Global Climate Change: The Energy Tax Incentives in the President's FY1999 Budget

98-193 E

March 4, 1998

CRS Report for Congress

Received through the CRS Web

Global Climate Change: The Energy Tax

Incentives In the President’s FY1999 Budget

Salvatore Lazzari

Specialist in Public Finance

Economics Division

Summary

The President’s FY1999 budget includes several energy tax incentives designed to

help the United States reduce greenhouse gases that are linked to possible global

warming. These incentives subsidize energy conservation, energy efficiency, and

substitution toward alternative fuels such as solar power and electricity produced from

biomass and wind. The conservation and efficiency tax incentives are in the form of

nonrefundable tax credits for energy-saving capital goods, and they target each of the

energy end-use sectors: transportation, industry, residential and commercial. In addition,

some of the tax credits are intended to directly reduce the amount of harmful greenhouse

gases that would otherwise be released into the atmosphere. Most of the incentives are

new, some resembling versions of energy tax incentives that were enacted under

President Carter’s Energy Tax Act of 1978 (as amended), but have since expired. Two

of the provisions constitute a liberalization of existing energy tax subsidies.

Residential and Commercial Buildings

Three tax credits are proposed in the FY1999 budget to reduce the use of

conventional energy — electricity from fossil fuels, natural gas, heating oil, etc. — in

residential and commercial buildings: (1) tax credits for equipment that uses solar energy;

(2) a tax credit for the purchase of energy-efficient, new homes; and (3) a tax credit for

purchases of energy efficiency equipment, and materials.

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

credit for two types of solar energy using 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.

Congressional Research Service ˜ The Library of Congress

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The credit for photovoltaic systems would last for 7 years, beginning in 1999; the

credit for water heating systems would last for 5 years, also beginning in 1999.

Photovoltaics are solar cells made of semiconductor material capable of converting

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

into a panel, which can be interconnected and used as part of a sunlight-absorbing roof or

as separate self-contained electricity generating system on the ground.

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 FY1999 proposal,

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

current 10% tax credit and the proposed 15% tax credit.

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. But there are otherwise no special tax incentives

to encourage the supply of energy efficient homes. The President’s FY1999 budget

proposes a tax credit for the cost of a new home that would meet certain specified and

stringent energy efficiency standards. The tax credit would equal to 1% of the home’s

purchase price up to a maximum credit of $2,000 for homes purchased between 1999 and

2003,and $1,000 for homes purchased during either 2004 or 2005. Qualifying new homes

would have to be at least 50% more energy efficient than the standard for single family

homes specified in the Model Energy Code.

Tax Credit for Energy-Efficient Building Equipment. The last of the three tax

credits to reduce the use of conventional energy in residential and commercial buildings

is a 20% tax credit for the cost of six types of advanced energy-efficient equipment and

technologies for space heating and cooling and hot water heaters, as follows:

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More efficient air conditioners

High energy-efficiency advanced natural gas water heaters

More energy efficient natural gas heat pumps

Energy efficient electric heat pumps

Energy efficient electric heat pump water heaters

Fuel cells.

Each of these six types of qualifying equipment would have to satisfy stringent energy

efficiency standards, as compared with current types of equivalent non-energy efficient

equipment. Only costs up to a maximum ceiling — as yet unspecified — would qualify

for the tax credit. The credit would be available for the costs of qualifying equipment

purchased during the 5-year period from January 1, 1999, to December 3, 2004.

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

to make business stuctures more energy efficient. The 1978 Energy Tax Act provided for

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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. As with the 1978 solar energy tax credits, these energy equipment tax credits

also expired at the end of 1985.1

Industrial Energy Use

Under the President’s proposal, three types of industrial energy equipment would

qualify for a 10% investment tax credit: (1) combined heat and power systems ; (2) certain

circuitbreaker equipment; and (3) certain recycling equipment.

Tax Credit for Combined Heat and Power Systems. A 10% investment tax credit

would be provided for businesses that invest in combined heat and power systems that

meet certain energy efficiency standards. Combined heat and power systems capture the

thermal energy (for either heating or cooling) or the mechanical power — whatever the

case may be — that would otherwise be wasted when industrial manufacturing processes

generate electricity. Thus, they are essentially a type of cogeneration equipment: with one

source of energy, a company can simultaneously power its turbines to generate electricity

and either heat and cool its building or provide mechanical power needed in some

manufacturing process. Fuel inputs are conserved by making an energy-using process —

the generation of electrical power — more efficient: the otherwise wasted energy would

be harnessed and would be used in the same process.

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

Cogeneration 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, 3 years before the expiration of the residential energy tax

credits and the other business energy tax credits.

Tax Credit for New Types of Circuitbreakers. Some large circuit breakers used

by public power companies (electric utilities) in the transmission and distribution of

electricity use a gas (sulfur hexafloride) that leaks into the atmosphere when the breakers

age. Under the President’s proposal, a 10% tax credit would be available for the

replacement of these leaky, older (pre-1985) circuit breakers with new power

circuitbreaker equipment. The Administration believes that sulfur hexafloride is an

extremely harmful greenhouse gas. No similar tax credit or other tax incentive has ever

been provided.

