WP-018: Hunt Allcott, Christopher Knittel, and Dmitry Taubinsky, "Tagging and Targeting of Energy Efficiency Subsidies" (May 2015)

Energy efficiency subsidies are often justified on the grounds that they help correct market distortions, primarily including pollution externalities, credit constraints, landlord-tenant information asymmetries, imperfect information and “behavioral biases” such as inattention to energy costs. These distortions, however, vary across consumers. For example, wealthy people are less credit constrained, homeowners are unaffected by the landlord-tenant problem, and environmentalists are more attentive to energy costs and believe that energy efficient goods save more money.

Allcott, Knittel and Taubinsky develop a model to study optimal subsidies for energy efficient durable goods such as air conditioners, insulation, and cars. They define “targeting” as a measure of whether high-distortion consumers are more responsive to the subsidy. They also study the gains from “tagging,” which is limiting eligibility for the subsidy to individuals subject to greater distortions.  They empirically study three major energy efficiency subsidies, showing that all three are preferentially adopted by consumers who appear to be less affected by distortions: wealthy environmentalist homeowners.

There are two policy implications. First, corrective energy efficiency subsidies cannot be justified simply by the generic argument that “market distortions reduce energy efficiency investments.” Instead, we need to show that consumers affected by distortions are also affected by the subsidies. Even if the subsidies cause energy conservation, from a welfare perspective it matters who is conserving. This calls into question the wisdom of policies such as energy efficiency resource standards, which require utilities to help consumers conserve energy but do not require that utility energy efficiency programs be well-targeted.

Second, tagging could increase the welfare gains from energy efficiency subsidies. Indeed, tagging becomes more valuable when existing subsidies are more poorly-targeted. Tagging could involve limiting subsidy eligibility to low-income households, rental properties, or consumers who have not yet participated in other utility programs (because previous program participation suggests being well-informed about energy). If restricting eligibility is not politically feasible, targeted marketing at these groups would also generate gains.