Efficiency and Equity Impacts of Energy Subsidies

Economic theory suggests that energy subsidies can lead to excessive consumption and environmental degradation. However, the precise impact of energy subsidies is not well understood. We analyze a large energy subsidy: the California Alternate Rates for Energy (CARE). CARE provides a price reduction for low-income consumers of natural gas and electricity. Using a natural field experiment, we estimate the price elasticity of demand for natural gas to be about - 0.35 for CARE customers. An economic model of this subsidy yields three results. First, the natural gas subsidy appears to reduce welfare. Second, the economic impact of various policies, such as cap-and-trade, depends on whether prices for various customers move closer to the marginal social cost. Third, benefits to CARE customers need to increase by 6 percent to offset the costs of the program.

Automated summary

Studies suggest that energy subsidies may lead to negative economic and environmental impacts, as seen in the case of the California Alternate Rates for Energy (CARE) providing discounts to low-income consumers. Despite expectations, the actual effects of this subsidy may not be as beneficial as originally thought, requiring an increase in benefits to offset program costs.