Niskanen Notes
Rethinking The Value of The Electric Vehicle Tax Credit
Recent advancements in the electric vehicles (EV) market have seen a surge in EV sales, with more than a million EVs now on the road in the U.S. Although the federal EV tax credit has encouraged the adoption of EVs and has played a role in reducing the costs of this technology, the $7,500 credit reduces CO2 at the social cost of carbon (SCC) of roughly $100 per metric ton, which is higher than most estimates of the SCC. So what would an EV credit based on avoided emissions look like?
The average passenger vehicle emits 404 grams of CO2 per mile driven, and a vehicle averages roughly 13,476 miles per year. Thus, the average vehicle emits roughly 5.44 metric tons of CO2 per year just from the burning of gasoline. Most EV manufacturers offer an 8-10 year warranty on their battery, and using a 10 year lifespan, a traditional internal combustion engine vehicle will produce approximately 54 metric tons of CO2 over its lifetime. At a social cost of carbon of $50 per metric ton, the subsidy value would be around $2,722 per EV. That is if the EV is subsidized as if it runs on 100 percent carbon free power.
EVs are significantly cleaner than traditional ICE vehicles, but the fact that they rely on electricity means that they do contribute to some level of emissions. A study by the Union of Concerned Scientists found that the average EV in the U.S. produces emissions equivalent to a hypothetical gasoline car achieving 73 mpg. Assuming the average EV is driven as much, an EV would produce roughly 16 metric tons of CO2 over its lifetime. At $50 per metric ton, this equates to a cost of $820 per EV. When accounted for, this would bring down the true value of the EV subsidy to $1,902 per EV.
Based on carbon alone, the subsidy value should be less than what is currently offered. Of course, the rationale behind the current value of EV subsidies is to motivate purchases to reduce the costs of EV technology by pushing it down the learning curve. The EV tax credit is encouraging greater deployment of this technology, which will help bring EVs to price parity with ICE vehicles sooner, and at which point the market (hopefully incorporating carbon pricing) can takeover. As EVs reach price parity with traditional vehicles, there seems to be a rationale for having an upfront credit or subsidy based on the carbon benefits of an EV.
Article of the Day: On Making the World Three Times Better Off
Having just won the Lucas Prize, the paper “The Geography of Development,” by Klaus Desmet, Dávid Krisztián Nagy, and Esteban Rossi-Hansberg, has recently been making the rounds. From the abstract:
We develop a dynamic spatial growth theory with realistic geography. We characterize the model and its balanced-growth path and propose a methodology to analyze equilibria with different levels of migration frictions. Different migration scenarios change local market size, innovation incentives, and the evolution of technology. We bring the model to the data for the whole world economy at a 1° × 1° geographic resolution. We then use the model to quantify the gains from relaxing migration restrictions. Our results indicate that fully liberalizing migration would increase welfare about threefold and would significantly affect the evolution of particular regions of the world.
While the key advance in the paper is the way the authors model the transition to the new steady state, the calibration exercise gives a sobering estimate of the welfare gains left on the table by immigration restrictions. The table below from the paper highlights those estimates, showing the future of productivity, output, and welfare over the next 600 years (!) under the present migration regime with the solid lines, partial liberalization with the long dotted line, and full liberalization with the short dotted line. Talk about trillion-dollar bills on the sidewalk…
Evaluating The Case For The Electric Vehicle Tax Credit
The federal electric vehicle tax credit is the primary policy being used to induce drivers to purchase EVs, and last Wednesday the bipartisan “Driving America Forward Act” was introduced to expand the tax credit by 400,000 vehicles on top of the existing 200,000 vehicles eligible per auto manufacturer in terms of cumulative sales. Given that proposal, it is useful to ask, what are we buying with these tax credits?
There is no doubt that the tax credit program is a straight-up subsidy program with some unsavory aspects. While it is not all that expensive in the grand scheme of the federal government—The Congressional Budget Office estimated that the federal credit will cost $2.0 billion between 2009 and the end of 2019, that cost will go up if the vehicle cap is raised by 400,000—it is a gift to the rich. A study by Severin Borenstein and Lucas Davis found that the EV tax credit was disproportionately going to high-income households, with the top income quintile receiving about 90 percent of all the tax credits. Lastly, on a cost per ton basis, the tax credits are expensive. As of 2012, CBO estimated that the EV tax credit reduces emissions at a cost between $300 and $1,200 per ton, depending on the battery size of the EV, which is significantly higher than most estimates of the social cost of carbon.
