How to Make Two Vital Tax Incentives Even Better

Renewable energy tax credits and tax-exempt municipal bonds would be even more effective if their benefits were also available as direct cash grants.

Renewable energy tax credits and tax-exempt municipal bonds would be even more effective if their benefits were also available as direct cash grants.

Two vital federal tax incentives need an overhaul from Congress to make them even more powerful in meeting environmental goals. Providing a cash grant option for renewable energy tax credits and tax-exempt municipal bonds would drive greater renewable energy deployment and more green infrastructure.

Tax credits for renewable energy investments1 include an investment tax credit (ITC). Mostly used for solar, the ITC is a tax credit based on the amount of money invested to construct the facility. As amended by last year’s stimulus bill, the Consolidated Appropriations Act, 2021 (the Act), the credit is 26% for solar facilities2 where construction commences before 2023 and 22% where construction commences in 2023 (if placed in service before 2026).3 The Act also extends the ITC for offshore wind projects—at 30%—for five years, applying to projects that begin construction before 2026.

There is also a production tax credit (PTC), often used for wind, measured by production of energy (rather than money invested). The PTC is available for a ten-year period, starting when the project is placed in service. The PTC was extended for one year, covering wind facilities that begin construction before 2022. The extension is at 1.5 cents per kilowatt-hour, 60% of the original rate.4

These tax credits, which reduce the tax that otherwise would be payable by the project developer, have been critical to catalyzing investment in renewable energy. 

But delivery of this vital incentive could be made even more effective. Currently, in order to take full advantage of these credits, the taxpayer must have sufficient taxable income to generate enough tax to use the tax credits.  Historically, renewable energy developers have not been in a position to use these tax credits themselves because of insufficient taxable income.  Thus, to monetize these tax credits, renewable energy developers have reached out to so-called “tax equity investors”.  These investors are generally banks or other large public companies with sufficiently large tax bills to use the tax credits. These tax equity investors provide capital for the renewable energy projects and receive most of their return in the form of tax credits (or accelerated depreciation, another tax benefit), rather than cash.

In practice, there has been a small group of tax equity investors with the tax capacity and sophistication to finance these transactions. And tax equity deals are complicated to execute and generate high legal and other transaction costs. As a result, renewable energy developers have not always been able to arrange tax equity financing, particularly for smaller transactions.

The small pool of tax equity investors could shrink even further because of the economic crisis caused by the COVID-19 pandemic. A downturn in the economy leads to lower corporate profits and therefore less tax liability. Less tax liability can mean less demand for tax credits.

The scarcity of tax equity investors results in a higher return having to be paid on the capital provided by the tax equity investor. Since the return is mostly paid in the form of tax credits, this means that the capital investment generated for renewable energy production becomes relatively expensive, in terms of tax credit “paid”. From the perspective of the federal government, this reduces the efficiency of delivering this important incentive for renewable energy investment.  The complexity and high transaction costs of tax equity deals just adds to the inefficiency.

Fortunately, there is a more effective way to deliver the incentive provided by these tax credits. By claiming a credit amount in the form of a direct payment from the federal government, renewable energy developers could avoid having to bring in tax equity investors. As part of the stimulus bill enacted in the wake of the 2008-09 financial crisis, the American Recovery and Reinvestment Act of 2009 (ARRA), renewable energy developers could elect, in lieu of claiming the PTC or the ITC, to receive a grant from the federal government (called a “Section 1603 grant”) equal, in most cases, to 30% of the amount invested.  This was viewed as critical, since the severe economic conditions thinned the ranks of corporations with sufficient tax payable to absorb these tax credits.

There was broad uptake of the Section 1603 program. Nearly 110,000 projects (mainly solar and wind) were funded with grants totaling $26.2 billion and estimated total private, regional, state, and federal investment of $94.3 billion.5 A National Renewable Energy Laboratory (NREL) study estimated that the Section 1603 program resulted in between 52,000 and 75,000 direct and indirect jobs during the construction period and between 5,100 and 5,300 direct and indirect jobs during the systems’ operational period.6 But the Section 1603 program, after a one-year extension, expired at the end of 2011.

