Dirty energy taxes and clean energy innovation

I am and have long been an unabashed advocate of carbon taxes and gas taxes, but… I have a concern that not enough attention is being paid to the innovation function for clean energy. Right now clean energy prices are marching steadily downward in the form of declining solar costs, my question is: would a carbon tax slow this innovation trend? A few big caveats are necessary for what follows: I’m going to write here in wide generalizations and with a highly simplified view, I’m not an energy expert by any means, I stand fully ready for any and all of my claims corrected by someone who knows more, and I don’t have any answers just questions.

Here is a chart of solar energy prices marching downward over time from NREL:

A 

simplified view of the future of energy is this: when the total cost of solar energy goes below the cost of dirty energy like coal, it will be a huge deal and will lead to widespread adoption of solar. While this threshold varies greatly by geography, think of dirty energy costs as a line to cross that when a solar company gets below it they can take a huge chunk of market share and supplant existing dirty energy. This means economic benefits of getting below this threshold are big, and this gives the market strong incentives to innovate to push costs down right now.

However, once we go below that threshold and solar is cheaper than dirty energy, the incentives to push costs further down will be reduced. This matters for policy, because what a carbon tax does is push the required cost threshold up. This would allow solar to become the more profitable source of energy in the US sooner and increase the speed of its dominance here.

However, a carbon tax would raise the threshold in the US relative to the threshold for developing countries.  In other words, the race for solar companies in the U.S. becomes to be cheaper than dirty energy + a carbon tax, which is a higher threshold than being cheaper than dirty energy alone, which is the threshold in many developing countries. It is easy to see how this could cause downward march in solar costs to slow, and as a result solar would reach the threshold for China, India, and other developing countries perhaps much much later.

If this is true, it would suggest that for clean energy to become globally dominant faster it’s better for the U.S. to just subsidize solar innovation and let the untaxed U.S. market price of dirty energy stand as a strong incentive for solar to drive costs lower.

To see this, consider a world where solar was already dominant in the U.S. with current technology and costs, perhaps via a total ban of dirty energy. The supply curve of the installed base of solar technology would be much more price inelastic than the supply curve of today’s installed base of dirty energy due to higher fixed costs and lower marginal costs.  This means a steeper residual demand curve for marginal innovators that provides less market share rewards for marginal declines in price, and therefore lower rewards for marginal cost cutting.

In this way, a carbon tax could make global warming worse. There are some alternatives to this view though. First, is that taxing dirty energy and using all the money for subsidies of clean tech innovation is really more efficient than subsidies without taxes. And after all, the money for subsidies will need to come from somewhere. In addition, one can imagine that economies of scale and learning by doing are extremely important in this industry. This would mean solar companies taking over the U.S. market will accelerate the decline of costs and speed up the point where it becomes cost competitive for the rest of the world.

This raises some questions. Can subsidies provide a better incentive to innovate than market prices? How much do economies of scale matter for innovation? I don’t have answers for these questions, but I think they are under discussed.

Overall, the downward march of solar energy costs is perhaps the most important factor determining how successful we will be at mitigating global warming, and I think policy should really be almost entirely about how do we keep this going and how do we accelerate it. Given the global nature of the problem, I see everything else as window dressing.

http://www.forbes.com/sites/modeledbehavior/2015/03/18/half-of-fergusons-young-african-american-men-are-missing/