Global Climate Change: The Energy Tax Incentives in the President’s FY2001 Budget

98-193 E

Updated March 14, 2000

CRS Report for Congress

Received through the CRS Web

Global Climate Change: The Energy Tax

Incentives in the President’s FY2001 Budget

Salvatore Laser

Specialist in Public Finance

Resources, Science, and Industry Division

Summary

The President’s FY2001 budget includes several energy tax incentives intended to

reduce greenhouse gases linked to possible global warming. The incentives subsidize

energy conservation and promote energy efficiency in each of the energy end-use sectors

— residential and commercial, industrial, and transportation — and encourage

substitution toward alternative energy technologies such as solar and wind power and

electricity produced from alternative energy resources such as biomass. The conservation

and efficiency tax incentives are in the form of nonrefundable tax credits for energysaving capital goods. In addition, some of the tax credits are intended to directly reduce

the quantity of harmful greenhouse gases linked to possible global climate change. Some

are versions of energy tax incentives that were enacted under President Carter’s Energy

Tax Act of 1978 (as amended), but have since expired. Two provisions of the FY2001

budget constitute a liberalization of current law energy tax subsidies, while others are

new subsidies.

The President’s FY2001 budget, submitted in February of 2000 includes several

energy tax proposals, all favoring energy efficiency and renewable fuels technologies.

These energy tax initiatives, which were first proposed as part of the FY1999 budget and

modified for the FY2000 budget, are targeted toward energy efficiency and alternative

fuels to reduce fossil fuel combustion, improve air quality, and reduce greenhouse gases.

There are no tax incentives for oil and gas; and in fact the budget proposes to reinstate

several expired environmental excise taxes on oil, including the Superfund energy taxes.

Energy Efficiency in Residential and Commercial Buildings

Two tax credits are proposed in the FY2001 budget to improve the energy efficiency

of both new and existing residential and commercial buildings: (1) a tax credit for the

purchase of energy-efficient, new homes; and (2) a tax credit for purchases of energyefficient building equipment, and materials.

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Tax Credit for New Energy Efficient Homes. Some federal laws and certain states

require energy-using home appliances, heating and cooling equipment, and insulation to

meet certain energy efficiency standards. There are also voluntary federal guidelines for

energy efficient building design. But there are otherwise no special tax incentives to

encourage either the demand for, or the supply of, more energy efficient homes. The

President’s FY2001 budget proposes a tax credit for purchasers of a new home that would

meet certain specified and stringent energy efficiency standards. The tax credit would be

$1,000 for new homes that are at least 30% more efficient than the 1998 IECC

(International Energy Conservation Code) standard and purchased between January 1,

2001, and December 31, 2003. The tax credit would be $2,000 for new homes that are

at least 50% more energy efficient than the IECC standard and purchased in the 5-year

period between January 1, 2001, and December 31, 2005.

Tax Credit for Energy-Efficient Building Equipment. The second of the two tax

credits to reduce fossil fuel use in residential and commercial buildings is a 20% tax credit

for the cost of specified types of advanced energy-efficient equipment for space heating

and cooling and hot water heaters. The maximum credit varies by type of eligible

equipment, as indicated below. The tax credit would be provided for the purchase, on or

after January 1, 2001, and before January 1, 2005, for the following three types of energyefficient equipment:

! Fuel cells with a minimum generating capacity of 5Kw, and a generation efficiency

of at least 35%. (The maximum credit would be $500 per kilowatt of capacity.)

! Energy efficient electric heat pump water heaters. A maximum tax credit of $500

per unit for heaters with an energy factor rating of at least 1.7 in the Department

of Energy test procedure;

! More energy efficient natural gas heat pumps. Those with an energy factor of at

least 1.25 for heating and at least 0.70 for cooling would qualify for a maximum tax

credit of $1,000 per unit;

Under current law, no tax credits or other tax incentives are provided for equipment

to make residential or business structures more energy efficient. The 1978 Energy Tax

Act provided for a system of business energy investment tax credits for several categories

of energy conservation property — called “specially defined energy property” — but these

were essentially equipment used in manufacturing or industrial processes rather than in

buildings. These energy equipment tax credits generally expired at the end of 1982.

