How Damaging Are Environmental Policy Targets in Terms of Welfare?

International environmental agreements can lead to the design of environmental policy targets for individual countries. One of the most timely examples are targets aiming at increasing the share of renewable energy production in the overall energy mix. To reach these targets, corresponding governments must stimulate the private sector to undertake sufficient investments in time. This paper studies the effect of a subsidy on the probability of reaching a policy target and on the resulting welfare. The subsidy in the form of a fixed price support accelerates investment and increases the investment size. As such it helps to reach a policy target in time, but also has its own effects on the total surplus, the latter being the sum of producer and consumer surplus. The paper defines a new measure, "the expected Total Surplus corresponding to the Policy Target" abbreviated by TSPT, which takes all these effects into account, including the penalty that is incurred upon not reaching the policy target. Based on the TSPT we determine the optimal subsidy size. We find that a policy target increases the optimal subsidy size. An international policy target can cause a tradeoff in the sense that a large investment is required to achieve the target, while at the same time such a large investment is bad in terms of total surplus. We also find that targets designed with earlier deadlines and intermediate levels of target sizes are more effective in motivating governments to reach the target with a high likelihood. A larger penalty can induce more subsidy support from the government, but always harms total surplus.& COPY; 2023 Elsevier B.V. All rights reserved.