What are tax credits?
Generally, tax incentives are policy tools to advance various financial, economic, and social goals. For example, tax credits are a type of incentive that can encourage the deployment of a specific technology by providing a dollar-for-dollar reduction of the tax liability of a consumer, investor, or business when they purchase or use the technology, effectively reducing the cost of the product. In the energy industry, tax credits have been used for solar, wind, oil production, carbon capture and sequestration (CCS), and more. Ideally, tax credits incentivize investments in innovation, which results in less carbon and other pollution, and more jobs and economic activity, while providing consumer choices with greater choices for cleaner and more energy efficient technologies and products. This brief focuses on three federal tax credits: the renewable electricity production tax credit, the investment tax credit, and the plug-in electric vehicle tax credit.
How do tax credits work?
Tax credits offset the tax liability of a consumer, investor, or company, and are designed differently depending on the actions or outcomes they intend to incentivize. The credits can benefit various stakeholders including homeowners, vehicle owners, technology developers, and investors. Emerging technologies, including many clean energy technologies, have higher initial costs and face market, policy, and regulatory barriers compared to their incumbent competitors. Tax credits can help reduce the cost and attract private capital to such technologies until they become cost-competitive at scale.
Production tax credits are based on the production of a desired outcome. Only developers of projects that actually produce that desired outcome can claim the credit. For example, the renewable electricity production tax credit (PTC) provides a tax credit on a per-kilowatt-hour basis for electricity produced from qualifying energy sources. Therefore, the tax-paying owner of the qualifying energy resource, such as a wind facility, earns a larger tax credit as more electricity is produced and then sold to an unrelated party. The PTC is most well-known for supporting the growth of wind power.
Investment tax credits, on the other hand, are based on the level of investment. As long as an investment is made and the technology is deployed, no matter the output, the credit can be claimed. For example, the federal investment tax credit (ITC) for several technologies is based on a percentage of the initial cost of an eligible energy system, most notably for solar photovoltaics. In a simple case, if the ITC is 10 percent and a company installs $30,000 worth of equipment for a solar project, the company could claim a $3,000 credit on its federal corporate income taxes. For solar power, it is available for both residential and commercial projects.
A third type of tax credit is purchase based. For example, the plug-in electric vehicle tax credit provides a credit ranging between $2,500 and $7,500 for purchasers of qualifying plug-in electric vehicles. The credit phases out when a vehicle manufacturer has sold 200,000 qualifying vehicles. Tax-paying businesses and individuals can claim the credit.
Any of these tax credits may be structured as either refundable or nonrefundable. If a tax credit is refundable, a person or entity whose tax credit is larger than their tax liability will receive a cash refund for the portion of the credit remaining after their tax liability is reduced to zero. Nonrefundable tax credits can only reduce an entity or person’s tax liability to zero, and the remainder of the credit is carried over to a future year or lost. “Tax equity” investors with sufficient tax liability or “tax appetite” can become equity partners in projects. This allows the tax equity investor to monetize the tax credit while allowing the project’s economics to be more competitive by recognizing the full value of a tax credit. The tax regulations, however, are quite complicated and effectively cut out a large investor class who could otherwise be investors. Some programs may provide cash grants in lieu of refundable tax credits to ensure eligibility for entities without sufficient tax appetite.
Key Design Considerations
Which technologies should be eligible for the tax credit? Should the tax credit be technology-neutral to reward activities on the basis of emissions reductions, not predefined technologies? Should enabling technologies such as energy storage – currently eligible as long as the project stores power produced by renewable energy – be eligible for stand-alone tax credits? Are eligible technologies in the appropriate stage of their development for tax credits to be an appropriate tool to advance them?
Do potential entities who may claim a given tax credit have sufficient tax liability for a nonrefundable tax credit ? Does making a tax credit refundable enable broader utilization and/or ensure that credits are available to smaller businesses or less affluent households?
Is tax equity sufficiently available? Can delivering cash grants in lieu of refundable or nonrefundable tax credits, particularly in times of economic uncertainty that can affect tax equity markets, better deliver desired outcomes?
Should tax credits end at a certain date, phase down over time or be permanent? What signal will the duration of a tax credit send to developers about whether a project is worthy of investment?
The renewable electricity production tax credit was first enacted under the Energy Policy Act of 1992 and scheduled to terminate in 1999. It has been extended 12 times since 1999. The credit applies to several technologies, but is best known for its impact on wind power. The full tax credit rate for 2019 and 2020 is 2.5 cents per kilowatt-hour. Wind projects that began construction in 2017 are eligible for 80% of the full tax credit, with that eligibility declining to 60% in 2018 and 40% in 2019. The PTC was scheduled to expire in 2019, but the Taxpayer Certainty and Disaster Relief Act of 2019 extended the wind credit for one year. The extension made wind facilities that begin construction in 2020 eligible for 60% of the full tax credit. The PTC has significantly contributed to the growth of the wind industry and other renewable energy electricity sources. However, it also has had the negative effect of contributing to the booms and busts of the industry due the tax credit law almost expiring multiple times over the years.
