The way Congress funds clean energy is a mess. Max Baucus thinks there’s a better idea.

December 19, 2013

The big Max Baucus news this week is that the Montana senator will — for whatever reason — get tapped to be the next U.S. ambassador to China.

How to fund. (AES)
How to fund clean energy? (AES)

The more intriguing Max Baucus news, though, might have been the energy tax reforms he unveiled on Wednesday. (You read that sentence correctly.) Baucus, who chairs the Senate Finance Committee, put out a plan (pdf) to dump all 42 existing tax incentives for specific energy sources. Instead, he would create two broad tax credits that would boost clean energy without picking specific technologies or explicitly taking sides between, say, nuclear energy and wind power.

Baucus's proposals aren't likely to become law anytime soon. But they could shape the debate over how Congress funds clean energy in the years ahead. So let's take a look:

How Congress currently funds clean energy

At the moment, Congress offers 42 different tax breaks to aid certain energy technologies. There's a production tax credit for electricity from wind turbines. An investment tax credit for solar farms. Credits for drivers who buy electric plug-in vehicles. Credits for energy-efficient appliances. Credits for enhanced oil recovery. You get the idea.

Who gets a tax credit? (Reuters)
Who gets a tax credit? (Reuters)

Here's one downside to this approach: If a company has an idea for reducing pollution that's not on Congress's list of favored technologies, it's at a disadvantage. Consider the notion of producing electricity by capturing excess waste heat from a factory or power plant. This technique has plenty of potential for cutting greenhouse-gas emissions. But there's no tax credit for it. Yes, Congress could add a credit, but there will always be new and unforeseen technologies like this. The market can innovate faster than lawmakers can keep up.

Another problem: 25 of these tax credits regularly expire, every year or so, and lawmakers often dither over whether to renew them. The production credit for wind power is set to lapse in January. Will it get renewed? Possibly, but no one knows for sure. That creates uncertainty for energy industries — leading to what analysts call "boom-and-bust" cycles.

There are plenty of ways to change this. Lawmakers could just abolish all tax carve-outs for energy, which would arguably most benefit the dominant existing power sources like coal, natural, gas and oil. Or, if Congress were concerned about climate change and greenhouse-gas emissions, it could enact a flat carbon tax to create incentives for lower emissions. But Baucus is taking a slightly different route...

Baucus's idea for energy tax reform

Baucus's proposal would be to get rid of those 42 energy tax incentives and, in their place, create two broad credits:

1) First, any facility producing electricity that is at least 25 percent cleaner than the average for all electricity production facilities would receive a tax credit. The cleaner the facility, the larger the tax credit. (By "clean," Baucus is referring to greenhouse-gas emissions per unit of electricity produced.)

This credit starts at 2.3 cents per kilowatt of generation and rises to a maximum of 20 percent of the total cost of the investment. Companies couldn't get the credit until they started producing power, and then they'd get the break for 10 years.

All of these credits, meanwhile, would phase out in four years once the greenhouse-gas intensity of the entire U.S. electricity sector is 25 percent below current levels. So there's an overall limit.

2) Likewise, any transportation fuel that is at least 25 percent cleaner than conventional gasoline will generally receive a credit. Again, the cleaner and more energy-efficient the fuel, the larger the credit — and the bill would take the entire life-cycle into account when judging the fuel. So if, say, corn-based ethanol wasn't cleaner than gasoline, no tax credit.

(Note that the credit for transportation fuels would likely need to be paired with a repeal of the Renewable Fuel Standard that requires refineries to blend a certain amount of ethanol into gasoline. It wouldn't make sense otherwise. But Baucus's committee doesn't have jurisdiction over that fuel standard, so this part isn't in the proposal.)

The upside to this reform, Baucus notes, is that any technology could qualify for these credits so long as it meets the goal of curbing greenhouse-gas emissions. An ultra-efficient natural gas plant could qualify. So could a wind farm. Or a nuclear reactor. Or a coal plant that can capture its emissions and bury it underground.

"One advantage of this reform is that it wouldn't favor the 'golden boy' technologies like wind and solar," says Paul Bledsoe, a fellow with the German Marshall Fund and a former staff member on the Senate Finance Committe. "That old approach has created a lot of resentment in the business community."

So, what's the catch? Well, this wouldn't be easy to implement. Baucus would wipe away 42 existing tax credits, some of which have strong backers. That list includes:

-- Section 25C credit for residential energy efficiency
-- Section 30B credits for fuel cell motor vehicles
-- Section 30D credits for electric plug-in vehicles
-- Section 43 credit for enhanced oil recovery costs
-- Section 45I marginal well production credit
-- Section 45N mine rescue training credit
-- Section 45Q carbon dioxide sequestration credit
-- Section 45L credit for construction of energy-efficient new homes
-- Section 45M credit for energy efficient appliances
-- Section 48C credit for investment in advanced energy property
-- Treatment of gain resulting from Federal Energy Regulatory Commission restructuring

The oil and gas sector isn't happy about the prospect of losing incentives for exploration and drilling. “Our concern," they wrote in a letter, "is that the proposals in your discussion draft, such as extending the period during which businesses can recover their operating or labor costs — as in the case of drilling expenses — will take cash away from capital-intensive businesses like ours and significantly reduce future domestic investment."

Other potential complaints: Industries that focus on making buildings more efficient would lose out, since there's nothing in Baucus's proposal to promote efficiency. Similarly, automakers would no longer get tax breaks for building cleaner vehicles. (Baucus's staff made these choices "in order to target tax incentives on areas that appear to have the largest bang-for-the-buck in reducing air pollution and enhancing energy security.")

In his discussion draft, Baucus argued that if Congress extends all of the current energy-related tax packages, it will spend $150 billion over 10 years. By contrast, his plan would cut those costs roughly in half.

These energy proposals were released as part of a larger overhaul of the corporate tax code that Baucus and the Senate Finance Committee have been working on. (The savings would be used to lower corporate tax rates.) Now that Baucus is likely going to be heading off to China, it's not clear where that overhaul will stand. It's worth noting, though, that Sen. Ron Wyden (D-Ore.), who could succeed Baucus as chairman of the committee, has called the tax proposal a "promising start," albeit with reservations about the repeal of efficiency measures.

Why this and not a carbon tax?

Whenever the subject of energy and taxes come up, economists usually suggest a simple fee on oil, gas, and coal as the best option. A carbon price, they say, is the best way to reduce emissions and tackle global warming. People and businesses would look for more efficient ways to use fossil fuels — or seek out cleaner alternatives.

The main advantages of a carbon tax is that it would affect all sectors equally. Businesses would have more incentive to reduce their energy use or seek out cleaner sources of electricity or make their operations more energy-efficient. Baucus's proposal, by contrast, only provides incentives for power providers to generate cleaner electricity or produce cleaner fuels. (There's no incentive for people to use energy more efficiently.)

The main downsides of a carbon tax are, well, it's a tax. It raises the price of electricity and other goods. Baucus's proposal, by contrast, is more convoluted — it's essentially a tax cut for some companies and not others. It might not be as effective, but these sorts of credits are typically less likely to provoke a political backlash.

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Brian Fung | December 19, 2013