Energy Efficiency in Transportation

To encourage greater energy efficiency of vehicles, and reduce petroleum used in

transportation, the FY2001 proposes the following new tax credit for a relatively new

technology in fuel-efficient vehicles: the hybrid-vehicle.

Tax Credit for Fuel Efficient Hybrid Vehicles. A tax credit would be available for

the purchase of cars and light trucks (including minivans, sport utility vehicles, and

pickups) that utilize a hybrid drivetrain. Hybrid vehicles combine an electric motor and

battery pack with a gasoline or diesel engine in various configurations. In some cases, the

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combustion engine provides primary power to the wheels, while the electric motor adds

supplemental power for acceleration and climbing. In others, the motor provides primary

power, while the combustion engine simply recharges the batteries. In any case, one of

the key features of these vehicles is regenerative braking, which returns energy to the

batteries, instead of dissipating it as heat (as happens with conventional braking). These

vehicles tend to be very efficient, with higher fuel economy and range than conventional

vehicles.

The FY2001 budget proposes a credit that would range from $500 to $3,000 per

vehicle depending on 1) how much additional power is provided by the auxiliary

rechargeable energy storage system, and 2) how much additional energy is provided by the

regenerative braking system. This credit would be available for vehicles purchased

between December 31, 2002, and January 1, 2007. While the proposal is intended to

improve a vehicle’s energy efficiency, there is no explicit numerical efficiency standard for

the credits. In the FY2000 budget proposal, the tax credit was a function of the

percentage improvement in energy efficiency. Such a qualifying vehicle would have to

satisfy all emission requirements applicable to gasoline vehicles.

Current tax law contains several tax incentives — and some nontax disincentives —

to conserve conventional, petroleum-based motor fuels, particularly gasoline and diesel

fuel. First, gasoline and diesel fuel are taxed at the rates of 18.4¢ and 24.4¢ per gallon.

Second, an excise tax is imposed on the sale of domestically produced or imported “gas

guzzlers” that do not meet the fuel economy standards (the CAFÉ standards) established

by the Environmental Protection Agency. The tax rate is graduated, ranging from $1,000

for vehicles rated between 21.5 and 22.5 miles per gallon (MPG) and $7,700 for vehicles

rated at less than 12.5 MPG.

In addition to taxes on conventional fuels and “gas guzzlers,” federal tax law has

provided, since 1992, a tax deduction for the purchase, by individuals or businesses, of

vehicles that run on alternative fuels. Taxpayers can deduct, from adjusted gross income,

a portion of the cost associated with the purchase of dedicated alternative fuel vehicles

(AFVs), or the cost of converting vehicles so that they can operate on clean-burning

alternative fuels (dual fuel AFVs) in addition to gasoline. Dedicated AFVs are new

vehicles designed to run on an alternative fuel only.

For dedicated AFVs, costs up to $2,000 for qualified property can be deducted for

a vehicle up to 10,000 lbs., up to $5,000 for a truck or van of 10,000 to 26,000 lbs., and

up to $50,000 for a truck or van weighing more than 26,000 lbs. Qualified property for

a dedicated AFV includes the full cost of the engine, the fuel delivery system, and the

exhaust system. For a dual-fuel vehicle, the qualified cost is limited to the incremental cost

of the same components compared with the systems for conventional fuels. Alternative

fuels are defined as compressed natural gas, liquefied petroleum gas, liquefied natural gas,

hydrogen, electricity, and fuels that include 85% alcohol, ether, or any combination of

these. In addition, all of the property that qualifies for the deduction — the new vehicle,

or the conversion equipment — must be new. Qualifying vehicles must meet any

applicable federal and state environmental standards. For business taxpayers, the basis of

the property for purposes of the depreciation deduction is reduced by the amount of cleanfuel-vehicle deduction. In general, each of these deductions terminates at the end of 2004.

But there is a phase-out provision in the case of new clean-fuel burning vehicles or retrofit

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equipment. The deduction is phased-out evenly over a 3-year period beginning in January

2002.

