A subsidy for GHG emissions reduction pays entities a specific amount per tonne of CO2eq for every tonne of GHG reduced or sequestered. Such a subsidy encourages implementation of measures to reduce emissions or enhance sequestration that are less costly than the subsidy.
Under certain circumstances, a uniform subsidy can lead to the same emissions reduction outcome as an equivalent uniform tax. In theory, in an industry with homogeneous firms, both taxes and subsidies (set at the same levels) yield exactly the same outcome in the short run. In general, a tax is more efficient than a subsidy because the subsidy can result in too many firms in the industry, and thus an inefficient amount of both pollution and goods associated with the pollution (Kolstad, 2000). This is always the case in the long run because a subsidy lowers the average cost of production, while the tax increases the average cost of production. In the short run, it is also the case in an industry with heterogeneous firms. A subsidy may allow some firms to continue operating that would not continue in the case of a tax (those with average variable costs above prices). Besides, a subsidy requires that revenue be raised somewhere else in the economy, which can also produce dead-weight losses.
An emissions reduction subsidy, like an emissions tax, does not guarantee a particular level of emissions. Therefore, it may be necessary to adjust the subsidy level to meet an internationally agreed emissions commitment. In addition, criteria other than efficiency, such as distributional impacts, are likely to influence the design of the emissions subsidy (or the combination of subsidies and taxes in what is known as fee and/or rebate). The distributional and competitiveness impacts help explain why, in practice, some energy and emissions taxes are coupled with tax exemptions or subsidies. Also, the use of subsidies for environmental purposes may cause problems under WTO agreements on subsidies and countervailing measures.
Technological progress is mainly achieved in the private sector, through learning by doing, incorporating new findings developed elsewhere into the production process, or through firms own R&D activities. A major, and generally increasing, part of funding of R&D expenditures is initiated by and in the private sector itself (Table 6.1). Government funding of R&D on energy has historically favoured nuclear and coal technologies (IEA, 1998a; OECD, 1998a). Research on renewable energy and energy-efficient technologies is gaining ground, but it is still a relatively small portion of R&D budgets in the OECD. This is important when assessing what governments can do to promote innovation. Perhaps governments can provide a reliable legal framework to protect research findings in the area of energy efficiency improvement from being copied elsewhere without compensation.58
| Table 6.1: Public expenditures as percentage of gross domestic expenditures on R&D (1985–1995) (OECD, 1998a) | |||
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| Country/ region | 1985 Public % of total | 1990 Public % of total | 1995 Public % of total |
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| Overall OECD | 43.0 | 37.8 | 34.5 |
| USA | 50.3 | 43.8 | 36.1 |
| Canada | 48.9 | 44.3 | 37.7 |
| EU | 44.4 | 40.9 | 33.1 |
| UK | 42.2 | 35.5 | 33.3 |
| France | 52.9 | 48.3 | – |
| Japan | 21.0 | – | 22.4 |
| Germany | 37.6 | 33.9 | 37.1 |
| South Korea | – | 17.0 | 18.2 |
| Czech Republic | – | 30.6 | 34.9 |
| India | 88.5 | 87.3 | 84.6 |
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