Energy Institute at Haas

This paper explores the efficiency consequences of pursuing pollution reduction through a reliance on green subsidies rather than pollution taxes. It presents a stylized model of “subsidy-first” policy in which subsidies are rationalized by missing or incomplete taxes on some goods. It delineates five sources of inefficiency in subsidies, several of which relate to information requirements. In the model, green subsidies are justified because they induce substitution away from dirtier alternatives. Thus, subsidies hinge on counterfactuals, which creates information challenges analogous to the additionality problem. Insights from the model are used to comment on the Inflation Reduction Act.