Per-Unit Subsidies & Tax Credits

Definition

Per-unit subsidies and tax credits provide a predetermined payment for each unit of a specified product or service produced or purchased. These tools create volume-based incentives that scale with output or adoption. As adoption increases, companies innovate and learn to produce products more efficiently, lowering costs.

Unlike advance market commitments, output subsidies like per-unit subsidies and tax credits are generally used for products that already exist but could benefit from greater adoption to achieve cost reduction through scale. When implemented through the tax code, output subsidies are known as “per-unit tax credits.” When implemented through direct payments to a consumer or producer, they are commonly known as “per-unit subsidies.”

Why might per-unit subsidies be the right funding approach?

Per-unit subsidies are best suited for innovation challenges where solutions scale well and outputs are easy to measure, such as novel energy deployment, or where incentives spur consumer adoption, such as with new crop varieties.

Per-unit subsidies work best when the target innovation has one or more of the following characteristics:

• Clear definition of target activities or outputs: The funded activities or products must be both well-defined and verifiable. Ambiguous definitions increase compliance costs and create opportunities for gaming.
• Scalability: These mechanisms are most useful when the benefits of the innovation happen at scale, such as with vaccines for endemic diseases.
• Learning-by-doing potential: Certain innovations experience dramatic cost declines as production increases. Per-unit incentives help accelerate this learning curve, making technologies cheaper for broader adoption over time.
• Need for end-user tailoring: These tools preserve market mechanisms by allowing consumers to choose among qualifying products and forcing researchers to compete to meet real-world consumer needs. They are actor-agnostic, working with businesses large and small as well as individual consumers, and center on end-user choices.

Per-unit subsidies offer important advantages over other funding approaches:

• Paying for results: Subsidies tie rewards to real-world outcomes, paying only when products are actually produced or purchased. This ensures funds support successful deployment.
• Scalability and administrative efficiency: The US tax system has a well-established infrastructure to handle credits, making large-scale deployment feasible. The administrative burden is largely tied to compliance and monitoring, rather than complex program management.
• Incentivizing widespread adoption: Per-unit subsidies can drive broad technology adoption by lowering the effective cost to consumers or increasing returns to producers, making innovations with public benefits competitive in the marketplace.

What can go wrong?

Policymakers should be aware that, depending on how they are designed, per-unit subsidies can come with the following risks:

• Poor targeting: Often, per-unit subsidies result in payments for activities that would have occurred without incentives, reducing the program’s efficiency. They can also direct incentives toward activities the program wasn’t meant to support.
• Pricing and standard-setting: Determining the right subsidy level is difficult without clear market signals, potentially leading to activity above or below the optimal level. Overly broad or ambiguous standards can lead to suboptimal outcomes, while overly narrow ones may miss promising innovations. Long timelines between setting the standards or subsidy level and deploying technologies increase this risk.
• Overspending: These programs often lack built-in budget caps. Total expenditures can balloon if take-up for credits or subsidies significantly exceeds projections.
• International competitiveness issues: Subsidies for localized industries can trigger trade disputes or “subsidy races” among competing foreign governments.
• Tax liability: When implemented through the tax code, participants must have a US tax liability to benefit from the incentive.
• Regressive early uptake: Since early subsidies often target newer, more expensive technologies, initial subsidy dollars tend to flow disproportionately to well-off consumers. These purchases can help scale production and lower costs to later allow access to typical consumers, but programs often phase out support just as less affluent buyers come online.

To help mitigate these challenges, policymakers can incorporate design features such as spending caps to control overspending risks, careful eligibility criteria to reduce leakage, and regular program reviews to adjust standards as technologies evolve. However, these mitigation strategies can increase regulatory uncertainty and reduce incentives for companies and consumers. Successful implementation requires careful balancing of these competing considerations.

Examples

Per-unit subsidies and tax credits are widely used to promote innovation, especially in sectors like energy and chemicals production, where clear outputs can be easily tracked and rewarded:

• Renewable Electricity Production Tax Credit (PTC): Introduced in 1992, the renewable electricity production tax credit (PTC) provided a per-kilowatt-hour credit for electricity generated by wind, biomass, geothermal, and other qualifying renewable electricity sources. It catalyzed private investment in renewable energy infrastructure. Wind energy capacity, for example, increased from roughly two gigawatts (GW) in 2000 to over 150 GW by 2024. The PTC worked well in this context because renewable output is easy to measure, payments were tied to actual generation, and only technologies that supplied the grid received support. This design accelerated learning-by-doing, which helped lower the costs of wind and other renewables.
• Unconventional gas credit: The federal unconventional gas credit, created in 1980, gave producers about $3 per barrel of oil-equivalent for unconventional wells drilled through 1992, with payments continuing until 2002. By linking funding directly to production, it lowered the risks of costly shale projects and corresponded to a doubling of unconventional gas output, laying the foundation for the fracking boom.
• Electric Vehicle (EV) Tax Credits: The federal EV tax credit provided up to $7,500 for consumers purchasing qualifying electric vehicles. The credit is based on the verified sale of a qualifying vehicle, ensuring measurable results while giving buyers the freedom to choose among models. This flexibility matters because car buyers often have idiosyncratic preferences. By reducing upfront costs for buyers, the program accelerated the adoption of EVs, spurring private sector investments in battery technologies and EV manufacturing. Despite challenges in ensuring long-term competitiveness, the credit helped establish a viable market for EVs sooner.
• Carbon capture and removal subsidies (Section 45Q): Created in 2008 and revised multiple times since, Section 45Q is a US federal tax credit that incentivizes carbon capture, utilization, and storage (CCUS). As of 2025, it offers between $60 and $180 per metric ton of sequestered carbon dioxide. It can be used for projects that store carbon in geologic formations, store carbon in oil and gas fields, or convert carbon into useful products. The credit ties rewards to verified tons of removal, which can be quantified with reasonable accuracy.

Related funding approaches

Funders can complement per-unit subsidies with other mechanisms to create a comprehensive innovation support strategy:

• Advance market commitments: AMCs create guaranteed demand for products with a set fund and clear upfront endpoints, especially in sectors like global health or climate technology. Output subsidies are a broader category, and AMCs are a specific subset with certain setup characteristics.
• Prizes: While prizes reward technical achievements, per-unit subsidies focus on market deployment and adoption, making them complementary approaches for different stages of innovation development.
• Procurement contracts: Governments can pair subsidies with procurement mandates, ensuring reliable markets for subsidized innovations while driving adoption.

Further reading

1. Economic Implications of the Climate Provisions of the Inflation Reduction Act by Catherine Wolfram
2. Don’t Fret About Green Subsidies by Dani Rodrik