The tragedy of Solyndra

A wonderfully-titled new paper—The Tragedy of the Carrots—by Boston College law professor Brian Galle got me thinking about Solyndra, the failed solar panel company that has become something of a poster child for botched industrial policy.

By now, you probably know Solyndra’s sad tale. The firm got $537 million in federal loan guarantees from the Obama Administration. The California-based firm also got a $25 million state tax break and very likely also benefited from federal tax subsidies to boost demand for green energy. All of these incentives were supposed to further the multiple goals of energy independence, a cleaner environment, and domestic jobs.

But Brian, a Tax Policy Center fellow this year, argues that whatever you think of these aims, government carrots–rewards for doing “good” things—are usually a poor way to achieve them. Brian concludes that if lawmakers really want to tilt economic decision making, they are better off with sticks than vegetables. In other words, punishing people or businesses for doing the wrong thing is usually more effective than rewarding them for doing the right one.

In fact, he argues government might not even have to impose these penalties very often. The simple threat might be enough to get bad actors (however you define them) to clean up their acts—but only if that warning is credible.

It’s an interesting time to have this argument since many in Congress are questioning of the efficiency of tax subsidies (aka tax expenditures) in the face of big budget deficits. After all, one nice thing (unless you are a tea party fan) about raising taxes on bad actors is that it may reduce the deficit. Targeted tax cuts, by contrast, increase it.

Environmentalists often concede the theoretical arguments against subsidies but insist that pollution is such a big problem that policymakers should take what they can get. In other words, carrots may not be great but they are better than nothing. Brian, however, says they actually are. “Acceding to demands for carrots is like capitulating to blackmail: it only leads to greater incentives for bad behavior in the future.”

Think of it like this: If you are going to pay me to stop smoking, I’m might pick up the bad habit just so I can be rewarded for dropping it. And the bigger the subsidy, the harder I’ll lobby to keep it. After all, I’ll happily not smoke for the rest of my life and take tax dollars for the opportunity.

Although Brian is a lawyer, his argument is supported by many economists. For instance, TPC director Donald Marron made much the same case in testimony to a House subcommittee last month. But Brian asks why politicians prefer to lavish, say, tax subsidies on “good” behavior rather than tax “bad” behavior.

One reason may be that pols like nothing better than to cut ribbons and it is easy for voters to make the link between a tax break and a new plant. It is a lot more complicated for a pol to argue that the facility was built because he got a bill passed that raised taxes on the owner’s competition. And, of course, raising taxes on anyone these days is in such bad odor that few lawmakers are willing to do it.

Brian notes there’s little economic distinction between carrots and sticks. But there is a big psychological difference. As Wall Street and Las Vegas understand all too well, we fear losses more than we prize gains. It’s why we double-down when the dice don’t roll our way.

The implications of this argument are pretty interesting. Imagine taxing people who don’t give to charity instead of rewarding those who do—at least those who also itemize deductions. And, back to Solyndra, imagine a carbon tax instead of a rats nest of subsidies all aimed at encouraging green energy. No ribbons to cut, of course, but as President Obama is learning, that may be a very good thing.