Pricing energy consumption and residential energy-efficiency investment: An optimal tax approach

Abstract

We analyze a Pareto optimal income tax problem à la Mirrlees in which households consume three types of goods: energy goods, energy-efficient investments, and nonenergy goods. The two main ingredients of our normative analysis are: (i) an indirect relationship between energy and the satisfaction of energy needs, as energy-efficient investments transform energy into services, such as light, heating, and air conditioning; and (ii) imperfect information of the policy designer as regards the level of energy efficiency of households' housing and their labor market productivity. Each household differs with respect to these two latter characteristics, and the government designs a nonlinear income tax combined with energy and energy-efficient investment nonlinear pricing that maximizes a weighted sum of households' utilities. We show that a benevolent social planner should distort energy prices in a way that depends on the difference between the saturation of energy needs and the complementarity between energy and the level of energy efficiency in the provision of energy services. A sufficient condition for energy consumption to be subsidized is that the rebound effect is small. Second, when individuals can invest in energy efficiency on top of energy consumption, these investments should always be subsidized and the marginal subsidy should always be higher than the one on energy consumption.