Cost-Effective and Equitable Targeting of Corrective Subsidies: Differentiated Green Subsidies for New and Existing Homes

This paper studies the optimal design of corrective subsidies when eligibility and subsidy levels can be differentiated across observable recipient categories, such as geographic location or housing type. Although such categorical targeting is common in practice, there is little normative guidance on how to design it when externality correction, cost-effectiveness, and redistribution must be balanced under a budget constraint. We develop a framework that decomposes the optimal subsidy for each category into three components reflecting these objectives. We show how the optimal design depends systematically on category-specific primitives---positive externalities, subsidy responsiveness, and the average social welfare weight of subsidy recipients---and on the program budget. We apply the framework to residential solar PV installation subsidies in Japan, some of which differentiate support between new and existing homes. We provide causal evidence that existing homes are 2 to 3.5 times more responsive to subsidies than new homes. Our simulations show that this large difference makes it optimal in most scenarios to assign higher subsidies to existing homes, generating sizable welfare gains relative to a non-differentiated design (15% in the benchmark case). More generally, our theoretical and empirical results highlight the importance of systematically incorporating these factors into the design of categorically targeted corrective subsidies.