Individual Time Preferences and Energy Efficiency

Abstract:

We examine the role of individual discount rates in energy efficiency decisions using evidence from an extensive survey of U.S. homeowners to elicit preferences for energy efficiency and cash flows over time. We find considerable heterogeneity in individual discount rates. We also find that individual time preferences systematically influence willingness to invest in energy efficiency, as measured through product choices, required payback periods, and energy efficiency tax credit claims. Individual discount rate heterogeneity is in turn significantly related to characteristics of the individual and their household, including their financial situation. Individuals with less education, larger households, low income, and low credit scores had systematically higher discount rates, as did black, non-Hispanic respondents. Our findings highlight the importance of individual discount rates to understanding energy efficiency investments, the energy-efficiency gap, and policy evaluation.

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Federal tax credits to promote household investments in EE were in place 2006–2011. These credits were popular, with 23 percent of single family homeowners in our sample taking advantage of the credits.  Using individual discount rates elicited in the survey, NS find the current EnergyGuide label came very close to guiding cost-efficient decisions, on average. However, using a uniform five percent discount rate—typical of government regulatory analysis, but much lower than the average individual elicited rate—the EnergyGuide label led to choices resulting in a one-third undervaluation of EE. These results reinforce the importance of intertemporal choice and discounting both for understanding individual behavior and for guiding policy decisions.

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We elicited individual discount rates using an experiment where the respondent chose between a $1,000 payment available in one month and a higher payment available in 12 months. The elicited discount rates indicate considerable heterogeneity (Fig A1), and are generally consistent with other similar experimental evidence (see NS for a more detailed review). The mean rate was 19 percent, the median was 11 percent, and the standard deviation was 23 percent. The distribution has a concentration at relatively low discount rates (≤10 percent) and is skewed right with a few observations at high rates (≥40 percent). An advantage of our sample is that it is more representative of the population than is typical of the time preference elicitation literature; this breadth also allows for exploration of the effect of demographic variables.

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WTP for annual operating cost savings declines by about 1.6 percent for each percentage point increase in the individual’s discount rate. This is intuitive: for individuals with higher discount rates the value of reduced future operating costs is lower, as is their WTP for EE.

by Richard G. Newell, Juha V. Siikamaki
National Bureau of Economic Research (NBER)
NBER Working Paper No. 20969; Issued in February 2015

http://www.nber.org/papers/w20969