Global Climate Change: The Energy Tax Incentives in the President's FY2000 Budget

Salvatore Lazzari
Specialist in Public Finance
Economics Division

Updated February 4, 1999

98-193 E

Residential and Commercial Buildings

Three tax credits are proposed in the FY2OOO budget to reduce the use of conventional energy -electricity from fossil fuels, natural gas, heating oil, etc. - in residential and commercial buildings: (1) a tax credit for solar energy equipment; (2) a tax credit for the purchase of energy-efficient, new homes; and (3) a tax credit for purchases of energy efficiency building 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. The credit for photovoltaic systems would last for seven years, beginning on January 1, 2000; the credit for water heating systems would last for 5 years, also beginning in 2000. 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 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 FY2OOO 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 New Energy Efficient Homes. Some federal laws and certain states require energy-using home appliances, heating and cooling equipment, and insulation meet certain energy efficiency standards. But there are otherwise no special tax incentives to encourage the supply of energy efficient homes. The President's FY2OOO 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 be $1,000 for new homes that are at least 30% more efficient than the WCC (International Energy Conservation Code) standard and purchased between January 1, 2000, and December 31, 2002. The tax credit would be $1,500 for new homes that are at least 40% more efficient than the IECC standard and purchased between January 1, 2000, and December 31, 2002. The tax credit would be $2,000 for new homes that are at least 50% more energy efficient than the IECC standard and purchased between in the 5-year period between January 1, 2000, and December 31, 2004.

Tax Credit for Energy-Efficient Building Equipment. The last of the three tax credits to reduce fossil fuel use in residential and commercial buildings dings is a tax credit for the cost of specified types of advanced energy-efficient equipment and technologies for space heating and cooling and hot water heaters. This is actually a bi level tax credit of either 10% or 20% dependent upon the efficiency rating of the eligible equipment. A 10% tax credit of the price would be provided (subject to am maximum credit of $250) for the purchase, on or after January 1, 2000, and before January 1, 2002, for the following three types of energy-efficient equipment:

· Electric heat pumps with a heating efficiency of at least 9 HSPF Heating Seasonal Performance Factor) and a cooling efficiency of at least 13.5 SEER (Seasonal Energy Efficiency Rating);

· Central air conditioners with an efficiency rating of at least 13.5 SEER;

· Advanced natural gas water heaters with an energy factor of at least 0.65 in the standard test procedures used by the Department of Energy (DOE).

The credit would be 20% of the purchase price (with the maximum credit varying by type of qualifying equipment, as noted below) for purchases on or after January 1, 2000, and before January 1, 2004, for the following types of energy efficient equipment:

· More efficient air conditioners. Those with an efficiency rating of at least 15 SEER would qualify for a maximum tax credit of $500 per unit;

· High energy-efficiency advanced natural gas water heaters. Those with a DOE energy factor of at least 0.80 would qualify for a tax credit of $500 per unit;

· 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;

· Energy efficient electric heat pumps. The maximum tax credit would be $500 for units with a heating efficiency of at least 9 HSPF and a cooling efficiency of at least 15 SEER;

· 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;

· Fuel cells: A tax credit of $500 per kilowatt hour for fuel cells with a minimum generating capacity of 5 kilowatts and a generation efficiency of at least 35%.

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 also expired at the end of 1985. 2

Industrial Energy Use

Under the President's proposal certain types of industrial energy equipment would qualify for a 10% investment tax credit.

Investment Tax Credit for Combined Heat and Power Systems. An 8% investment tax credit would be provided for businesses that invest in combined heat and power systems that meet certain standards of energy efficiency, generation capacity (in terms of kilowatts), and mechanical capacity (in terms of horsepower). Businesses that would claim this investment tax credit would not be able to use accelerated depreciation provisions. The credit would be available on investments made after December 31, 1999 and before January 1, 2003.

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 to either heat or cool its building or provide mechanical power used in some manufacturing process. Fuel inputs are e 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. 3

Transportation Energy Use

Two tax incentives are proposed in the FY2OOO budget intended to conserve e petroleum in the transportation sector and to induce substitution to alternative e transportation fuels: (1) a tax credit for fuel-efficient hybrid vehicles; and (2) repeal of the phase out of the current tax credit for electric vehicles.

