Sticks vs carrots: Climate policy under government turnover

There is an active debate among economists on the value of using clean energy subsidies to address climate change. However, the models used to inform this debate typically make a common simplifying assumption: the preferences of the government are kept constant over time. In reality, control of the government often rotates between parties with very different policy preferences. This paper finds that adding turnover in party control of the government can have significant implications. Specifically, when the two parties are sufficiently polarized, the party more concerned about the environment (“the green party”) finds it optimal to subsidize irreversible investments in clean energy, even when carbon taxes are available and can be placed at any level. We then provide quantitative evidence on the green party’s optimal subsidy using two approaches: sufficient statistic estimation and a calibration exercise. The results suggest that the optimal subsidy is quantitatively significant, between 5% and 17% of the cost of investment. Furthermore, if the green party naively uses just a carbon tax, clean investment is 34% lower than when they use their optimal subsidy.