The GREEN Act, a recently re-introduced House bill (H.R. 7330) that, in part, updates and extends renewable energy and energy efficiency provisions, laudably would permit taxpayers to elect a refundable ITC and PTC (essentially a cash grant). But the bill would apply a 15% credit “haircut” to taxpayers electing the cash alternative. The haircut would create two classes of taxpayers: those rich enough (in the sense of having sufficient taxable income) to claim the regular (non-refundable) credit—who would receive the full credit—and those not rich enough to monetize the credit without resort to tax equity—who would elect the refundable credit (or use tax equity with functionally the same result) and receive only 85% of the credit amount. Since the purpose of the refundable credit option is to eliminate the extra cost and other hurdles suffered by taxpayers unable to use the credits themselves, this purpose would be better served by eliminating the haircut and treating all taxpayers equally.

In sum, as part of the Biden administration’s stimulus efforts, the administration should revive the program of providing direct federal cash payments7 in lieu of the ITC and PTC that renewable energy developers could otherwise claim.8 As was the case in the wake of the 2008-09 financial crisis, the availability of tax equity financing may be curtailed because of the COVID-19 induced economic crisis. In addition, direct cash payments in lieu of tax credits would be a more efficient way of delivering this important incentive for renewable energy development.9

(See Part II of the tax incentive blog here for how Congress should improve municipal bonds.)

1. Tax incentives for renewable energy are newcomers to the Internal Revenue Code when compared to the tax incentives for oil and gas development, notably percentage depletion and the deduction for intangible drilling costs. Percentage depletion has been part of the tax law since 1926 (its predecessor dates back to 1918) and continues, with narrower applicability and at a lesser level, to this day. The deduction for intangible drilling costs, which continues today, was in Treasury regulations as far back as 1916 and was recognized by the courts, although not codified in the Internal Revenue Code until 1954.

2. Solar photovoltaic (PV) and water heating.

3. The credit then drops to 10%. Although the Act extended the credit, it did not reinstate the 30% credit that was previously available. There is also ITC available for fiber-optic solar, fuel cells, and small wind projects (phase-down similar to that for the solar PV and water heating, except that the credit drops to zero, not 10%, if not placed in service before 2026), a 10% ITC for microturbines and combined heat and power (CHP) extended to the end of 2023, and a 10% ITC for geothermal that does not expire. There is also a new ITC for waste recovery projects that is phased out in the same way as for fiber-optic solar, fuel cells, and small wind.

4. The PTC has also been extended, at varying rates, for closed and open loop biomass, geothermal, landfill gas, municipal solid waste-to-energy, certain hydro, and marine and hydrokinetic facilities. The election to take the ITC in lieu of the PTC has also been extended, but, for wind facilities, the elected PTC would be 18%, a 40% reduction from the 30% historic rate.

5. See US Treasury report, Final Overview of the Section 1603 Program, March 1, 2018, available at P Status overview 2018-03-01.pdf (

6. The NREL report covers grants made through November 11, 2011. See NREL, Preliminary Analysis of the Jobs and Economic Impacts of Renewable Energy Projects Supported by the Section 1603 Treasury Grant Program, available at

7. Alternatively, the payments could be structured as refundable tax credits. As such, the developer would claim the credit on the developer’s tax return and, if the developer did not owe enough tax to use the credit, for example because of COVID-19-related losses, the developer would receive a tax refund in the amount of the unused credit.

8. For additional analysis in support of providing renewable energy tax credit benefits through direct federal incentive payments, see B. Bhattacharyya, Center for American Progress, “Renewable Energy Tax Credits: The Case for Refundability” (2/28/20) available at….

9. The renewable energy tax credits should also be extended and their sunsetting rationalized, so that renewable energy developers and investors can plan their transactions without constantly having to race against credit reduction or expiration deadlines, but that is a subject for another day.

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