The investment tax credit was first enacted under the Energy Tax Act of 1978. It has applied to several renewable energy technologies including geothermal energy, microturbines, and most notably, solar power. The ITC has been reformed several times over the last four decades. The Consolidated Appropriations Act of 2016 extended a 30% credit for solar electric or heating property through 2019. The solar credit is set to phase down to a 26% credit for 2020, a 22% credit for 2021, and then a permanent 10% credit for commercial projects starting in 2022. The residential project credit will expire in 2022. Since its implementation, the solar investment tax credit has contributed to the significant expansion of the U.S. solar industry.
The plug-in electric vehicle tax credit was first enacted by the Energy Improvement and Extension Act of 2008. Depending on the vehicle’s battery capacity, the tax credit can be as high as $7,500 for vehicles purchased after December 31, 2009. The tax credit begins to phase out once a vehicle manufacturer sells 200,000 eligible vehicles. During the phase-out period, the credit is 50% of the total credit amount for two quarters and then 25% of the total credit amount for two more quarters. It is then fully phased out. Tax credits for electric vehicles have had a positive impact on increasing electric vehicle sales, though only two manufacturers have met the phase-out threshold and no others are expected to reach it until at least 2022.
State governments have also utilized tax credits to advance climate-related goals. At least 17 states have personal tax credits for some climate-related activities or clean technologies and at least 15 states have corporate tax credits for similar activities or technologies. At least 12 states have tax credits for alternative vehicles or alternative vehicle infrastructure. For example, New York has a solar energy system tax credit worth up to $5,000, and Hawaii has a state income tax credit for eligible renewable energy technologies including a 20 percent credit for wind-powered energy systems. Colorado also has tax credits for qualified all-electric vehicles and plug-in hybrid electric vehicles including a $4,000 tax credit in 2020 for the purchase or conversion of eligible light-duty vehicles.
- Congressional Research Service: https://fas.org/sgp/crs/misc/R44852.pdf
- Tax Policy Center: https://www.taxpolicycenter.org/briefing-book/what-are-tax-credits-and-how-do-they-differ-tax-deductions
- Columbia University: The Next Generation of Federal Clean Electricity Tax Credits
- ITIF: https://itif.org/publications/2019/12/02/less-certain-death-using-tax-incentives-drive-clean-energy-innovation
- Congressional Research Service: https://www.everycrsreport.com/reports/R41635.html
- Department of Energy: https://www.energy.gov/sites/prod/files/2013/04/f0/FACT%20SHEET%20–%2048C%20MANUFACTURING%20TAX%20CREDITS.pdf
- Hawaii State Energy Office: https://energy.hawaii.gov/developer-investor/financing-and-incentives-for-renewable-energy-projects/state-of-hawaii-and-federal-incentives
- DSIRE: https://programs.dsireusa.org/system/program?fromSir=0&state=CA
- Department of Energy: https://afdc.energy.gov/
- EnergySage: https://www.energysage.com/electric-vehicles/costs-and-benefits-evs/ev-tax-credits/
- Rhodium Group: https://rhg.com/research/can-tax-credits-tackle-climate/
- American Wind Energy Association: https://www.awea.org/policy-and-issues/tax-policy
- Congressional Research Service: https://fas.org/sgp/crs/misc/R43453.pdf
- CohnReznick: https://www.cohnreznick.com/insights/2019-trends-in-utility-renewable-energy-financing
- Congressional Research Service: https://fas.org/sgp/crs/misc/IF10479.pdf
- Department of Energy: https://www.energy.gov/eere/solar/downloads/residential-and-commercial-itc-factsheets
- Solar Energy Industries Association: https://www.seia.org/sites/default/files/2020-01/SEIA-ITC-Factsheet-2020-Jan_1.pdf
- Congressional Research Service: https://fas.org/sgp/crs/misc/R45693.pdf
- Energysage: https://news.energysage.com/congress-extends-the-solar-tax-credit/
- Argonne National Laboratory: https://www.energy.gov/sites/prod/files/2017/01/f34/Plug-In%20Electric%20Vehicle%20Policy%20Effectiveness%20Literature%20Review.pdf
- Congressional Research Service: https://crsreports.congress.gov/product/pdf/R/R45747
- Department of Energy: https://afdc.energy.gov/laws/11702
- Congressional Research Service: https://fas.org/sgp/crs/misc/IF11017.pdf
- Energysage: https://www.energysage.com/electric-vehicles/costs-and-benefits-evs/ev-tax-credits/
- IRS: https://www.irs.gov/businesses/plug-in-electric-vehicle-credit-irc-30-and-irc-30d
- CRS: https://crsreports.congress.gov/product/pdf/R/R45747
- EVAdoption: https://evadoption.com/about/
 During the Great Recession, the American Recovery and Reinvestment Act of 2009 created the Section 1603 grant program, which provided cash grants in lieu of tax credits for renewable energy projects. Under the program, developers or owners of eligible energy projects could receive a one-time cash grant equal to the value of a tax credit under the PTC or ITC programs. Parties receiving the grant would receive the direct payment rather than having their tax liability reduced when they file federal income taxes. A refundable tax credit first reduces a party’s tax liability rather than providing a direct cash transfer. If a party is owed more than their tax liability, their tax liability is reduced to zero and they receive the remaining credit as a refund. The refund is similar to a cash grant since it is a direct cash payment.
 The full tax credit for 2017 and 2018 was 2.4 cents per kilowatt-hour.