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Federal Tax Credits Handcuff Clean Energy Development

| Written by John Farrell | 5 Comments | Updated on Dec 5, 2011 The content that follows was originally published on the Institute for Local Self-Reliance website at http://www.ilsr.org/federal-tax-credits-handcuff-clean-energy-development/

Clean energy advocates should cast aside their worries about increasing Republican scrutiny of energy subsidies.  The clean energy industry’s foolish reliance on tax incentives has already handcuffed its expansion.

Unlike the leading nations in the clean energy race, the United States has no coherent energy policy.  Rather, its energy market is balkanized by 50 distinct state policies and overlaid with poorly conceived federal tax incentives.  Federal tax incentives have one redeeming feature.  To get a tax incentive only takes one vote of Congress while getting any other kind of monetary subsidy requires two votes, an authorization and then an appropriations bill.

The drawbacks are much more substantial.  Building a clean energy future on a foundation of tax credits and deductions means significant inefficiency, reduced opportunity for the public sector, and handcuffing clean energy deployments.

Tax incentives may be politically expedient, but they are financially wasteful.  In fact, tax credits cost Uncle Sam (and the taxpayer) twice as much as handing out cash.  Why?  For many clean energy projects, the developer doesn’t have enough tax liability to effectively use the 30% investment tax credit or production tax credit.  Instead, they need a “tax equity partner” (like a Wall Street banker) who can use a big tax credit.  With some legal finagling, the two partners ink a deal that “monetizes” the entire federal incentive, but the Wall Street equity partner takes a hefty cut.  In 2010, renewable energy developers were selling their tax credits to financiers for 30-50 cents on the dollar, with the remainder padding the pockets of financiers rather than buying down the cost of clean energy.

These tax equity partnerships aren’t just an inefficient use of public dollars for clean energy, they  make locally owned projects more difficult to developundercutting the political clout of clean energy by reducing the local economic value of (and commensurate support for) wind and solar projects.

Tax credits also curb pubic sector participation in clean energy.  “Solar for schools” may be a great rallying cry for the solar industry and for education, but tax code incentives don’t apply to schools, municipal buildings or non-profits.  Instead, schools and others must seek private partners to offer them a lease, power purchase agreement, or other ownership structure that allows the project to capture at least some of the federal tax incentives.  As the following chart illustrates, however, these arrangements for schools are never quite as cost effective as privately-owned solar projects.  Furthermore, the partnerships mean the public sector can’t use its best weapon, low cost financing (e.g. bonding) to spread clean energy development.

The use of tax credits may also artificially cap the clean energy market.  Since clean energy projects must rely on a limited set of tax equity partners and a limited-size tax equity market, when tax equity dries up, so do wind and solar projects.  The economic crisis of 2008 made the problem particularly evident, as the tax equity market shrank by 80 percent from 2007 to 2009.  Only the cash grant program saved the wind and solar industries from total collapse in the intervening years (2009-11), and the cash grant will likely expire at the end of 2011.  The following chart from a SEIA presentation illustrates [pdf] the problem, even though it was devised before the 1-year extension of the cash grant in 2010.

A chart of the limited capacity for tax equity to finance renewable energy projects

The problem of limited tax equity isn’t just short term.  Marshal Salant, managing director of Citigroup Global Markets Inc., said in a recent interview: “There’s more demand for tax equity to finance renewable energy projects than we will ever have in the way of supply.”

In other words, using the tax code for energy policy handcuffs U.S. clean energy development.  The limited market for clean energy will also continue to suffer from major inefficiency and severely constrained options for the public sector, undermining public support for clean energy policies.

There are alternatives to the reliance on tax incentives (outlined last week in our discussion of Germany’s run-away success with its comprehensive feed-in tariff energy policy).  But until the clean energy industry is ready to admit the folly of its marriage to tax equity, the American market for wind and solar will suffer.

Photo credits: handcuffs by Vectorportal, Wall Street sign by runnx, collage by John Farrell.

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About John Farrell

John Farrell directs the Energy Self-Reliant States and Communities program at the Institute for Local Self-Reliance and he focuses on energy policy developments that best expand the benefits of local ownership and dispersed generation of renewable energy. More

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  • Alan Nogee

    John,
    Sure tax credits are relatively inefficient, and may be a 3rd or even 4th best policy. And they can and should be improved upon. But that doesn’t mean they “handcuff” renewable energy, or that they make any better policies less likely. Quite the opposite.

    While you give a not to “political expediency,” the sad fact is that it has often been much easier politically for DC to give money through the tax code than diresctly. The one vote versus two votes is part of it, but rightly or wrongly, (and I think wrongly) they are often not perceived as subsidies as much as direct spending is. It is also the mechanism Congress uses for lots of giveaways to the fossil and nuclear industries. There are some good arguments that, short of all subsidies being eliminated–which isn’t going to happen, and would be a problem for new entrants if it did–they are essential for renewables to achieve some sort of tax parity.

    The weakest part of the argument is that they are somehow blocking enactment of other policies. In fact, they make Feed-In Tariffs, or renewable standards, more affordable, by spreading some public good costs to all taxpayers, not just to specific utility, state or individual consumers who would otherwise have to bear the entire costs of the renewable energy technologies. Without the tax credits, more state renewable standards would be likely to bump up against price caps, and be less effective. Feed-in tariffs would have to be higher to stimulate an equivalent level of development, making them less politically viable. And a federal FIT has virtually zero viability now, and certainly hasn’t been viable any time since the tax credits were enacted in 1992. Nor does the fact that they are unavailable to entities without any tax appetite mean that eliminating them would do anything positive for those same entities.

    Ongoing political viability for the tax credits–or any federal financing substitute–will require reducing their cost and increasing their effectiveness, in my opinion. And we need additional policies–standards, long-term contracts, and FITs. But arguing that the industry would be better off without tax credits at all simply increases the odds that they will be eliminated by Congress with nothing put in their place, putting the continued expansion of renewable energy in significant jeopardy.

    Alan Nogee
    Clean Energy Consulting
    Former Clean Energy Program Director, Union of Concerned Scientists
    @alannogee

  • Insider

    @Alan

    Yea but…

    If the global political machine provides enough incentive to PURCHASE ~ 20GW of solar on an annual basis, then the solar industry does everything it can to PRODUCE only 20GW. This is not a theory — this is a well known truth. Therefore, the subsidies create a false ceiling. This is exactly why we have the issue with CASE V CASM. The Chinese have violated the “unspoken” production quota. This of course, on purpose…

    Furthermore, this artificially induced production cap has stifled innovation. That is a FACT. I personally know of a well funded (tier one VCs) solar company that is having trouble raising capital. They have invented a new technique to produce polysilicon using less steps, energy and with less loss because they move straight to finished wafer. The reason they are being given is ” you have no competitive advantage. Next week the Chinese will move poly prices to $ 20pkg — then to $15pkg”

    We need to end all the solar subsides here and now. Energy is the worlds largest market. A lack of subsidy won’t keep multinationals and wiley entrepreneurs away. But shifting sand politically led subsidies and artificial market caps certainly will.