Tax Credit for Fuel Efficient Hybrid 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 more economical fuel efficient than comparable vehicles in their class. The credit would range from $1,000 to $4,000 per vehicle depending on the hybrid's fuel efficiency rating as compared with a vehicle in its class. For vehicles rated at least three times as efficient, and purchases made between December 31, 2003, and January 1, 2007, the credit would be $4,0 00. For vehicles rated at least twice as efficiently as comparable vehicles the credit would be $3,000 if purchased between January 1, 2003, and January 1, 2007. For vehicles rated at least two-thirds more fuel efficient, the credit would be $2,000 if the vehicle was purchased between December 31, 2002, and January 1, 2007. Finally, a tax credit of $1,000 would be available for vehicles rated at least one-third more fuel efficient than comparable vehicles, and if purchased between December 31, 2002, and January 1, 2005.

A qualifying hybrid vehicle would be a vehicle powered by onboard fuel and which uses regenerative braking and an energy storage system that will recover at least 60% of the energy in a typical 70-0 braking event. Such a qualifying vehicle would have to satisfy all emission requirements applicable to gasoline-powered automobiles.

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 1 8.4 cents and 24.4 cents 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 51,000 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. 4 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 g 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 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.

Tax Credit Electric Vehicles. Under current law, consumers that purchase an electric vehicle can claim a 10% nonrefundable tax credit for the cost of the vehicle place d 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 1st year, $4,100 the 2nd year, $2,450 the 3rd year, and $1,475 in any subsequent year in the recovery period. Each of these amounts is adjusted annually for inflation that has occurred since 1987 50 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. 5

The President's FY2000 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 d be available through 2006.

Tax Credit for Electricity Produced from Wind and Biomass

The last of the energy tax incentives in the President's FY2000 budget would liberalize and expand the current law tax credit for electricity produced from wind systems or closed-loop biomass systems. Under current law, an income tax credit is provided, as part of a tax code section, in the amount of 1.5 cents per kWh. (in real, 1992 dollars) for electricity generated from wind or from closed-loop biomass Systems. The credit for 1997 was 1.6 cents per kWh. The credit is available to facilities that are place in 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. Closed loop biomass Systems use plants grown exclusively for electricity production. 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 to generate electricity.

Also under current law, the 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 cents per kWh to 11 cents per 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 cents per kWh for facilities producing electricity from wind, and 0.0 cents per kWh for facilities producing electricity from closed-loop biomass systems For 1997, the reference prices were 6.4 cents and 0.0 cents, 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 cents per kWh. In calendar year 1996, there were no sales of electricity produced from closed-loop biomass energy resources under contracts signed after December31, 1989.

The President's proposal would make three basic amendments to the tax credit produced from wind and biomass: 1) the placed-in-service deadline would be extended by 5 years to July 1, 2004, and the credit would continue to be available for up to 10 yeas after that; 2) the definition of eligible biomass sources would be 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 forest-related resources; and 3) electric plants that use biomass and coal to generate electricity would qualify for the tax credit but at a reduced rate of 1 .0 cents per kWh hour adjusted for post -1999 inflation.

References

1 The FY1999 budget proposal included two tax incentives to reduce industrial energy use - a tax credit for new types of circuit breakers, and a tax credit for recycling equipment - which are not part of the FY2000 budget proposal. The FY 1999 budget proposal also included a greater tax break for mass transit, and a different type of tax break for fuel efficient vehicles than that which is in the FY2000 budget.

2 U.S. Library of Congress. Congressional Research Service. An Explanation of the Business Energy Investment Tax Credits. CR5 Report 85-25 E by Salvatore Lazzari. January 24, 1985. Washington.

3 Op Cit. explanation of the Business Energy Investment Tax Credits.

4 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.

5 The Internal Revenue Service Restructuring and Reform Act of 1998 further liberalized this provision.