Reforming energy investment incentives

GLOBE-Net, May 15, 2013 – There have been many calls for reform of the subsidies and incentives provided to the energy sector. A report from the International Monetary Fund (IMF) released last month urged policymakers the world over to reform subsidies for products from coal to gasoline, arguing that this could translate into major gains both for economic growth and the environment.

The report Energy Subsidy Reform – Lessons and Implications, estimates that energy subsidies amount to a staggering $1.9 trillion worldwide-the equivalent of 2½ percent of global GDP, or 8 percent of government revenues.

[stextbox id=”custom” float=”true” width=”200″ bcolor=”add3d5″ bgcolor=”add3d5″ image=”null”]Progress in the reform of energy subsidies has been slow or non-existent, in part due to the entrenched power of the oil and gas sector in the economies of many nations, but also because repealing subsidies and incentives for the energy sector politically is easier said than done.[/stextbox]

The United States has been singled out as one of the main providers of incentives and subsidies within the energy sector, though by far, the level of financial support provided to the fossil fuel industries (oil, gas and coal) far exceed those available for other less carbon intensive energy sources. The lack of bipartisan support for changing these various incentives regimes has until now delayed any serious efforts for reform.

That may be changing. As noted in a companion GLOBE-Net article Congressional lawmakers from both parties are taking a step to catalyze the nation’s clean energy economy: After 32 years of restricting a crucial investment tool to expanding fossil fuels, they’re pushing to open it to renewables. (See GLOBE-Net article ” A Rare Bipartisan Clean Energy Bill Is Ready for Passage“).

Interest in energy subsidy reform is growing in Washington circles. A recent paper by the U.S. Senate Finance Committee outlines practical measures that might end up on the order paper for the reform of Incentives affecting infrastructure, energy and natural resources. Everything from carbon tax, to performance-based standards, to the complete repeal of incentives was put forward in the paper as plausible reform options.

The paper first addressed the many problems associated with existing subsidies, tax breaks and other incentives. These include:

• Distortion of investment decisions: Energy tax subsidies distort investment choices, which may hamper economic growth.
• Accounting for externalities: Measuring externalities is difficult and imprecise, especially in the area of carbon.  The lack of a price on pollution, such as emissions of CO2 and other harmful greenhouse gases, is viewed as a market failure because pollution produces costs that are not borne by the polluter.
• Duplication with spending programs: Tax benefits and direct spending programs need to be better coordinated argued the paper because many incentive schemes by individual agencies overlap to some degree with other initiatives.
• Neutrality across different technologies: Current U.S. laws provide a variety of incentives for specific energy technologies, but it would be more efficient to structure these incentives on a technology-neutral basis to avoid governments picking winners and losers among competing technologies.
• Overall complexity: Multiple provisions for the same purpose create complexity and some would argue diminish their effectiveness.
• Temporary nature of certain tax expenditures: The temporary nature of expiring tax expenditures creates uncertainty for taxpayers, makes it difficult for businesses to plan and may diminish their effectiveness.
• Low bang-for-the-buck for tax incentives: Some argue that energy-related tax incentives could achieve more at a lower cost.

The Reform Options

The paper suggests any reform options for the energy and conservation sectors should address the following principles:

• Provide businesses with greater certainty.
• Consolidate and simplify such tax expenditures.
• Make such tax expenditures fairer and more efficient.
• Encourage energy independence through a comprehensive approach.
• Carefully consider whether and how to address any positive or negative externalities.

It identified the following “reform options”:

1. Eliminate all existing tax expenditures for the energysector – i.e. eliminate oil- and gas-specific tax expenditures, such as expensing of intangible drilling costs, accelerated depreciation for alternative energy assets, investment tax credit for solar and geothermal electricity, and various temporary tax credits for solar and other resources and production and investment tax credits for wind and other resources. Other tax breaks that would end are tax credits for biodiesel and advanced ethanol, liquefied hydrogen and hydrogen refueling property, tax credits for vehicles utilizing fuel cell technology and plug-in electric drive motor vehicles. 
    
2. Replace existing energy tax expenditures with technology-neutral tax expenditures – i.e. eliminate existing energy tax expenditures for targeted industries or technologies and replace them with one or more technology-neutral tax incentives such as a new, performance-based tax credit for residential energy efficient retrofits; or a new tax credit for transportation-quality biofuel based on the total carbon reduction of the fuel compared to gasoline or diesel fuel. A new tax credit for the purchase of energy efficient vehicles based on fuel efficiency alone compared to the corporate average fuel economy (CAFE) or a new production tax credit for electricity based on the energy content (in British thermal units or BTUs) of the energy source were also suggested.
    
3. Modify and consolidate some incentives while eliminating others – i.e. reduce the total number and cost of tax expenditures while making them permanent. For example make refundable and permanently extend the alternative electricity production tax credit for energy efficient commercial buildings or make permanent the individual tax credit for energy efficient home retrofits. It would alsoend the production tax credit or solar investment tax credit, and replace them with expensing or accelerated depreciation. 
    
4. Equalize tax treatment of master limited partnerships (MLPs) in the energy sector – i.e.extend the ability of certain MLPs to pay tax on a pass-through basis to MLPs in the renewable energy sector. Current law allows certain publicly-traded businesses in the oil, gas, mineral and real estate sectors to pay tax on a pass-through basis; most publicly-traded businesses must pay the corporate income tax.
    
5. Establish a carbon tax or cap and dividend approach – i.e. coupled with eliminating most or all other existing energy tax expenditures this would eliminate most or all existing tax expenditures for the energy sector and create a new federal excise tax on the sale or importation of fossil fuels.
    
6. Modify conservation easements – i.e.make permanent the expansion of the charitable deduction for contributions of conservation easements  and increase the limitation on the estate tax exclusion for land subject to a qualified conservation easement.

Over the past decade the U.S. Congress has shown little enthusiasm for meaningful or comprehensive reforms of energy incentive programs. So whether any of these reform options takes root is far from certain. But the fact that the paper builds on proposals that have been put forward by both the Republican and Democratic proponents might suggest there is a modest basis for hope.

Notwithstanding this, there is an important caveat in the paper/s opening paragraphs that is worth noting:

“The options listed are not necessarily endorsed by either the Chairman or Ranking Member. Members of the Committee have different views about how much revenue the tax system should raise and how tax burdens should be distributed. In particular, Committee members differ on the question of whether any revenues raised by tax reform should be used to lower tax rates, reduce deficits, or some combination of the two. In an effort to facilitate discussion, this document sets this question aside.”

The Senate Finance Committee Paper is available here.

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