In a response to a New York Times ‘Room for Debate’ forum on energy efficiency, Cato Institute scholar Peter Van Doren argues that energy efficiency standards are problematic, and that the most effective way to reduce fossil fuel use is to tax fossil fuels to increase their price.
Van Doren writes “if fossil fuel combustion produces byproducts that cause negative health effects on third parties as well as changes in the temperature of the atmosphere, the obvious lesson from economics is to increase fossil fuel prices enough through taxation to account for these effects. Then firms and consumers will react to these prices in thousands of different ways, the net result of which is less aggregate fossil fuel combustion.”
Regarding energy efficiency standards, Van Doren argues that they offer two significant drawbacks.
“First, more efficient appliances and automobiles cost much more to achieve equivalent energy savings than a tax on fossil fuel consumption. This occurs because higher prices encourage all possible avenues of reducing energy consumption — which efficiency standards do not. Second, more efficient appliances and automobiles reduce operating costs, which leads consumers to use more energy than they would if prices had increased.
“Why are efficiency standards so popular? They put the blame and the need to “fix things” on corporations rather than on individuals, who vote. They also create invisible rather than explicit costs. Finally, they allow corporations and other interest groups like unions to shape the regulations to their advantage, whereas taxes on fossil fuel consumption are harder to avoid.”
Do you agree with Mr. Van Doren’s argument? Are energy efficiency standards, as commonly conceived, problematic? Is taxation more efficient than efficiency?
While I don’t disagree that allowing energy prices to reflect their full costs, including environmental costs, is an important element of a sound energy policy, Van Doren presents a false either-or choice between energy prices and efficiency standards. Both are needed.
In response to Van Doren’s two specific criticisms of efficiency standards:
1. Standards cost more than energy taxes. Twenty years of US appliance standards experience has shown that consumer prices of products covered by NAECA standards have generally fallen in real dollars. For example, refrigerators subject to the 2001 NAECA standard cost less in real dollars than they did in 1980, while using 75% less energy. Long-term price elasticities for electricity run in the 25% range (based on ICF’s extensive power sector modeling experience). This means that to reduce electricity use in refrigerators by 75% through price elasticity alone, electricity rates would have had to increase by 300% in real terms, and would be well north of $.30 per kWh today instead of in their current $.11 range. That would have imposed a $260 billion annual cost on American consumers, almost $3000 per household; compliance costs to manufacturers have been a vanishingly small fraction of that amount. As a result, we have frigs that cost less to buy and to operate, with reasonable power prices. That’s one of the best policy deals America has ever made.
2. Standards increase energy use. Van Doren alludes to the Javons Paradox, a theory put forth in the 19th century by the eponymous British economist. There is a grain of truth in Javons’ thinking, that lowering the cost of a product or service tends to increase its demand. However, the Javons effect refers only to the operating costs of energy-using technologies. Buyers have to take into account the capital costs as well as the operating costs when purchasing products or systems. Just because a refrigerator costs, say, $100 less per year to run, it does not follow that consumers will run out and spend another $1000 for a second frig. Capital remains constrained. The ultimate refutation of the Javons theory is that little or no evidence exists to support it. Thirty-plus years of energy efficiency program experience shows that the “rebound effect”, as Javons’ theory is termed in program evaluation practice, is very limited. People apparently don’t leave the refrigerator door open just because it’s less costly to run, and nor do they turn up thermostats or leave lights on after efficiency measures are installed.
Javons, Van Doren, and other latecomers to this issue also conveniently overlook the wider economic forces at work in energy end-use markets. Income elasticity, for example, does more to explain the increase in demand for residential energy. As consumers’ incomes rise, they have more disposable income for larger homes, larger and more appliances, larger and more vehicles. They don’t base their decisions mainly on operating costs, but on their available funds or credit for purchasing such goods.
Van Doren’s enthusiasm for energy taxes, apart from its blithe oversight of the political impossibility of significant energy tax increases in any elected body in the United States today, also ignores another key component of economic price theory. His energy tax advocacy presupposes that every penny of energy tax increase has a direct and focused effect on energy use, and on no other economic activity. Yet any reputable economist will concede that cross-elasticities are real and significant in energy markets. Cross-elasticities refer to the effect that the increase in the price of one good or service can have on the demand for a different product or service. Every gasoline price spike in recent decades has been accompanied by measurable drops in retail sales, with only minor drops in gasoline consumption. Consumers cut back on other things when gas prices spike: they still drive to the mall, but they forgo a pair of shoes, a video game, or dinner out in the way home. This cross-elasticity effect also cuts the other way: when the cost of operating an energy-using device drops, consumers have more money to spend on other goods, creating secondary and tertiary economic benefits. This cross-elasticity affect tends to blunt the impact of price-alone policies, making them expensive and inexact as policy levers.
There is not room in this brief discussion to go into the market barriers that keep price signals from having their intended effects on consumer end use energy markets. An IEA study in 2007 titled Mind the Gap included some research I was involved in, which showed that in US residential space heating and water heating end use market, the principal-agent problem alone (home builder vs home buyer, landlord vs. tenant) affected almost half of energy use. So even if energy prices could be taxed into the ranges needed for significant energy savings, they would not affect great swaths of US energy markets. This further weakens Van Doren’s notion that energy taxes alone are the answer to U.S. energy policy needs.
Energy efficiency standards have been shown to be effective, flexible, economically-sound energy policies. They also drive innovation and profit in affected industries. For example, twenty years ago, clothes washers were a flat-line, boring business. You could get any kind fo washer you wanted, as long as it cost $500, was white and was a top-loader, central agitator design. Today, prices range from $500 to $1300, and innovation driven by the 2001 NAECA standards has revolutionized the business, creating better-performing machines, bringing new competitors into the market, and making a boring business a new profit opportunity for manufacturers.
To sum up: Van Doren is not wrong for advocating energy taxes. He is wrong in posing taxes as an either-or policy alternative to standards. Standards have saved American consumers billions while avoiding the economic damage that massive energy taxes would have wrought. To solve the energy and climate crisis, we will need higher energy prices that reflect their true costs. But standards have been shown to be more effective, less costly, and more politically viable. Until the American public shows a political appetite for higher taxes, energy standards will be a very viable path for U.S. energy policy.