This may interest practitioners in renewable energy.
Economics ES530 [Ecological Economics]
March 1, 1998
Tax Credits and the Development of Renewable Energy in California, a review
by John Foster
In 1992, 11 % of the electricity consumed in the state came from geothermal,
biomass, wind, and solar power plants, compared with only 4 per cent a
decade earlier (1) Regulatory reforms enabled small renewables developers
sell power to utilities; and tax credits that helped these developers
finance their projects. An eligible activity recieves a credit against a tax
they would otherwise have to pay.
The US National Energy Policy Act (1992) made permanent an investment tax
credit for solar and geothermal power, and introduced a ten-year production
credit for wind and biomass. The development of renewable energy has given
California cleaner air, lower greenhouse gas emissions, and an economy less
vulnerable to fuel price increases and supply disruptions.
California is in a position to benefit economically as world energy markets
increase their demand for renewables in response to these environmental
challenges. The 1992 National Energy Policy Act provides a credit against
income tax for investors in solar and geothermal property equal to 10
percent of the amount invested. Capital recovery subsidies defer tax
payments by allowing a taxpayer to deduct capital expenses from income
earlier in the life of an asset than allowed under normal accounting rules
some states exempt residential solar water heaters from sales tax while
others exclude solar energy equipment from the tax base on which local
authorities assess property taxes.A permanent credit was introduced in the
1992 US National Energy Policy Act for solar and geothermal only.
A different type of incentive called a production credit was introduced for
wind and biomass electric generation in the 1992 US National Energy Policy
Act. The new federal production credit is set at 1.5 cents per kilowatt-hour
besides hydropower geothermal, biomass, wind and solar has been eligible for
tax credits in California the California Public Utilities Commission (PUC)
reduced the regulated profit rate of the state's largest utility, Pacific
Gas and Electric as a penalty for its early resistance to renewable energy.
The PUC required three utilities to sign several standard power purchase
contracts which ensured small developers could obtain reasonable terms from
the utilities for the sale of their renewable electricity.
The Qualifying Facilities could either contract for a 10 year period fixed
at an agreed projection of future oil prices, instead of fluctuating oil
prices, during the 1980's regulators, utilities, consumers, etc.,
came to agreed that the demand side of the meter offered numerous low-cost
options to reducing electrical demand. Tax subsidies can be an valuable for
promoting emerging technologies, economic competitiveness, and societal
goals like pollution prevention policy intervention is warranted to correct
market failures like natural monopolies, external social costs and benefits
and poor information.
Failures are commonplace as evidenced by environmental problems and national
security risks associated with a dependence on oil imports. The major energy
technologies developed in the US all
benefited from government support through direct subsidies (oil/highways,
hydro, nuclear) or the creation of a favourable institutional environment
(monopoly-owned central power stations).
A country can gain competitive advantage and serve other public goals by
using targeted tax subsidies to promote early commercialization of
technologies, especially those promising significant price declines as
production increases in a democratic society, technology development should be
shaped by public values, not just prices which reflect consumer preferences.
A property exemption is required for renewable technologies like solar and
wind power since they are highly capital intensive compared to fossil fuels.
The fuel for renewable energy is free, but must be captured by costly
capital that is subject to annual property taxes, and therefore,
California's property tax becomes the largest operating cost for a solar
power plant. The California Energy Commission (CEC) calculated that the
owners of the LUZ solar electirc generating plants would pay 38 per cent
more state property taxes owners of an equivalent natural gas combined-cycle
power plant, wven after subtracting the 10 percent solar tax credit. In late
1992, Congress passed the National Energy Policy Act which made permanent
the 10 percent investment credit for solar and geothermal energy and added a
1.5 cent per kilowatt hour production credit for wind energy and closed-loop
biomass.
Incentive effects
Budgetary problems forced the state to rely on legislative votes to extend a
credit in 1991 which lasted until 1994 for state property tax exemption for
renewables. Investment and production credits provide different incentives
and affect project finances in different ways. Credits can be critical to
the financing of capital intensive projects such as solar thermal power
plants with benefits are up front.
An investment tax credit can provide little incentive to install equipment
that operates efficiently.
A production credit is linked to output and provides the greatest tax
benefit for the equipment that works the best. Production credits leave
investors more exposed to risks of technology failure than do investment
credits. Production credits provide a stronger incentive for risky,
innovative investments and for spurring technology development. Tax benefits
of a production credit are spread over the life of a project, or in the case
of the new federal credit, the first ten years of operation. A production
credit of ten years solves uncertainty investment credits favour using
capital rather than labour, whereas production credits are neutral between
the two. The continuation of the production credit is subject to
congressional approval; however if funds are not available through
subsidies, then the production credit is reduced.
The impact on long-term investment decisions
Development of California's Renewables Industry
A slowdown in the economy and an increasing emphasis on demand-side
investments and falling natural gas prices made it difficult for renewables
to compete with combined-cycle gas-fired plants.
In 1991 a bidding systems was used to allow non-utility generators to
compete in a second-price auction to supply identified blocks of future
utility need a specific share of future utility need for renewables was
placed into a seperate bidding arena with the first bid held in
1993,resulting in substantial additions to renewable state energy supply.
A decade of commercial development in California has brought major
improvements in performance and cost-effectiveness that could not have been
achieved in the laboratory alone Development of Wind Energy successful wind
developers claim that wind industry could not have developed without the
benefit of tax credits. This is supported by a CEC study which estimated
that 90 percent of
wind systems could be attributed to the existence of the federal and state
credit by the early 1990's wind energy was proving a reliable technology
that could compete with conventional generation
while offering potential for further cost improvement. Capacity is expected
to double following 1993 auctions. Three developers were selected to develop
1500 megawatts of new wind turbines( Wind Energy Weekly, 1994). Kenetech
Windpower won most bids and it's new variable speed
wind turbine is perhaps the most significant accomplishment of the decade of
wind development in California. Current estimates are that this turbine will
generate electricity at a cost of 6.3 cents per kilowatt hour.
The Development of Solar Energy
The LUZ solar thermal plants are a world first in large-scale, commercial
developer of solar energy for supply of electricity their development was
made possible by the federal and state tax credits.
Good policy design requires careful consideration of the interaction between
a tax subsidy and the broader tax system fiscal incentives, regulations and
institutional reform can complement each other.
Tax credits can serve both environmental and economic development goals by
accelerating the
commercialization of promising technologies policy certainty is critical to
the effectiveness of
fiscal incentives
1. Frank Muller, Center for Global Change
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