The Environmental Effects of Clean Energy Innovations under Rate-Based Regulation

Despite the popularity of this class of policy, the economics of rate-based approaches have not been well developed. In this paper we show that technological advances that reduce the cost of clean energy will increase use of the dirty energy source whenever the regulation is fixed and binding. Since environmental damage depends on the level of dirty energy and not its proportion, these otherwise desirable clean technology innovations result in additional pollution. We set up simple analytical models to show how the basic result applies to each of the three canonical cases: a renewable portfolio standard, an emissions rate standard, and a vehicle fuel economy standard.