Working Paper

The Environmental Effects of Clean Energy Innovations under Rate-Based Regulation

Sep 28, 2015 | John Horowitz, Joshua Linn

Summary

The economics of rate-based environmental regulations have not been well developed, and a serious potential problem exists: technological innovations that reduce the cost of clean energy can lead to an increase in overall emissions under this approach.

Key Findings

  • Rate-based standards, which are based on proportions of “clean” and “polluting” sources, are a common form of environmental regulation.
  • When standards are binding, technological advances that reduce the cost of clean energy will increase use of the dirty energy sources.
  • Examples are provided for three canonical cases: a renewable portfolio standard, an emissions rate standard, and a vehicle fuel economy standard

Abstract

Despite the popularity of this class of policy, the economics of rate-based approaches have not been well developed. In this paper we show that technological advances that reduce the cost of clean energy will increase use of the dirty energy source whenever the regulation is fixed and binding. Since environmental damage depends on the level of dirty energy and not its proportion, these otherwise desirable clean technology innovations result in additional pollution. We set up simple analytical models to show how the basic result applies to each of the three canonical cases: a renewable portfolio standard, an emissions rate standard, and a vehicle fuel economy standard.