However, as the volume and market share of EVs grow, the costs of producing these vehicles should drop, subsequently bringing down the per-ton costs of the tax credits. This begs the question of how effective the tax credits have been at incentivizing the adoption and deployment of EVs in the United States, and if further subsidies should be expected to reduce costs.
Measuring the effectiveness of subsidy programs to incentivize the purchase of EVs is hard, but it has been tried. A 2016 study by Gil Tal and Michael Nicholas used a choice experiment to establish the impact of the federal tax credit on the EV market. The authors concluded that 32.5 percent of plug-in EV sales between 2010 and 2014 could be attributed to the federal incentive, because the purchaser would have purchased an internal combustion alternative without the tax credit. Almost 257,000 of the EV models they assessed were sold in the United States between 2011 and 2014; implying the tax credit incentivized the purchase of about 83,500 EVs that would have otherwise not been sold. Their results also indicate that the tax credits advanced the purchase time of a new vehicle by at least 12 months. If correct, that study indicates that tax credits will spur some EV purchases, but only a minority of them.
The cost competitiveness of EVs is heavily dependent on the cost of the batteries, which comprise roughly 49 percent of the cost of an EV. Cost reductions in battery technology are reliant on the mass manufacturing of EVs and the federal electric vehicle tax credit is driving the scale-up of EV manufacturing. Almost every industrial activity shows signs of a learning curve, i.e., as volume scales, learning occurs, and prices drop, and the battery sector is benefiting from the integration of lessons and innovations that build over time. Research from Bloomberg New Energy Finance indicates that there is a 19 percent learning rate in electric vehicle batteries, meaning that for every doubling of cumulative capacity, we observe a 19 percent reduction in price.
A little back-of-the-envelope math shows how that learning rate could justify the extension of the EV tax credit. Using EV stock forecasts from the Edison Electric Institute, we can expect EV batteries to break the $100/kwh threshold by roughly 2026, at which point most experts agree that EVs would be cost competitive with traditional vehicles. Without the tax credit, the cumulative stock of EVs would grow more slowly, and price parity would not be reached till roughly 2029. Increasing the vehicle cap by 400,000, as the Driving America Forward Act would do, would mean that the tax credits for EVs would have a total budgetary cost of $4.5 billion per manufacturer spread over the years it would take the manufacturer to reach the 600,000 vehicle cap.
The EV market, and the battery technology supporting it, are both nascent industries, and the premature removal of these tax credits could negatively affect their growth. These tax credits can reasonably be expected to speed up the adoption of EVs and help companies push down the learning curve, and in the absence of something better, it makes sense that policymakers would support their expansion. The tax credits’ role in expanding the EV market, and the beneficial spillovers being realized by the battery industry, make this a worthwhile incentive to keep pursuing to achieve emissions reductions in the transport sector … at least for the time being.
One big challenge to the Green New Deal
Rapid decarbonization will require closing down working equipment
The Green New Deal (GND) has become a potent symbol in U.S. politics. The proposed environmental and economic package lays out a broad vision for how the country should tackle climate change. Assuming that the GND meets its goals through its proposed 10-year national mobilization plan, the resolution would aim to generate 100 percent of power from clean, renewable, and zero-emission sources by 2030*.
There is no doubt that decarbonization of the electricity sector is necessary if we are to limit global temperature increase at any level, and renewables will be a major part of this effort. And because of its positive aspects–low cost, zero carbon, decentralized–a high renewable future is desirable. However, we are far from that future today, with coal still providing 27.4 percent of all electricity generated in the U.S., and natural gas providing 35.1 percent.
So, what are the implications of pursuing a rapid decarbonization of the power sector for existing infrastructure?
According to the EPA’s eGRID, as of 2016, there were 5,371 natural gas generators and 811 coal generators operating in the U.S. Additionally, there were 336 natural gas generators planned for installation (or currently under construction). The average retirement age for these generators is roughly 50-60 years for coal and 40-50 for natural gas.
For advocates of rapid decarbonization, the good news is that the average age of the coal generators in the U.S. is roughly 39 years, with approximately 88 percent of coal generators having been built prior to 1990. A large majority of generators will be nearing their retirement age by 2030, meaning a rapid transition to a zero carbon energy system would probably leave very few coal assets stranded.
However, the explosion in natural gas infrastructure between 2000-2010–depicted in the figure above–suggests a different story for natural gas. Natural gas has become the dominant source of electricity in the U.S., providing 32 percent of the country’s electricity. Roughly 55 percent of operating natural gas generators were built in or after the year 2000, and these generators could potentially operate till at least 2040. This means that a zero-carbon transition by 2030 goal would leave over half of natural gas assets stranded—and that does not account for natural gas generators that are planned or already under construction. These stranded assets are going to increase the economic costs of a zero-carbon target, and will make the GND a much harder sell politically.