Alternative Energy: Technology Incentives and Production Tax Credits

Several tax incentives are proposed to encourage greater production and use of

alternative forms of energy and investment in alternative energy technologies in residential

and commercial buildings (a tax credit for solar energy equipment), for the transportation

sector (tax credit for electric cars), and to encourage small-scale self-generation and

storage of electricity (so called “distributed power”). Also, existing tax incentives are

expanded for technologies for producing electricity from alternative fuels.

Tax Credits for Solar Energy Equipment. The Administration proposes a tax

credit for two types of solar energy equipment: (1) a 15% tax credit for up to $13,334 in

investments in rooftop solar equipment that uses photovoltaic cells to generate electricity,

for a maximum tax credit of $2,000; and (2) a 15% tax credit for up to $6,667 in

investments in solar water heating equipment (other than swimming pools), for a maximum

tax credit of $1,000. Solar equipment installed in either a personal residence or a business

would qualify for this tax credit, which would be nonrefundable, i.e., limited by the amount

of tax otherwise owed. Both credits would be available beginning on January 1, 2001, but

the credit for photovoltaic systems would last for seven years, terminating on January 1,

2008, while the credit for water heating systems would last for five years, terminating on

January 1, 2006. Photovoltaic systems use solar cells made of semiconductor material that

convert sunlight directly into electricity. A photovoltaic solar system combines individual

cells into an interconnected panel used as part of a sunlight-absorbing roof or as separate

self-contained electricity generating system.

Current law provides for a 10% tax credit for investment in solar photovoltaic

systems or for solar equipment used to heat or cool a structure or for solar process heat.

Only businesses qualify for this credit, which also applies to geothermal systems. The

equivalent credit for residential solar systems expired at the end of 1985. The business

solar credit is the remnant of the more extensive system of residential and business tax

credits for conservation and renewable energy that were part of President Carter’s

National Energy Plan of 1978, but which largely expired at the end of 1985. Only the

business energy tax credits were extended several times beyond 1985, and for gradually

fewer and fewer types of energy equipment. Under President Clinton’s FY2001 proposal,

businesses that invest in qualifying solar equipment would have to choose between the

current 10% tax credit and, if enacted, the new 15% tax credit.

Tax Credit for Electric Vehicles. Under current law, consumers that purchase an

electric vehicle can claim a 10% nonrefundable tax credit for the cost of the vehicle placed

in service prior to 2005. The tax credit is in lieu of the current law tax deduction, or the

new tax credit for hybrid vehicles should it become enacted. The maximum credit is

$4,000 but only for purchases made through 2001. For vehicles purchased between 2002

and 2004, the credit is reduced by 25% each year. Also, for businesses that purchase

electric vehicles, the maximum amount that may be deducted annually for depreciation is

three times larger than the depreciation limit for other types of automobiles. In general,

the amount that businesses may deduct annually for depreciation of an automobile is

limited to $2,560 the first year, $4,100 the second year, $2,450 the third year, and $1,475

in any subsequent year in the recovery period. Each of these amounts is adjusted annually

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for inflation that has occurred since 1987 so that the amounts for 1997 (for most cars)

were $3,160, $5,000, $3,050, and $1,775. For electric vehicles, however, the base

amounts are $7,680, $12,300, $7,350, and $4,425, respectively. The higher depreciation

limits for electric vehicles, which are also adjusted for inflation after 1997, were part of the

Taxpayer Relief Act of 1997.

The President’s FY2001 budget proposes to repeal the phase-out of the credit, and

the credit would be extended through 2006. Thus, the maximum $4,000 tax credit would

be available through 2006.

Accelerated Depreciation for Distributed Power. The President’s FY2001 budget

proposes to accelerate depreciation deductions for small electricity generating and storage

systems (self-generated power) and for co-generation systems, which the budget calls

distributed power technologies. Such technologies allow industrial, commercial, and even

residential users (such as apartment buildings) to generate or store their own electricity

and thus either be completely independent power producers or rely less on electric utilities.

The proposal covers technologies that are defined more by size and by the on-site feature,

and thus could include small diesel engines, internal combustion engines, and

microturbines. The intent is to encourage small alternative technologies (to the traditional

electricity generating technologies) such as fuel cells.

