Congress in the Dark on Renewable Energy

 | Dec 09, 2011 | 3:30 PM EST
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Many believe that Republicans are about to raise taxes for the nation's owners of renewable energy facilities. The concern has many scrambling to commission energy projects in time to qualify for U.S. Treasury grants and bonus depreciation. As bleak as it may seem for renewable energy, leaders believe there is a small chance Republicans will extend some, if not all, federal incentives at the last minute.

Up until Dec. 31, there have been two important tax incentives motivating investors to build, own and operate solar and wind facilities. From the perspective of the federal budget, both incentives are revenue neutral. The first is Section 1603 of The American Recovery and Reinvestment Act, simply known as "1603." As I wrote last month in "Solar Program to Darken at end of Year," 1603 provides a cash grant in lieu of an investment tax credit. Without 1603, only large and wealthy corporations will be able to take advantage of any remaining federal incentives, leaving out medium and small developers.

The second tax incentive is called bonus depreciation. Normally, depreciation schedules track the useful life of an asset, or in some cases, accelerate it to five or six years. This federal incentive allows owners to depreciate qualified assets within one year.

Together, both incentives provide powerful incentives for investors -- but they may die simply because politicians and bureaucrats have difficulty understanding why these incentives are revenue neutral, good policy, good for balancing the budget and good for America.

Politicians need to understand what investors already know: Federal incentives provide highly focused tax cuts. The cuts are limited to future tax revenues and only for businesses that do not currently exist. Without these incentives, these new businesses will not be formed. With these incentives, businesses will be formed and any federal incentives offered do not affect federal revenues.

Federal incentives only reduce federal income taxes owed by new entities, and only new entities that qualify for the program. If owners of these new businesses are not profitable and if they are not creating enough taxes to consume the tax benefits offered, the tax benefits are forfeited.

Regardless, these incentives for wind and solar will not affect the federal government's income tax revenues. In the parlance of Washington, these federal incentives are "revenue neutral."

When the analysis expands beyond federal income taxes, it turns out that federal incentives provide taxpayers with huge returns on investments in three ways. First, while solar and wind facilities may enjoy a reduction in corporate income taxes in the early years, they will have almost zero expenses to write off in subsequent years. In fact, they will have zero production costs, zero depreciation, and for reasons of project finance, almost zero interest expense. Their wind plants and solar farms will be producing nothing but taxable revenues for 15 to 20 years. These same facilities will be locked into the maximum income tax bracket, not only for the federal government, but also for each state government with income taxes. Federal incentives have the unexpected benefit of helping individual states raise revenues.

Second, federal incentives offer benefits beyond corporate income taxes, they also generate taxes from individuals. Constructing and operating new renewable energy projects creates jobs. When people have jobs, they pay all manner of taxes from income to sales tax. Current federal incentives are not really revenue neutral, but are revenue enhancing. Incentives for wind and solar generate far more taxes than are initially abated.

Third, the benefits of federal incentives extend beyond taxes. In deregulated markets, wind and solar facilities actually reduce the grid's average cost of power. Put simply, if your neighbor installs a wind or solar facility in his or her backyard, your electric bill will likely decline.

Price reduction is particularly true with solar. As more solar is added, inefficient gas turbines are idled. Inefficient turbines are the grid's most expensive resource and establish the market-clearing price of power. As expensive units are replaced with zero-production-cost units, the market-clearing price falls. Lower market-clearing prices at the wholesale level lead to lower prices at the retail level.

While all this makes for sound policy, sources indicate that politicians don't understand the issue and are reacting to sound bites. It appears there is less than a 50% probability that Congress will extend federal tax incentives. If it does, look for a rally in manufacturing companies such as First Solar (FSLR) and SunPower (SPWR), and a benefit for tax equity investors such as NextEra Energy (NEE), Exelon (EXC), Duke Energy (DUK), and Dominion Resources (D).

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