Baucus Draft to Extend and Reform Energy Incentives

It's the beginning of 2014, and Congress did not pass legislation to extend the "tax extenders," a collection of over 50 provisions that expired at the end of 2013. Although they might later be extended retroactively, that means that a motley collection of tax breaks for research and spending by small businesses, along with specialized breaks for Puerto Rican rum, NASCAR tracks, racehorses, and movie studios have vanished, at least for now. Some of the largest incentives that expired were for energy, especially the wind production tax credit and the credit for the blending of biodiesel. Rather than extending these breaks for another year in their current form, Senate Finance Chairman Max Baucus (D-MT) released a discussion draft last month that would have simultaneously extended them, simplified the credits, and made them available to a wider range of industries. It is the fourth discussion draft he has released as part of his joint effort with his House counterpart Dave Camp to revamp the U.S. tax code and make it more competitive.

The draft is a dramatic simplification of the current tax incentives for energy. It consolidates 42 different energy incentives into 2: one for clean energy and one for clean fuel. The idea behind these two credits is to avoid picking "winners and losers" among clean energy industries and to offer some long-term certainty to the markets.

During the transition, the largest of the current credits are extended for three years. Meanwhile, the Environmental Protection Agency will perform the complex calculations needed to determine the cleanliness of a fuel and write rules for accomodating new technologies. The new credits take effect in 2017 and phaseout once their respective sectors are 25 percent cleaner than today's technology.

Below, we describe the reform in more detail.

Credit for Clean Electricity

The Baucus draft reforms the wind production tax credit (PTC), which was the largest of all the tax provisions that expired at the end of 2013. Since the credit is still paying existing wind farms, this credit will provide $22 billion to wind producers between 1992 and 2022. Baucus would reform this credit by making it available to all producers of clean energy, not just wind farms. An energy source that produced no greenhouse gas emissions would be eligible for the full current tax credit. The credit decreases for energy that produces more greenhouse gases, disappearing entirely for energy that is not at least 25 percent cleaner than the current national average.

For example, under this system, a plant with zero emissions - like wind, solar, nuclear, or hydroelectric - could receive a credit of 2.3 cents for every kilowatt-hour (kWh) of electricity it produced. A plant that was not emissions-free, but cleaner than the national average would get a smaller credit; a wood burning biomass plant would get a credit of 2 cents/kWh. A coal or pure natural gas plant would not qualify for any credit.

Currently, investors can claim an alternate investment tax credit (ITC) instead of the PTC. The credit is between 10 and 30 percent of the amount invested to build a plant, depending on the type of plant built. Baucus would make this credit permanent at 20 percent for zero-emission plants and similarly decrease it for plants expected to produce more greenhouse gases.

The credit is available for the first 10 years of a new power plant's operation and indexed for inflation. It is available for all electricty produced, not just electricity sold, so small producers (like an individual with a solar panel on their roof) can now qualify for the revised credit.

Credit for Clean Fuel

The Baucus draft provides a very similar production and investment tax credit for producers of clean fuels. The maximum credit is $1 per gallon (the current credit available for biodiesel) for a zero-emission fuel. The credit decreases for fuels that produce more greenhouse gases, disappearing entirely for fuels that are not at least cleaner than corn ethanol.

For instance, biodiesel produced from soybeans, which produces 41 percent of the greenhouse gas of ethanol per unit of energy, can claim a credit of $0.41 per gallon. EPA would have the ability to certify new technologies as they are developed, so a future fuel that produces zero emissions could claim the full $1 credit.

The fuels are measured on lifecycle emissions as determined by the EPA, a standard which considers not just by the gases produced by burning the fuel, but all the energy used to produce the fuel (e.g., the energy used to grow crops for biofuels). Similar to the electricity credit, it is available for the first 10 years of a new refinery's operation and indexed for inflation. 

Cut Back Other Incentives

The draft would eliminate other tax credits for energy-efficient homes and appliances, along with tax breaks for fuel cell-powered and electric cars. Industries would lose special credits for carbon sequestration and a mine safety tax credit.

A previous Baucus draft already trimmed some breaks available to oil producers: the ability to deduct drilling costs (see our analysis here), tax credits for refineries, and a special form of “LIFO” accounting used disproportionately among oil & gas companies (see our analysis here). Under that draft, alternative energy companies would lose special depreciation for solar and wind energy investments.

Certainty Through Long-term Credits

Currently, most alternative energy incentives are passed as short-term provisions. For instance, prior to the enactment of the American Taxpayer Relief Act, 27 energy tax extenders were set to expire in 2011 or 2012, creating uncertainty among investors who did not know whether a specific tax credit would be available in the future. These credits end uncertainty by persisting for many years. They take effect in 2017 and last until their respective sectors are significantly cleaner: when electricity produces 25 percent less greenhouse gas per unit of energy than in 2013 and the fuels are 25 percent cleaner than gasoline.

Most of the energy incentives expired at the end of 2013 but would cost about $150 billion over the next ten years if extended permanently. The draft trims the total amount of tax credits by about half, meaning it would cost about $75 billion compared to current law. Some of Baucus' other business tax reforms have raised enough one-time revenue to cover this additional cost.  Under Baucus' fiscally responsible standard of steady-state revenue-neutrality, one-time revenue generated by repealing other tax incentives can be used to pay for these temporary energy incentives (in addition to reducing the deficit), while the bill is intended to be revenue-neutral over the long term – the money raised from corporations will be used to lower the corporate tax rate.

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The idea of evening out clean energy subsidies across sources, judging technologies based on their emissions, and offering long-term certainty to the marketplace are ideas that energy reformers have often promoted. The Baucus draft incorporates many of these principals and represents a thoughtful contribution to the debate about how to reform the nation's tax code. Now that Baucus has been named to serve as the next Ambassador to China, it is unlikely that the bill will be enacted this year. However, the Baucus drafts and any released by Chairman Camp this year are helpful tools for advancing the debate and reforming our outdated tax code

This draft is the fourth in a series of drafts Baucus has released about how he would change the U.S. income tax code. We’ve written summaries on the previous three drafts on the international tax system, tax administration, and cost recovery.