Small Tweaks To The Tax Code Can Mean Big Improvements In Renewable Energy Deployment

by Richard W. Caperton

“How much is the production tax credit for wind worth?”  That sounds like an easy question to answer: 2.2 cents per kilowatt-hour.

The truth, however, is that the PTC is worth different things to different people, and that the 2.2 cents per kwh is just the amount that it costs taxpayers.  For wind turbine owners, the credit is sometimes worth far less than 2.2 cents.  This isn’t just true with wind.  Other renewable energy technologies have access to similar tax incentives, and also find that they are sometimes worth less to project developers than the cost to taxpayers.  To get the most bang for the buck (or, the most renewable energy for the taxpayers’ dollars), Congress should work to make sure renewable energy tax incentives are delivering value efficiently to wind project developers and owners.

As CAP has previously written, supporting renewable energy through the tax code has been beneficial for clean energy companies and for taxpayers.  The production tax credit for wind, for example, has been a tremendous success in building a thriving wind industry in the United States.  Senator Chuck Grassley (R-IA) recently said:

I’ve championed the wind energy tax credit as a way to provide a level playing field for a very clean, renewable resource. As a result, wind energy has become more efficient and cost-effective. The cost of wind energy has declined by 90% since the 1980’s. Wind has accounted for 35% of all new American electric generation in the last five years… As a result of the tax incentive, the wind energy has actually created new manufacturing jobs in the United States. Today 60% of the wind turbines’ value is now produced in the United States, compared with just 25% six years ago. There are now 400 facilities building wind components in 43 states. That is why a bill in the House of Representatives to extend the wind energy production tax credit has 80 cosponsors, including 18 Republicans.

At the same time, there is reason to believe that we could have even more wind power – and all the benefits that entails – if the PTC were fully optimized.  The issue is that not every wind project owner can use the tax credit.  The credit simply reduces the amount of taxes a company owes.  For many wind projects, the owners don’t actually owe taxes because they’ve just invested large amounts of money.  In other cases, a company may owe taxes, but not as much as the credit is worth.  As an illustration, if a company owes $1 in taxes but has a $2 credit, they can only use $1 worth of the credit.

Today, companies deal with this problem by bringing in a so-called “tax equity investor”.  The exact structure of these transactions is complex, because you’re not technically allowed to “sell” tax credits, but the gist of the transaction is that the tax equity owners pay to use the tax credits.  Of course, they buy the credits at a discount, in order to turn a profit on the deal.  That is, they may only pay 75 cents for a one dollar credit.

This discount is critical.  A middle-man has now entered the equation, and has reduced the value of the credit to the wind project developer, even though it still costs the taxpayers 2.2 cents per kwh.

Congress could address this issue by making minor changes to the PTC so that the discount the middle-man demands would be smaller.  One way to do this would be to make the rules for “tax equity” easier, so that more companies would want to participate in the tax equity market.  The problem with this is that it may have a negative side effect of increasing the use of money-losing ventures as tax shelters.  Fortunately, there’s another option: Decrease the uncertainty around whether or not a project will qualify for a tax credit.

Here is the key point: As the law is now written, a project is only eligible for a tax credit if it is “placed in service” by a certain date.  For wind projects, that date is December 31, 2012.  This means that a wind project will only qualify for the PTC if it begins generating and selling electricity by December 31.  This is the end of a very lengthy permitting, procurement, and construction process, any step of which can take longer than expected, and none of which can move forward without all of the financing in place.  This means that tax equity investors are expected to commit money to a project and allow much of that money to be spent, even though there is some risk that construction may not finish in time and the project may not be “placed in service” by the deadline.  Tax equity investors are aware of this risk, and account for it when figuring out how much they should discount the PTC when pricing the transaction.

This situation could be avoided if the law was changed so that a project is eligible for a tax credit if construction begins by a certain date.  Under this “commence construction” structure, there is no longer any risk that construction delays will make the project ineligible for the tax credit, which reduces the risk for tax equity investors.  This change has no effect on taxpayers, because under either structure the project can only claim the credit for electricity generated.

There’s another benefit to making this rule change.

Renewable energy tax credits all expire in the coming years.  For wind, it’s at the end of 2012.  For solar, it’s at the end of 2016.  Planning, permitting, financing, and constructing a project can take years, so a project just in the planning phases today may not be placed in service in time to qualify for the credits.  Changing to a “commence construction” system effectively gives developers a little more time to plan strong projects and still qualify for the valuable tax credits, because construction would no longer have to be completed by a certain deadline.

Changing from “placed in service” to “commence construction” is good policy, and makes sense for all renewable electricity tax credits.  Wind, solar, hydropower, geothermal, and biomass all qualify for tax credits, but each one is structured in slightly different ways.  Despite their differences, they would all be made better by eliminating construction risk from the tax credit qualification process.  For example, hydropower developers tend to be large, vertically-integrated utilities who do owe taxes, so they don’t need to bring in tax equity partners. When these project developers do internal planning and budgeting, they consider the risk that a project may not qualify for a tax credit if there are construction delays.  And, utility-scale solar projects face all the same development risks as wind and a change to “commence construction” in the investment tax credit would mean that the solar industry could fully and efficiently utilize their incentive.

It’s worth noting that there are another set of changes that could address this issue by simply eliminating the middle man.  The “Section 1603” program, which was created in the stimulus bill and has now expired, allowed renewable energy project developers to take a cash grant for the same amount of the tax credit.  So, even companies that didn’t owe taxes could benefit.  Best of all, a tax credit and a direct payment are financially equivalent to the government, so it doesn’t cost taxpayers anything extra.  Similarly, the PTC could be made into a “refundable” tax credit, which means that the government sends a check to companies who aren’t able to use the full tax credit for the remainder.  That is, if a company only owes $1 in taxes but has a $2 refundable credit, they can get a check for the extra dollar.  Under either of these plans, the middle-man has been eliminated, so the PTC is worth more for the project developer.

Tax credits have been incredibly successful at driving renewable energy deployment and are good deals for taxpayers.  There’s no urgent need to go in a radically different direction.  But, we should make sure that tax credits are used efficiently, and Congress should be open to making smart changes.  Changing from “placed in service” to “commence construction” would be a step in the right direction.

Richard W. Caperton is Director of Clean Energy Investments at the Center for American Progress.

One Response to Small Tweaks To The Tax Code Can Mean Big Improvements In Renewable Energy Deployment

  1. Although the tax credit are a good idea, would it not be much more productive (not to mention cheaper) to create a Feed-in-Tariff like the Germans have done? Over there, the FiT has lead to an incredible amount of renewable energy production and the cost is paid through the electricity bill – on average, around $10 a month.