Seductive subsidies? An analysis of second-degree moral hazard in the context of photovoltaic solar systems

This paper studies how subsidies for solar systems can lead to second-degree moral hazard - the impulse of installers to increase prices and/or reduce labor input when customers receive subsidies. Employing an instrumental variable strategy using plausibly exogenous variation in the size of subsidy levels to address concerns about self-selection of installers into specific subsidy levels, I quantify the impact of subsidy levels on total costs and electricity output of solar systems in California. The results are consistent with hypothesized drivers of second-degree moral hazard. First, larger subsidy levels are associated with a cost increase when customers receive unconditional upfront subsidies as compared to output-based subsidies. Second, stricter verification rules reduce costs. Third, the association of lager subsidy levels and increased costs is particularly pronounced when third-parties own the solar system and thus receive the subsidy. Finally, costs are larger for government customers and lower for non-profit customers.