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Wednesday, January 19, 2011

Tax-Favored Financing for Renewable Energy Resources and Energy Efficiency

Molly F. Sherlock
Analyst in Economics

Steven Maguire
Specialist in Public Finance

Tax policy is one tool available to promote the use of domestic renewable energy resources. Taxsubsidized financing, specifically tax-favored bonds, reduce the cost associated with making oftentimes capital intensive investments in renewables and energy efficiency. This report provides an overview of the various federally tax-favored financing options available for renewable energy and energy-efficiency investments. This report also highlights the economic foundations for subsidizing renewable energy investment and comments on economic issues specific to taxfavored financing.

Various forms of federally tax-favored bonds have been used to subsidize investments in renewables and efficiency. Some of these bonds, such as the Clean Renewable Energy Bonds (CREBs) and Qualified Energy Conservation Bonds (QECBs), are tax-credit bonds available only for investments in renewables or efficiency. CREBs alone have been used to finance 1,727 renewable energy projects, through $3.4 billion in CREB allocations. Other types of tax-favored bonds, such as tax-exempt governmental bonds or private activity bonds and Build America Bonds (BABs), are more widely available but have been used for energy-related projects. More than $10 billion worth of BABs have been issued to finance electric and public power projects (although it is not clear what share of this issue is dedicated to renewables).

The magnitude of the subsidy afforded by the different types of federally tax-favored financing differs from both the perspective of the bond issuer and the investor. An example, where a hypothetical CREB, BAB, and tax-exempt bond is used to finance the same project, illustrates how policymakers can adjust bond terms to manipulate the subsidy provided to issuers and investors.

Tax incentives promote investment in renewables and energy efficiency by reducing the cost of such investments relative to fossil energy alternatives. Investments in renewable energy generation capacity, especially wind, have led to an increasing share of renewables in the nation’s overall energy portfolio. Subsidizing investments in renewables using tax policy, however, may not be the most economically efficient mechanism for increasing the use of renewable energy and promoting energy efficiency. Subsidizing renewables through tax incentives leads to federal revenue losses, requiring that federal revenues be raised by some other, potentially distortionary, form of taxation.

Tax-exempt bonds may not be the best tool for subsidizing investment in renewables when evaluated in terms of economic efficiency and equity. With tax-exempt bonds, federal revenue losses may exceed the subsidy provided to issuers, and thus be an inefficient subsidy. Tax-exempt bonds also provide a larger subsidy to taxpayers in higher tax brackets, raising equity concerns. Tax-credit bonds, as an alternative, represent a tax-subsidization option that is not subject to the inefficiencies and inequities associated with tax-exempt debt.

While tax-subsidized financing has been a popular tool in recent years for promoting investment in renewables and efficiency, a number of these bonds are not currently available as options for project investors. Specifically, all available CREB financing has been allocated, and projects were unable to issue BABs after December 31, 2010. Whether these programs have successfully promoted renewable energy investment, and should be extended, may be an issue the 112
th Congress will want to consider.

Date of Report: January 10, 2011
Number of Pages: 29
Order Number: R41573
Price: $29.95

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