Improving tax incentives for wind energy production: the case for a refundable production tax credit.

• Author: Layser, Michelle D.
• Position: I. Introduction through III. Legal Uncertainty Surrounding Wind Tax Equity Investment Financing A. Sunset Provisions and Uncertainty About the Future of the Wind Energy Production Tax Credit, p. 453-483

1. INTRODUCTION

   Despite heated discussions in the media and on Capitol Hill, one climate change debate appears to be reaching a consensus: over ninety-seven percent of climate scientists now believe the world's climate is warming as a result of human activity. (1) In reaching an international agreement on climate change in Paris late last year, the United Nations called climate change "an urgent and potentially irreversible threat to human societies and the planet." (2) The Intergovernmental Panel on Climate Change has concluded that continued human interference with climate systems will increase the likelihood of "severe, pervasive, and irreversible impacts," including substantial species extinction, significant risks to food security, and temperature and humidity changes that may threaten normal human activity. (3) In the United States, a recent White House report asserted that climate change caused by emissions of greenhouse gases--and carbon dioxide in particular--is to blame for increasingly frequent and intense heat waves in the West and downpours in the Midwest and Northeast (4)

   Growing concern about climate change has been used to rally support for government subsidies for renewable energy investment. (5) Two important tax credits have been available to help subsidize renewable energy projects: the investment tax credit (6) and the production tax credit. (7) The two credits, which are mutually exclusive, serve similar roles in the renewable energy industry and face similar challenges. This Article, however, will focus on the more controversial of the two: the production tax credit, which was recently extended by Congress. (8) This Article argues that the production tax credit should be amended to make the credit refundable. As explained below, a refundable version of the production tax credit would make it more effective and better able to promote market efficiency and fight climate change by eliminating the need for costly transactions currently used to monetize the credit.

   The production tax credit was introduced as part of the Energy Policy Act of 1992, (9) which marked the first time that Congress "acted affirmatively to address the issue of global climate change." (10) The credit provides a dollar -for-dollar tax benefit to the owners of eligible renewable energy facilities, including certain wind farms, based on the amount of electricity produced and subsequently sold to unrelated persons. (11) The amount of the credit available to wind projects for any taxable year is 2.3 cents per kilowatt-hour ("kWh") of electricity generated: (12) the amount of energy required to power a 100-watt light bulb for ten hours. (13) In 2010, 246 claimants claimed a total of $1.7 billion in production tax credits, an average of roughly $6.9 million per claimant. (14) Eligible taxpayers can claim the credit during the first ten years after the renewable energy project began generating electricity. (15)

   Like most tax credits, the production tax credit is a nonrefundable credit that delivers economic value to taxpayers solely by offsetting their tax liability. (16) In other words, taxpayers can apply the credits to achieve dollar-for-dollar reductions to their tax bills. (17) In general, these tax credits are the economic equivalent of delivering a direct subsidy to a taxpayer in the form of a check; (18) however, because the taxpayer receives a reduction in taxes owed instead of a check, the "subsidy" delivered via a nonrefundable credit is limited by the amount of taxes owed. Nevertheless, because the production tax credit can be understood as a spending program administered through the tax system, this Article at times refers to the production tax credit as a subsidy for wind energy producers. The production tax credit, which is subject to periodic sunset provisions, was allowed to expire at the end of 2014. (19) Efforts to reinstate the credit were resisted by Republican lawmakers, who gained control of Congress in 2015, but the credit was ultimately extended along with several other expired tax provisions as part of a budget deal approved by Congress in December 2015. Given the widespread concerns about climate change--not to mention energy independence--it is safe to assume that legislators will continue to face questions about whether, and how, to encourage renewable energy production. Continued government involvement in renewable energy, whether through direct regulation or through the tax system, should be expected. Policymakers should revisit the traditional approach to incentivizing renewable energy through the production tax credit and seek ways to improve the credit.

