What are Carbon Removal Tax Credits?
Tax credits are utilized by governments to encourage private investment in new technologies, by providing a dollar-for-dollar reduction in an entity’s tax liability, effectively reducing the cost of the technology’s or practice’s adoption. These incentives are designed by legislation passed in Congress, and administered by the U.S. Treasury Department. Tax credits are typically more effective incentives than tax deductions or exemptions because they reduce the actual amount of tax due, rather than the amount of taxable income.
By encouraging private investment, tax credits have historically played critical roles in advancing clean energy technologies. Tax incentives can also promote other climate solutions, including carbon dioxide removal. As carbon removal projects can be capital- and time-intensive, tax credits can aid in overcoming the barriers to near-term deployment, along with stimulating the adoption of promising solutions. New or expanded tax incentive programs for natural and technological carbon removal would make it easier for carbon removal projects to overcome high start-up costs, drive innovation, and unlock private capital.
How do Carbon Removal Tax Credits work?
Many carbon removal practices and technologies face barriers to deployment that include higher initial costs and greater perceived risk compared to conventional investments in forestry, agriculture and energy technologies. Tax credits can lessen the cost burden and risk incurred by entities that undertake carbon removal projects by lowering the owner’s or investor’s tax liability. The credits can benefit various stakeholders including homeowners, technology developers, investor-owned utilities, landowners, and agricultural and timber producers.
Performance-based tax credits, which are currently used to support technological carbon removal projects, are an incentive-based form of compensation that requires achievement of performance targets, such as removing a specified amount of carbon from the atmosphere, in order to receive the total credit amount. Performance-based carbon removal tax credits are akin to the production tax credit (PTC) that exists for some renewable energy technologies, but performance is measured in tons of CO2 removed instead of kilowatt-hours of electricity produced.
Another type of federal tax credit used to support low-carbon energy technologies is the investment tax credit (ITC). The ITC reduces an eligible entity’s tax liability based on its level of investment rather than the project’s performance. Many factors influence the decision of whether a performance-based or investment-based tax credit is more appropriate for a given project, including the amount of upfront investment expected for the project, the expected value of output produced, the expected duration of that production, and the stage of technological development.
What are Key Design Considerations for Tax Credits?
Which technologies or practices should be eligible for the tax credit? Are eligible activities in the appropriate stage of their development for tax credits to be an appropriate tool to advance them?
How should measurement and verification of performance be conducted to ensure appropriate use of tax credits? For carbon sequestration projects, what is the proper timespan over which project benefits should be measured? For forest and agricultural carbon removal projects, how should baselines be calculated and used to measure net increases in carbon sequestration?
What rate should be set for the tax credit to encourage certain behaviors and performance targets? Should the value of the tax credit differ based on end use of the captured carbon? If so, by how much? Should the tax credit be based on investment or production?
Should the timeframe in which tax credits can be claimed end at a certain date, phase down over time or be permanent? Over how many years can the credit be claimed for a project? What signal will the duration of a tax credit send to developers about whether a project is worthy of investment?
What is the payment structure of the tax credit? At what point in the development of a technology or practice can it be claimed (early- vs. late-stage development)?
Do potential entities who may claim a given tax credit have sufficient tax liability for a nonrefundable tax credit? To what extent does making a tax credit refundable enable broader utilization and/or ensure that credits are more accessible? Should tax credits be made transferable to allow entities to sell excess tax credits?
U.S. Experience with Carbon Removal Tax Credits
In the context of carbon removal, the 45Q Carbon Capture Tax Credit is the primary U.S. experience with tax credits. Section 45Q provides a performance-based tax credit for carbon capture projects that securely store carbon dioxide in geologic formations, or utilize carbon dioxide as a feedstock or component of commercial products. In 2018, Congress passed the FUTURE Act (Furthering Carbon Capture, Utilization, Technology, Underground Storage, and Reduced Emissions Act), which amended the Internal Revenue Code to extend and modify the tax credit for carbon dioxide sequestration, increasing its value and applying the credit to more carbon removal technologies. 45Q tax credits can be claimed by the owners of carbon capture equipment. The current tax credit amounts are $35/ton for carbon dioxide securely stored in geologic formation through enhanced oil recovery (EOR), $35/ton for carbon dioxide or oxides used in commercial products, and $50/ton for carbon dioxide securely stored in geologic formations that are not used in EOR.
No tax credit currently exists for natural forms of carbon removal.
The PTC and ITC tax credits have both been used in advancing renewable energy. The PTC has been applied to closed-loop biomass, geothermal, qualified hydropower, and most notably, wind power. The growth of the wind industry is largely attributed to the PTC. Additionally, the ITC has been applied to geothermal energy, microturbines, and most notably, solar power. The expansion of solar power in the U.S. is largely attributed to the ITC.
- Food and Agriculture Climate Alliance Policy Recommendations
- Primer: Section 45Q Tax Credit for Carbon Capture Projects
- Carbon Removal Policy: Opportunities for Federal Action
- CARBONSHOT: FEDERAL POLICY OPTIONS FOR CARBON REMOVAL IN THE UNITED STATES
- Tax Credit
- Internal Revenue Code Tax Fact Sheet
- The Role of 45Q Carbon Capture Incentives in Reducing Carbon Dioxide Emissions
- Federal Policy Blueprint