives
Although carbon taxes may offer many advantages over green energy subsidies, there are other policy alternatives to consider. The most intuitive would perhaps be command-and-control (CAC) regulations, such as mandating certain types of green technology or specifying allowable emission levels. While there have been prominent examples of success with CAC regulations, most notably the Montreal Protocol, CAC regulations do not represent the optimal policy solutions in most cases. They are usually not cost-effective, nor do they most effectively promote the innovation or adaptation of new technologies (Aldy and Stavins 2012).
We should additionally consider one of the most popular and frequently discussed environmental policies: the cap-and-trade system. In a cap-and-trade system, the government sets a goal for carbon reduction, and auctions permit companies below them to constrain the number of emissions they can produce. Firms can then trade these permits as needed, incentivizing them to reduce their emissions. This strategy offers multiple advantages over carbon taxation. First, since firms can freely trade emissions allowances, the price of such allowances can dynamically adapt to account for changes in marginal abatement costs and achieve allocative efficiency over an extended period (Aldy and Stavins, 2012). Second, cap-and-trade is generally more politically viable because it avoids the negative reputation associated with taxation (Stavins, 2008). However, cap-and-trade systems also have notable drawbacks compared with carbon taxation, as they are more expensive to administer and involve a complex and often imprecise process for determining the distribution of allowances.
The key takeaway from examining various environmental policies is that identifying the optimal solution demands careful consideration of the specific economic and social contexts in which said policies would operate.
Figure 2: A graphic comparison of carbon tax and cap-and-trade systems
Broader Issues
In addition to adopting new policies, there are other issues that one must address in the construction of a comprehensive environmental strategy. These issues are bound to exist, regardless of the type of policy adopted. The most pertinent problem is emission leakage, where energy-intensive industries migrate to areas of the world where restrictions on carbon emissions are less intense, negating any positive effects of an emissions reduction plan. There have been a multitude of proposed solutions to this issue: the implementation of import tariffs, ensuring that imported goods face the same tax as domestically produced goods, the creation of international uniform carbon taxes, harmonized domestic carbon taxes, global cap-and-trade systems, to name a few. Nevertheless, all such proposals suffer from various difficulties: inaccuracies with pricing tariffs, legal issues, and difficulties with international cooperation and enforcement (Aldy and Stavins 2012). A promising new solution that has recently been investigated is the Extraction-Production Tax (EPT), which combines a tax on domestic fossil fuel extraction with one on emissions from domestic production, although the merits of such a strategy are yet to be examined in depth with empirical evidence (Weisbach and Kortum 2023).
Additionally, one of the most crucial steps towards reducing emissions that nations can utilize is the reduction of subsidies for “dirty” energies such as oil or coal. Such subsidies exacerbate environmental degradation, cost over $130 billion annually, contribute to growing government deficits, and diminish the effectiveness of recycling efforts (Myers 1999). Many fossil fuel subsidies provide disproportionately regressive benefits, with over 80 percent of the total subsidy benefiting the wealthiest 40 percent of households; likewise, most diesel and petroleum gas subsidies, at over 65% and 70% respectively, primarily benefit higher-income groups (Coady et al. 2010). Moreover, these subsidies are often popular with the public despite their negative impacts, making them difficult to discontinue, a major example being electric subsidies in India (Subramanian and Navneeraj 2024). Despite the political challenges involved, reducing subsidies is essential for promoting equity, fiscal responsibility, and environmental sustainability.
Conclusion
To conclusion, addressing climate change requires acknowledging that there is no perfect, one-size-fits-all solution. Each policy instrument, from carbon tax to subsidies and beyond, has precise advantages and limitations. As such, more important than the theoretical efficacy of any policy is its applicability to specific regions of the world and its effectiveness under unique sectoral circumstances. Additionally, we must consider broader issues of emission leakage and fossil fuel subsidies alongside attempts at environmental policies on a local or national scale, as they can undermine the success of even the most well-designed policies. Ultimately, the effectiveness of these policies depends on international co-operation. Only by working together can nations overcome economic disparities, align regulations, and foster innovation to create a sustainable future.
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