Evaluating the Cost-Effectiveness of Domestic Policy Portfolios for Emissions Abatement in the Electricity Sector

Abstract

Increased scientific certainty about anthropogenic climate change coupled with the Obama administration taking office has the United States poised to enact legislation to reduce greenhouse gas emissions. Studies have suggested that a combination of policy instruments will be more economically efficient than any single strategy in order to correct for multiple externalities in the market. This paper employs a theoretical model of the electricity sector developed in Fischer & Newell (2008) to compare the cost-effectiveness of individual and combinations of policy instruments. Despite many of the parameter values changing significantly in the numerical application of the model, this analysis affirms the relative rankings of the policy instruments in terms of economic efficiency found in Fischer & Newell (2008). Beginning with the most cost-effective instrument, the order is as follows: emissions price, tradable emissions performance standard, tax on fossil output, renewables portfolio standard, renewables production subsidy, and R&D subsidy. Several policy portfolios are modeled and costs compared to an emissions price. The results indicate that simultaneous policies for climate mitigation tend to be more cost-effective than any single instrument. While combining an emissions price with a renewables portfolio standard offers cost advantages over an emissions price alone, the best complementary policy for an emissions price is an R&D subsidy. The sensitivity analyses show that this is a robust conclusion for a broad range of parameter values. It is therefore recommended that policymakers seriously consider a substantial R&D subsidy for renewable energy technologies in addition to establishing a cap-and-trade system.