Tax Credit for Certain Recycling Equipment. A 10% investment tax credit would

be provided to producers of semiconductors for investments in equipment used to recycle

two harmful greenhouse gases used in the production of semiconductors: perfluorocarbon

(PFC) and hydrofluorocarbon (HFC). The tax credit would apply to new equipment

placed in service in the 5-year period beginning January 1, 1999, and ending December 31,

2003. Under current law no special tax credit is provided for this type of recycling

1

U.S. Library of Congress. Congressional Research Service. An Explanation of the Business

Energy Investment Tax Credits. CRS Report 85-25 E by Salvatore Lazzari. January 24, 1985.

Washington.

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equipment, although such equipment may be depreciated over 5 years. The 1978 business

energy tax credit provided for a 10% tax credit for businesses that recycled solid wastes.

This tax credit expired at the end of 1982.

Transportation Energy Use

Two tax incentives are proposed to conserve petroleum in the transportation sector:

(1) a tax credit for fuel efficient vehicles; and (2) a higher income tax exemption for mass

transit fringe benefits.

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

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

that are at least twice as economical as current vehicles in their class. For vehicles rated

at least twice the base fuel economy, the credit would be as follows: $3,000 if purchased

between January 1, 2000, and January 1, 2004; $2,000 if purchased during 2004; and

$1,000 if purchased in either 2005 or 2006. If the vehicle is rated at least 3-times the base

fuel economy, the tax credit would be as follows: $4,000 if purchased between January 1,

2002, and January 1, 2007; $3,000 if purchased during 2007; $2,000 if purchased during

2008; and $1,000 if purchased during either 2009 or 2010.

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 CAFE 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 “guzzlers” of conventional fuels,

federal tax law provides a deduction for clean-fuel vehicles and a tax credit for electric

vehicles. Since 1992, a federal tax deduction has been available for individuals or

businesses that purchase vehicles that run on alternative fuels.2 Taxpayers can deduct

from adjusted gross income a portion of the costs associated with the purchase of

dedicated alternative fuel vehicles (AFVs), or the costs of converting vehicles so that they

can operate on clean-burning alternative fuels (dual fuel AFVs) in addition to gasoline.

Dedicated AFV’s 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 over 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,

2

For a more detailed discussion of these provisions see: U.S. Library of Congress.

Congressional Research Service. Energy Tax Provisions of the Energy Policy Act of 1992. CRS

Report 94-525E, by Salvatore Lazzari. Washington, 1994.

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hydrogen, electricity, and any other fuel that includes 85% alcohol fuels, ether, or any

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

the new vehicle, or the conversions 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 clean-fuel-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 equipment. The deduction is phased-out evenly over a 3-year period beginning

in January 2002.

In lieu of a tax deduction, 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 maximum credit is $4,000.3 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

1st year, $4,100 the 2nd year, $2,450 the 3rd year, and $1,475 each subsequent year in the

recovery period. Each of these amounts are adjusted annually 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. These annual limits are also adjusted for

inflation after 1997. The higher depreciation limits for electric vehicles was a provision

of the Taxpayer Relief Act of 1997.

Higher Tax Exemption for Mass Transit Fringe Benefits. The President’s budget

proposal includes a provision to increase the income tax exemption for employer payment

or reimbursement for the costs of mass transit (bus fares, subway or train fares) or van

pools costs to the level of tax exemption for employer provided parking benefits.

Currently, federal income tax law stipulates that mass transit or van pool payments above

$65 per month must be reported as income — i.e., up to $65 per month is exempt from

taxation. Current tax law also taxes employer provided parking or reimbursements for

parking expenses above $175 per month — i.e., the exemption for such expenses is $175

per month. The President’s proposal would raise the exemption for mass transit and van

pool passes to $175 per month, thus equalizing the two transportation fringe benefits..

Tax Credit for Electricity Produced from Wind and Biomass

The President’s FY1999 budget would extend by 5 years the current tax credit for

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

provided, as part of a tax code section, in the amount of 1.5¢ /kWh. (in real, 1992 dollars)

for electricity generated from wind or from closed-loop biomass systems. The credit for

1997 was 1.6¢ /kWh. Closed loop biomass systems use plants grown exclusively for

electricity production. Thus, the credit is not available for the use of waste and most other

biomass to generate electricity. Any plant used exclusively for electrical generation,

except standing timber, which is specifically disqualified, qualifies for the credit. The

3

The Taxpayer Relief Act of 1997 amended the excise tax treatment of luxury vehicles to

make it more difficult for clean-fuel and electric vehicles to be designated as luxuries subject to that

tax.

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credit is available to facilities that begin service after 1992 (for biomass) and 1993 (for

wind) but before July 1, 1999. Any qualified facility that opens during that period can then

earn the tax credit for its first 10 years of operation. The President’s proposal would

extend this to July 1, 2004.

This tax credit is phased out, proportionately, as 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 is adjusted annually

for inflation. The credit is also to be 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 0.0¢, respectively. Since both

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

electricity credit was not phased-out and remained at 1.5¢ / kWh. In calender year 1996,

there were no sales of electricity produced from closed-loop biomass energy resources

under contracts signed after December 31, 1989.