My last blog lamented the use of emotion-laden expressions such as “job-killing” to divert attention from regulations and incentives that would actually create large numbers of jobs. When I discussed the use of incentives, one commenter countered with the claim that incentives might create jobs directly, but would add to the deficit.
This concern about a clean energy investment program causing more deficits is misplaced. My book Invisible Energy shows how a suite of energy efficiency policies cuts government deficits significantly.
The key principle is to design incentives so that they enhance the market forces that lead to innovation. Let me show two examples of such incentive—one good example and one bad example.
The right way to incentivize efficiency is to establish limited-term incentives based on performance, not cost. Congress did this in 2005 when it established a $2000 tax credit to builders who constructed new homes that were certified by third-party professional energy raters to save 50% of heating and cooling energy. The bar was very high—less than 600 homes had ever been documented to even come close to meeting the goal.
But the incentive changed all that. By providing the same $2000 to every qualifying home, regardless of how much the builder spent to make it qualify, the tax credit created competition between designers and suppliers—as well as between builders—on how to meet the target at the lowest cost.
And construction of these super-efficient houses boomed. Fully 8000 homes qualified for the tax credit in 2006, and while the rest of the market tanked, the efficient homes market boomed, growing to over 30,000 homes in 2009. That’s more than 10% of all new homes sold: a remarkable success story for incentives taking super-efficiency from a level considered by the builders’ trade association as “impossible” in 2005 to a serious market segment in 2009.
The wrong way to do it is to base incentives on cost. Because if market failures are preventing consumers from investing in efficiency at today’s price, a 50% tax credit will most likely just encourage manufacturers and retailers to double their price and keep all of the incentive without doing anything.
I was reminded of this just this week, when I heard a radio ad for replacement windows that said that if you had bought their windows last month, you would have been entitled to a tax credit of up to $1500, so the advertiser promised their customers a discount of the same amount if they acted now. So the cost to the consumer turns out to be the same in this case with or without the tax credit. It’s clear that this tax credit did more to fatten the wallets of the vendors than to encourage new efficiency. (NRDC opposed this credit when it was first introduced, for these very reasons.)
How do incentives reduce deficits? Because, among other things, businesses use over $250 billion a year in energy and almost all of that is tax deductible (all business expenses are tax deductible on corporate income taxes). This deduction is worth almost $100 billion a year, and is projected to grow with increasing energy use.
If incentives are successful in getting businesses to cut energy use by half, as homebuilders did with their product, the government could reduce deficits by some $50 billion annually.
In the process of working on the new homes incentives I have talked about here, I worked with both Republicans and Democrats to apply the market based principles I describe here. On the Senate side, the champions of these principles were Senators Olympia Snowe (R-ME) Snowe and Dianne Feinstein (D-CA), both women with reputations for bipartisanship and thoughtful moderation. On the House side, our bill was cosponsored by a variety of members, but they included some of the most conservative Republicans in the House as well as some of the most liberal Democrats. We found that the package of incentives, not all of which were actually enacted, generated revenue to the government and cut the deficit. They did this because the reduced use of the deduction for energy costs for qualifying commercial buildings not only paid for the cost of the commercial buildings incentives, but paid for the costs of the entire package with room to spare, even just considering the first ten years.
Economic recovery is too important to lose in partisan bickering. And the principles behind a clean energy strategy, which is the cornerstone of a workable plan for recovery, have always been both bipartisan and nonideological. It’s time to get working on them.