Abstract
Electric utility investment in end-use efficiency and renewable energy resources is examined with current forms of Pigouvian taxes and subsidies that encourage investment in green energy resources. A model of a rate-of-return-regulated firm considers the impacts of policies on social optimality. It shows that cap-and-trade/floor-and-trade forms of Pigouvian taxes and subsidies cause electric utilities to (over) underinvest in conventional generation and (under) overinvest in green resources when the allowed rate of return (is above) equals the cost of capital. Therefore, these forms of taxes and subsidies combined with rate base rate-of-return regulation result in suboptimal investment in one type of asset or another regardless of the level of return exogenously set by regulators. Therefore, public utility investment is always suboptimal, one way or another. The form of regulation is empirically tested from stock price signals and observed by lack of investment in the electric power infrastructure and too much investment in green resources that will not meet renewable portfolio standards and the demand for electric services.
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