The impacts of early natural gas retirements will also be concentrated to certain regions of the U.S. The figure above represents the ratio of natural gas assets built in or after the year 2000 to the entire generator set within a state. The southeast has clearly invested a fair share of capital into natural gas infrastructure since 2000, including natural gas processing plants, pipeline infrastructure, and natural gas power plants. Texas, Arizona, Mississippi, Louisiana, and Florida all have at least 31 percent of their generation mix made of natural gas generators built in or after the year 2000. This young natural gas infrastructure made up at least 25 percent of 2016 nameplate capacity in Texas, Arizona, and Florida, and more than 35 percent of Mississippi nameplate capacity.
Of course, a very low emissions power sector could include natural gas infrastructure that has been maintained against methane leaks and power plants retrofitted with carbon capture and storage for post-combustion emissions. But retrofitting existing gas plants also adds cost, delay, and hassle. For the truly ambitious, I don’t know that it is better to retrofit such plants than it is simply buy them out. What is clear, however, is that the U.S. has invested a fair share of capital into a young natural gas fleet, and we should consider the costs of having to retire this infrastructure prematurely. Recognizing the infrastructural challenges associated with the GND proposal allows us to take seriously the costs and design of such a rapid decarbonization of our power grid.
*Correction per review from David Roberts. The Green New Deal aims for generating power from clean, renewable, and zero-emission sources through a 10 year national mobilization plan.
Decoupling Emissions Reductions from Economic Downturns and Moving Beyond Natural Gas
A carbon price would sustain emissions reductions.
A new report from the Rhodium group finds that after three straight years of decline, CO2 emissions from the U.S. power sector increased significantly in 2018. Based on preliminary power generation, natural gas, and oil consumption data, the report estimates that energy-related U.S. emissions increased by 3.4 percent last year–marking the second largest annual gain in more than two decades, and a departure from recent year-to-year trends.
Between 2007 and 2015, energy-related CO2 emissions from fossil fuel combustion fell at an average rate of 1.6 percent per year. This reduction in emissions was mostly driven by reduced power demand during the Great Recession and a shift from coal to cheaper natural gas, solar and wind power. Natural gas was, and still is, being hailed for its ability to act as a bridge between dirty fossil fuels and renewable energy sources. However, the pace of emissions reductions from energy combustion declined from 2.7 percent in 2015 to just 0.8 percent in 2017-and last year reversed. Increased power demand in 2018, and utilities burning more natural gas to meet this demand, caused the uptick in emissions.
Although the U.S. is on track for record coal plant retirements, natural gas capacity additions outpaced the closure of coal plants by a factor of 3. It is important to note that although natural gas has roughly half the CO2 to energy content than coal does, adding 3 times more natural gas than retired coal plants will increase overall emissions. This suggests that the potential for natural gas to continually replace coal and reduce emissions is not a given. Continued reliance on natural gas in the power industry will limit the ability to achieve deep reductions in CO2 emissions in this power sector, as well as the overall economy.
The Rhodium report also notes that new gas outpaced the addition of renewable energy to the grid by a factor of 4. This makes 2018 the first year since 2013 that renewables did not make up the majority of added capacity to the grid.
Decarbonization of the power sector is integral to reducing emissions in accompanying sectors such as transportation, buildings, and industry. Unfortunately, the Rhodium groups analysis also points out that emissions in all these sectors also went up in 2018.
The slowdown in emission reductions demonstrates the need for a more comprehensive approach to reducing emissions. For all of the progress that environmental groups have achieved in particular states with cap-and-trade schemes and clean energy standards, we are leaving emissions reductions on the table without an economy-wide approach based on carbon pricing.
Without a price on carbon, natural gas prices are artificially low compared to zero-carbon options, a contributing factor as to why natural gas has outpaced renewable power deployment to meet this increased demand by such a large margin. Pricing carbon would ensure that natural gas truly acts a bridge to a renewable energy-based power grid, rather than a road to wanton fossil fuel burning. A carbon tax, for example, would enable more efficient deployments of renewable and natural gas power, and would likely lead to greater levels of coal plant retirements. The combination of these factors would certainly create the environment for a more sustained reduction in power sector CO2 emissions. Although the power sector offers the greatest potential for immediate change, the broad-based incentives created by a carbon price will encourage emissions reductions across sectors, as well innovation in clean-energy technology.