   The purpose of this Article is to further our understanding of how the production tax credit works and does not work as a tax incentive to promote investment in renewable energy and to fight climate change. For reasons to be discussed, the tax incentives traditionally available present a number of transaction costs and limitations that make them less effective than alternative incentives. Specifically, this Article looks at the way the production tax credit is employed in the context of wind farm development. Because similar tax incentives and market conditions are relevant to other renewable energy industries, such as the solar energy industry, the wind industry was chosen as a representative case study within this context. (20) Though the production tax credit has been important for encouraging growth throughout the renewable energy industry, it has been especially important in the context of wind energy. (21)

   Wind farms, which use wind turbines to convert natural wind into mechanical energy and then electricity, (22) have been "the fastest growing energy technology worldwide, achieving an annual growth rate of over 30%" in total installed capacity. (23) Wind energy capacity, which is the amount of power that could be supplied if it were possible to run all wind turbines continuously at full-load, is measured in megawatts ("MW"). (24) One megawatt is roughly the amount of energy produced by ten automobile engines, and one megawatt-hour is enough energy to power about 330 homes for one hour. (25) From 2009 to 2014, U.S. wind energy capacity grew from 25,000 MW to over 61,000 MW. (26) The amount of electricity generated from these turbines grew 200% during that period, an increase the American Wind Energy Association attributes to "technological innovation and operational improvements, which [have] effectively driven down the costs and allowed development to occur in lower wind speed regions." (27)

   Opponents to the production tax credit assert that the wind industry has matured to the point that continued subsidies are no longer justified. Executives from traditional energy companies told Forbes magazine: "We believe the [production tax credit] has achieved its original purpose, namely shepherding a nascent industry to maturity, and any extension will cost taxpayers and electric consumers billions simply to benefit a handful of vested interests." (28) Conservative groups have opposed the renewable energy tax credits on the belief that the government should not interfere in the free market, arguing that "forcing new-energy companies to weather market forces is the best way to test their viability and strengthen the wider energy field." (29)

   There is truth to the view that subsidies can distort market activity; somewhat ironically, historical subsidies for fossil-fuel producers have contributed to distortions in the energy sector that now disadvantage wind energy producers and drive the need for renewable energy subsidies. (30) For example, the oil and gas industry has long had the benefit of tax-favored Master Limited Partnerships to help finance extraction activities. (31) While some economists have proposed parity for renewable energy companies, (32) others have advocated for ending all energy subsidies, for both traditional and renewable energy producers, based on faith in the free market and distaste for distortions caused by economic incentives. (33) To the extent that energy subsidies distort the market, rather than respond to and correct existing market distortions, such proposals have merit.

   However, the distortions in the energy sector exist apart from the historical fossil-fuel subsidies. First, University of Kansas School of Law environmental law professor Uma Outka has explained that "an implicit support structure for fossil energy is written into law in a range of areas, including environmental law, and ... statutory and regulatory concessions to fossil energy inevitably distort how the costs of bringing new energy technologies to scale are perceived." (34) These historical features of the energy industry continue to present significant barriers to newer players like wind energy producers. Second, and most importantly for this Article, traditional energy producers emit pollution, a negative externality that distorts prices in the energy industry to the detriment of clean energy producers. (35)

   The production tax credit is a subsidy intended to counter these distortions in the energy sector by making wind energy projects more profitable. 36 For this purpose, the production tax credit works very well. The wind energy industry is highly sensitive to the availability of subsidies like the production tax credit, and observers have collected significant data that correlates slowed growth in the wind industry with periods of political uncertainty about the future availability of the credits. (37) The expiration of the production tax credit at the end of 2013 was blamed for a decrease in the number of new wind projects and lost jobs related to the wind industry. (38) This Article does not discuss whether the production tax credit delivers a meaningful economic benefit to the wind industry. (39) Rather, this Article seeks to contribute to the understanding of how the production tax credit works to promote a more efficient...