Time-Limited Subsidies: Optimal Taxation with Implications for Renewable Energy Subsidies

Abstract

Pigouvian subsidies are efficient, but subsidies with limited durations are not Pigouvian. When using "time-limited" output subsidies, the optimal policy subsidizes output and investment, where investment subsidies separately correct for the limit. Because the change in production when the subsidy ends is a sufficient statistic for the optimal duration, we estimate this statistic using the US Renewable Energy Production Tax Credit for wind energy. Wind facilities reduce generation by 5-10% when the ten-year subsidy ends, demonstrating that time limits distort production even in inelastic industries, and suggesting that adapting to limits is key to improving industrial policy elsewhere.

Keywords: corrective taxation, alternative energy, optimal tax

JEL Classification: H21, H23, Q42