Tax Reform and Community Based Renewable Energy
by John Farrell, ILSR

The federal tax credits for renewable energy have been a major barrier to widespread ownership of renewable energy. The production tax credit, for example, can only be taken against passive income, a type of income that very few of us actually earn. Accelerated depreciation or investment tax credits can be taken against ordinary income – slightly better – but again the credit provides more benefit the higher one's tax bracket and the more tax liability one has. The overhead costs in aggregating sufficient tax equity to finance wind and solar projects have proven very high. Nevertheless, to date the industry has grown rapidly based on this inefficient and cumbersome arrangement.

The economic downturn, however, has all but eliminated the ability of renewable energy projects to sell their tax credits. The result is that in mid-January, AWEA and SEIA joined an increasing call to move toward refundable tax credits.

This is a useful step, for it opens up the possibility of investments in renewable energy from a much wider portion of the American people. But it is only a halfway step. It will apply to the production tax credit but probably not to the other types of tax benefits — accelerated depreciation and investment tax credits. Thus similar overhead costs in selling tax liabilities will occur and local ownership will still be stunted.

A better solution would be to avoid the need for tax incentives completely and set a price utilities have to pay for renewable energy sufficient to attract investors. Since investors would earn their money from the sale of electricity, not the sale of tax credits, a majority of Americans might be able to become investors.

The strategy is called a feed-in tariff (FIT). It has achieved remarkable success in Europe and has now been adopted by one Canadian province (Ontario) and one U.S. municipal utility in Gainesville, Florida. Half a dozen states are currently considering such a strategy.

Under a FIT, the government or public utility commission sets the price for renewable electricity high enough to attract investment. The price is varied to achieve multiple goals. For example, a government might prefer to encourage, with a higher price, rooftop solar rather than remote solar power plants. It might prefer to encourage, with a higher price, emerging technologies.

Utilities must enter into long-term (usually 20-year) contracts with the producer. The government revisits the tariff price every couple of years, lowering it when it feels producers are making excess profits, raising it when insufficient production is occurring.

Many Americans may react in horror at the idea of government setting a price. But in fact, that is the way the electric system has worked for more than a century. Regulatory commissions offer a utility a guaranteed rate of return sufficient to attract investment in new power plants.

Indeed, the U.S. now has two types of price setting. For conventional power plants utilities are given a cost-plus contract. Ratepayers will pay a price that recovers the cost of the power plant plus a healthy but reasonable profit. For renewable energy plants, however, we cobble together a byzantine array of tax benefits, rebates and mandates.

Some 38 states have renewable electricity mandates. In these states, government sets the quantity and the "market" sets the price, with the market massaged by tax and other incentives. Under a feed in tariff the government sets the price and the "market" the quantity. Neither is a pure market based strategy. But the feed-in tariff is much more transparent, comprehensible and — studies have shown — less expensive and more effective.

At a conference on feed-in tariffs held by the Institute for Local Self-Reliance in Minnesota in early January, former Minister of Energy of the German state of Schleswig-Holstein, Willi Voigt said that the renewable energy debate in the U.S. today sounds exactly like it did in Germany ten years ago. It was around that time that their experimentation with various renewable energy incentives gave way to a feed-in tariff. The renewable energy industry immediately took off. Renewable energy generators today satisfy 15 percent of German electricity needs. Half of the renewable energy power plants are locally owned.

The Germans are exceeding their renewable energy goals at a cost less than that of other European countries that have imitated U.S. strategies. American renewable energy generators face increased risk and cost from bundling energy incentives, confronted with the possible expiration of tax incentives, and having to find equity partners. German producers can attract low-cost financing because their electricity contract is guaranteed, the price is attractive and the process of gaining interconnection approval is simple and fast. German renewable energy policy also results in more economic development (and green jobs), because more than half of projects are locally owned.

Shifting to refundable tax credits is a good step, but the country and the renewable energy industry would do better to demand a new way of doing things. As our newly inaugurated president has suggested, we should set our sights higher.

John Farrell is a research associate at the Institute for Local Self-Reliance, where he examines the benefits of local ownership in renewable energy. His latest paper, Wind and Ethanol: Economies and Diseconomies of Scale, uncovers why bigger isn't necessarily better. He's a graduate of the University of Minnesota's Humphrey Institute of Public Affairs and currently resides in Minneapolis, Minnesota.
 

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