Efficient Management of Insecure Fossil Fuel Imports through Taxing Domestic Green Energy?

Abstract

A small open economy produces a consumer good as well as renewable (green) and fossil fuel based (brown) energy. It imports fossil fuel at an uncertain price and suffers from carbon emission damages. Unregulated competitive markets are shown to be inefficient. The implied market failures are due to the agents' attitudes toward risk, to risk shifting, and the uniform price for both types of energy. Under the plausible assumptions that consumers are prudent and at least as risk-averse as the producers of brown energy, the risk can be efficiently managed by placing a tariff on fuel imports (which is equivalent to taxing carbon emissions in the model at hand) and taxing green energy. The need to tax green energy contradicts the widespread view that subsidization of green energy is an appropriate means to enhance energy security in countries depending on risky fossil fuel imports.