Higher Energy Taxes or Prizes for Answers?
Brian Gongol

Global warming may be the greatest modern threat to humanity, a purely natural phenomenon, a serious consequence of both human and natural factors, or none of the above at all. The consequences could be dire and immediate, or there could be lots of time to wait before corrective action would become necessary.

Our judgement on the issue is colored by issues of political reality. Many of the supposed causes of global warming are linked to the things that make prosperity possible: Power generation, mass manufacturing, and transportation. Rich countries resist giving up those things because they are comfortable; developing countries refuse to give up their rights to them because they feel entitled to the benefits.

Moreover, energy consumption isn't just important because of the pollution it creates -- it's also an extremely important issue to geopolitical relations. Much of the energy that's consumed in the form of petroleum, for instance -- which is one of the main targets of those who demand action on global warming -- comes from politically unstable places like Venezuela, Nigeria, and Iran. So regardless of the climate-change issues involved, there are important reasons to consider the other consequences of high energy consumption.

One of the most widely-acknowledged suggestions has been the use of a Pigovian tax to discourage energy consumption. The idea goes that by increasing taxes on the use of energy (usually starting with higher taxes on petroleum), governments could discourage consumption and thus reduce dependency as well as environmental consequences.

Problems with high energy taxes

However, Pigovian taxes (sometimes called "sin taxes") have serious limits. First, it's hard to pick the right level for such a tax. If the tax is too low, it won't achieve the desired results. If the tax is too high, then people will be punished disproportionately to the actual consequences of their behavior.

Second, Pigovian taxes are hard to impose fairly. A low-income person in an otherwise rich country may have less ability to pay for the tax than a rich person in a relatively poor country. A poor person in a rich country coincidentally, may also have less ability to afford things like fuel-efficient vehicles or "low carbon-currency" foods. Since a Pigovian tax is generally imposed (like a sales tax) on income that's already been subjected to income taxes, it's a double burden on the poor.

Third, Pigovian taxes can end up distorting the wrong markets. Canada and New York City have both imposed high taxes on cigarettes to discourage people from smoking, which certainly sounds like a good idea -- on the surface. But in both cases, people have found it profitable to smuggle cigarettes from low-tax places and sell them on the black market. As a result, cigarette taxes are subsidizing Hezbollah in the US (where the group smuggles cigarettes from Virginia to New York City) and supporting organized crime in Canada (where 10% of cigarettes are sold on the black market -- in a country with a reputation for its sense of law and order).

Fourth, it's almost impossible for taxpayers to force their government to appropriate the money collected via a Pigovian tax in the ways they promise. To wit: Iowa, along with 45 other states, reached a major settlement with major tobacco companies in 1998 that included millions of dollars in payments to each state. More than $265 million of Iowa's tobacco-settlement money, which was supposed to be used for health-related programs, was used to cover a general budget shortfall instead in some of the first years of the payment period. On a national level, the same effect has been seen as the Federal government has borrowed heavily against the Social Security trust fund in order to offset deficit spending and give the appearance of having balanced budgets. The approach masks a lack of current fiscal discipline and further aggravates problems with the pension program's solvency.

But there may be a better way to reduce energy consumption (and thus mitigate the potential environmental consequences) without some of the unfortunate consequences of a Pigovian tax.

Using a big carrot instead of a stick

The concept of inducement prizes has a long history. Inducement prizes are awards that are offered for specific achievements that extend the boundaries of human skills or technology. Charles Lindbergh won an inducement prize for flying solo across the Atlantic, and (more recently) the Ansari X-Prize led to the first successful manned commercial spaceflight (the technology for which will soon allow commercial recreational space travel.

Rather than imposing higher consumption taxes (which seek to change behavior by discouraging and punishing), we ought to seriously consider the use of inducement prizes instead.

Specifically, the government could identify the top ten technological changes that would conceivably lead to lower energy consumption and offer specific inducement prizes for each.

Suppose, for instance, that a $1 billion prize were offered for each of these goals:
  1. A modification that could increase electric motor efficiency by an average of 10% or more for less than 2% of the motor cost
  2. An automobile engine modification that increases fuel efficiency by 10 mpg for less than $1000
  3. A mass-production method of installing green roofs at a comparable cost to conventional shingles
  4. An improvement to catalytic converters that would reduce emissions by 20% or more for $100 or less
  5. A fuel additive to improve power output by 5% for less than five cents per gallon
  6. A means of reducing transmission losses from power plants by 10% for less than the cost of the recovered power
  7. Insulation that could be installed like wallpaper to increase the heating/cooling efficiency in old homes that can't be cheaply renovated
  8. Variable-width tires that could be automatically widened in winter or hazardous conditions and narrowed in optimal conditions
For a billion dollars each, it's virtually certain that someone (or some organization) would enthusiastically hand over the answers to each of these questions in no time at all. Unlike Pigovian taxes (which seek to internalize the externalities of consumption), inducement prizes seek to monetize and concentrate the diffuse social benefits of positive discoveries.

Putting discovery to work

It would be good to offer prizes to induce the discovery of great energy-saving and pollution-reducing ideas -- but it would be even better if the government would purchase the intellectual property rights to those ideas with massive prizes and then turn over the intellectual property to the public domain. By purchasing and then turning over the ideas to the public domain, the government would be able to put those ideas to immediate use throughout every industry. Moreover, the act would get around one of the biggest obstacles to the development of new ideas -- the fact that China, which is probably the world's fastest-growing producer of pollution, is also one of the world's worst abusers of intellectual property rights. Patents allow inventors to accumulate the benefits of their great ideas with temporary monopolies on the use of those ideas. Huge inducement prizes would allow the government to supply the inventor with huge up-front benefits while putting those inventions to immediate use.

If $1 billion per idea sounds like a lot...well, it certainly is. It's definitely large enough to motivate lots of people to take action in the hopes of winning the prize. But compared to the FY 2006 budget for the Department of Energy ($23.4 billion), ten different billion-dollar prizes for ten different quantum leaps in energy use or pollution reduction would be a bargain.

Moreover, the spillover effects would certainly be huge. No one tries for an inducement prize alone -- 26 teams competed for the Ansari X-Prize, and a slew of pilots tried crossing the Atlantic before Lindbergh. Every attempt leads to new knowledge, and for every prize-winning idea, society would be likely to see hundreds of spin-off ideas from attempts that either failed on their own or simply didn't come in first. While the winning X-Prize team had its technology almost immediately licensed by other companies, some of the companies that didn't win are putting their technology to commercial use anyway. The prize simply created more incentive for the competing teams to accelerate their research agendas.

Suppose that someone discovered the answer to one of the problems but thought he or she could make more money by patenting the solution and licensing it instead. There's no inherent conflict: Either the government could give the prize to the second person or firm to create a novel solution to the problem, or it could dedicate the prize money to a new question altogether. Either way, society would still benefit from the use of the technology. But it would have to be a profoundly irresistible and brilliant solution for the inventor to decline a guaranteed $1 billion payout just to take the chance that the market would embrace (and pay for) the technology.

Inducement prizes may not be the best answer to issues of energy consumption and pollution. But inasmuch as they represent market-friendly, non-punitive ways of achieving laudable results, they deserve at least the consideration of policy-makers who would otherwise turn to higher taxes or harsher regulations in order to solve problems that we haven't yet fully identified.