Energy Efficiency Policies around the World: Review and Evaluation

3.4 Financial Incentives

Financial instruments include economic incentives to promote energy efficiency (e.g. subsidies for energy audits or investment, soft loans), as well as fiscal measures. Financial incentives aimed at encouraging investment in energy efficient equipment and processes by reducing the investment cost, either directly (economic incentives) or indirectly (fiscal incentives).

3.4.1 Economic Incentives

Economic incentives fall into two broad categories: investment subsidies and soft loans. In about one fourth of the surveyed countries, the economic incentives are related to energy or environment funds with financing mechanisms that tend to depend increasingly upon the banking system rather than coming from the public budget.

Investment subsidies

Investment subsidies to consumers were among the first measures to be implemented in the 1970s and early 1980s. Most countries developed various ambitious schemes, mainly to retrofit existing buildings or dwellings, as well as industrial equipment. The objective was to reduce the investment cost for consumers. In principle, these incentives apply to actions that are cost effective from the collective point of view, but which would not otherwise be undertaken by consumers. Subsidies can be defined as a fixed amount, as a percentage of the investment (up to a limit), or as a sum proportional to the amount of energy saved. Subsidies may also be given to equipment producers to encourage the development and marketing of energy efficient equipment.

In the surveyed countries, investment subsidies were mostly used in OECD countries: two third of surveyed countries have subsidy schemes, against one fourth of the countries for the other regions.

Industry is the main sector receiving subsidies (about 30% of all countries, 50% European), closely followed by households (about 25% of all countries, 50% in Europe) (Figure 3.8).

Ex-post evaluation of grant schemes showed several drawbacks:

• Subsidies schemes often attracted consumers who would have carried out the investments even without the incentive, the so-called "free riders" (e.g. high income households or energy intensive industries).
• Consumers who could use the subsidies and were targets of the scheme (small to medium industries and low-income households) did not take advantage of them because they were unaware of their existence. This demonstrates the challenges of informing a multitude of consumers adequately about the existence of the incentives.
• Procedures for grants applications were often found to be too bureaucratic (complex forms to be completed and long delays in obtaining the agreement) and costly (high transaction costs), especially in comparison to fiscal incentives (staff to process the forms).
• Finally, subsidy schemes may have a negative impact on the market by leading to an increase in the cost of equipment and to the deployment of equipment with a poor quality.

These drawbacks did not prevent the use of subsidies, but led to their more careful use, taking into account their real effectiveness. Grants are now better targeted to limit the number of beneficiaries (e.g. low income households , tenants). They are also restricted to certain types of investments (from a selected list of equipment), with a long payback time but high efficiency gains (e.g. renewables, co-generation), or to innovative technologies (demonstration or further investment). The approach used in Thailand is innovative, as the selection is not based on a list of equipment but on a criterion of cost-effectiveness (grants apply to investments that have an internal rate of return above 9%). Subsidies are increasingly viewed as a temporary measure to mobilise consumers, to prepare for new regulations, or to promote energy efficient technologies by creating a larger market than would otherwise exist, with the objective of a cost reduction for the subsidised energy efficient technologies.

Subsidies are generally given to consumers to lower the purchase cost of energy efficient equipment. Subsidies can also be given to producers to improve the quality and the cost of production. In some cases, the producer approach can lead to better results.

Soft loans

Soft loans are loans offered at subsidised interest rates (i.e. lower than the market rate) to consumers who invest in energy efficient technologies and equipment. Soft loans have the advantage of being easily implemented by banking institutions. Nevertheless, due to the current low level of interest rates, such measures are often not attractive to industrial companies.

Soft loans are less popular than subsidies as shown by the survey (Figure 3.8). Slightly less than 40% of all surveyed countries had such schemes (about 60% of them in Europe and 75% in OECD), where soft loans are almost equally used in industry, services and for households, whereas in non-OECD, industry is the main sector targeted.

Soft loan schemes are usually targeted at consumers. In some cased they are given directly to installers, which seem to be a promising approach in others, if well managed. This removes one important barrier, which is the access of consumers to information as the installers may have a commercial approach to promote energy efficiency.

3.4.2 Fiscal Incentives

Fiscal incentives include measures to reduce the tax paid by consumers who invest in energy efficiency. They comprise accelerated depreciation (industry, commercial sector), tax credits and tax deductions (households).

More recently, tax reductions on energy efficient equipment (on VAT or on import duties) or on energy efficiency investments (reduction in VAT rate) have been introduced in many countries.
Tax credits and accelerated depreciation are considered better than subsidies, as they are less costly. They can work well if the tax collection rate is sufficiently high. They usually have a poor performance in an economy in recession or in transition. They are more adapted to developed countries: tax credits exist in almost 40% of OECD countries (30% in Europe and 70% in OECD countries in America and Asia) (Figure 3.9).

Reductions on import tax or VAT on efficient equipment have been introduced in many countries and almost equally in all regions: they exist in about 30% of the surveyed countries . The compact fluorescent lamp is the most common equipment to which this measure applies outside the OECD (e.g. Ghana, Morocco, Israel), followed by electric motors.

In European countries, tax reduction also exits for clean and efficient cars. VAT concessions also exist on labour costs to reduce the investment cost in building renovation (e.g. France, Sweden, Switzerland).

Tax concessions for companies that make concrete commitments to energy efficiency gains/ CO2 reduction and meet their target are also another innovative way to promote investment in energy efficiency and CO2 reduction (e.g. Denmark or UK)