Under the President’s proposal, such equipment would all be depreciated over a 15

year recovery period, thus reducing the recovery period for many types of equipment used

in commercial and rental buildings, which were depreciated over much longer time periods.

This reclassification to shorter recovery periods also allows distributed power systems and

combined heat and power systems to qualify for a more accelerated method of

depreciation (150% declining balance rather than straight line depreciation) which basically

means that more of the equipment costs can be written off in the early years, thus

increasing the present value of the depreciation deduction, and reducing effective tax rates.

Distributed power equipment would be used in manufacturing plants would have to have

a rated capacity of at least 500 kilowatts.

Current tax law provides no tax credit for this type of industrial energy equipment,

generally treated as structural components for purposes of depreciation, which means a

much longer write-off period. Co-generation equipment was added in 1980 to the list of

property qualifying for the 10% business energy investment tax credits under the original

Energy Tax Act of 1978. These expired at the end of 1982, three years before the

expiration of the residential energy tax credits and the other business energy tax credits.

Tax Credit for Electricity Produced from Wind and Biomass. Finally, the

President’s FY2001 budget also proposes a liberalization of the current law tax credit for

electricity produced from wind systems and biomass. Under current law, an income tax

credit is provided, as part of tax code section 45, in the amount of 1.5¢/kWh (in real,

1992 dollars) for electricity generated from wind or from closed-loop biomass systems and

from poultry waste. The credit for 1997 was 1.6¢/kWh. The credit is available to facilities

that are placed in service after 1992 (for biomass) and 1993 (for wind) but before January

1, 2002. Any qualified facility that opens and begins generating electricity prior to January

1, 2002, can earn the tax credit for its first 10 years of operation. Closed loop biomass

systems use plants grown exclusively for electricity production. Poultry waste was added

as a qualifying fuel by the Tax Relief Extension Act of 1999 (P.L. 106-170), but only for

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facilities placed in service from January 1, 2000, through December 31, 2001. Under

current law, any plant used exclusively for electrical generation, except standing timber,

which is specifically disqualified, qualifies for the credit. Thus, the credit is not available

for the use of waste and most other types of biomass (except poultry waste) to generate

electricity.

Also under current law, the production tax credit is phased out, proportionately,

when and if the reference price — the average price of renewable electricity sold by

qualified wind and biomass facilities — rises from 8¢/kWh to 11¢/kWh. Both the credit

amount and the phase-out limit are adjusted annually for inflation. The credit is also

reduced during any taxable year for which the project has received grants, proceeds from

tax-exempt bonds, subsidized energy financing, and any other credit allowable for property

that is part of the project. For 1994, the reference prices were 5.4¢/kWh for facilities

producing electricity from wind, and 0.0¢/kWh for facilities producing electricity from

closed-loop biomass systems. For 1997, the reference prices were 6.4¢ and 0¢,

respectively; for 1999 (the latest year available) reference prices were 4.836¢ and 0¢.

Since both reference prices were less than the threshold prices for the credit phase-out,

(about 9¢/kWh) the renewable electricity credit was not phased-out and remained at 1.7¢/

kWh (1.5¢ times the inflation adjustment factor). In calender year 1996, there were no

sales of electricity produced from closed-loop biomass energy resources under contracts

signed after December 31, 1989.

The President’s proposal would make several important amendments to the

renewable electricity tax credit:

! The placed-in-service deadline for wind and closed-loop biomass would be

extended by 2½ years from January 1, 2002 (present law) to July 1, 2004 (the

credit would continue to be available for up to 10 years after that);

! The definition of eligible biomass sources would be substantially expanded to

include solid, nonhazardous, cellulosic waste material that is segregated from other

waste materials, and that is derived from one of several qualifying types of forestrelated resources. The credit for electricity produced from these would be reduced

to 1.0¢/kWh;

! Powerplants that can co-fire biomass and coal to generate electricity would qualify

for the tax credit but at a reduced rate of 0.5¢ per kWh hour adjusted for post-2000

inflation; and

! Output of electricity generated from facilities that use methane from landfills (biogas) would be eligible for a tax credit of either 1.5¢ or 1.0¢/kWh depending on

whether the facilities meet the Environmental Protection Agency’s New Source

Performance Standards.