This article examines the conditions under which tax incentives for innovative energy sources can be counterproductive, thereby leading to an increased postsubsidy use of nonrenewable, conventional fuel sources. The general problem of energy-capital complementarity is extended to the residential-sector production of space heating and domestic hot water services and is empirically explored in the context of federal and state tax incentives for solar thermal processes. Regional substitution and price elasticities are estimated using pseudo data generated from an engineering process model. The results enable one to analyze a host of possible future price scenarios under which a policy of subsidization would be injudicious.
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