Tax Reform: What Could It Mean for State and Local Energy Officials?

by Elizabeth Bellis

For the past couple of months, lawmakers in Washington, D.C. have been talking about rewriting the tax code. When talking about energy budgets, we often only think about money appropriated. But the tax incentives lead to lost revenue or “tax expenditures” on energy policy. In 2010 they amounted to over $18 billion. By comparison, 2010 State Energy Program (SEP) funding amounted to approximately $25 billion. Tax spending on energy policy rivals direct spending both in amount and in incentivizing force across the country. A tax code rewrite could have far reaching implications for energy policy.

The Internal Revenue Code is usually updated every 30-odd years. The last time it was fully overhauled was 1986 and prior to that redraft, in 1954. So it’s about time but it is also a long and all-consuming project for Congress. Should Congress decide to move forward, many longstanding energy tax provisions could be rethought or even eliminated. In their place, a new set of tax incentives and vehicles would affect the industry. While it is too early to know what would make it through the long process of rewriting the tax code, we can glean some insight from looking through Committee reports and testimony regarding tax reform options for infrastructure, energy and natural resources.

Several options are under deliberation, including eliminating specific subsidies and credits and replacing them with a comprehensive carbon tax to adding new specific subsidies and credits, extending others, and reducing or eliminating others. Here is a look at a few of the proposals on the table.

A Carbon Tax

The approach in its simplest form would involve eliminating all present energy subsidies and replacing them with a direct tax on carbon. Advocates for this approach note its technology and source neutrality and its potential simplicity compared to the current approach, among other benefits. Revenues could be used to reduce taxes on income or cut deficits, which appeals to some. Others express concern about the potential regressivity or “flat tax” aspect of a consumption tax compared to the current incentives, or question how an effective, feasible tax on carbon could be designed. Still others fear that a carbon tax would hinder the economy.

The Wholesale Rewrite

A number of proposals call for a complete revision of current energy provisions. Some would attempt to make them more technology or source-neutral. Others would modify and consolidate current provisions and eliminate others.

Provisions being targeted include: intangible drilling cost treatment for oil and gas industries; accelerated depreciation for alternative energy assets; the investment tax credit for solar and geothermal electricity, to expire at the end of 2016); the production and investment tax credit for wind and other resources, to expire at the end of 2013); tax credits for biodiesel and advanced ethanol, to expire at the end of 2013), as well as liquefied hydrogen and hydrogen refueling property, to expire at the end of 2014); tax credits for vehicles utilizing fuel cell technology, to expire at the end of 2014) and plug-in electric-drive motor vehicles, to be phased out after sale of 200,000 vehicles by manufacturer).

Proposals for replacement, modification or extension of the above provisions include:

  • Energy Efficiency: A performance-based tax credit for residential energy efficiency improvements. Alternatively, others have suggested making permanent the individual tax credit for energy efficient home retrofits.
  • Biofuels: A credit for biofuels based on reduction in carbon compared to traditional gasoline or diesel fuels.
  • Alternative Vehicles: A vehicle tax credit based on efficiency rather than specific technology.
  • Energy Production: Extending preferential master limited partnership tax treatment from oil/gas to renewable energy sector. A production tax credit for electricity based on the energy content and pollution or carbon content. Repealing the wind production tax credit and solar investment tax credit and replace them with expensing or accelerated depreciation.
  • Make It In America Credit for “Biobased Products”: A program that attempts to allocate tax credits on a more technology-neutral basis, modeled on the current Internal Revenue Code Section 48C program which provides a 30% investment tax credit for advanced manufacturing facilities.
  • Carbon Sequestration: Making the carbon dioxide sequestration credit allocation rules more certain for taxpayers

Others have discussed extending and expanding section 179D (energy efficiency improvements to certain commercial buildings) and/or modifying section 54D (qualified energy conservation bonds) to make the current provision more utilizable.

Any of these changes could alter the current balance of incentives and change the direction of energy development across the country.

In addition, a number of proposals would rewrite transportation and infrastructure provisions, with similarly sweeping potential effects. For example:

  • State Control Over Gas Tax Revenues: Devolve revenues from existing federal taxes and fees that are deposited in the federal Highway Trust Fund to the states according to their share of revenue collected, without restrictions on how states may use the funds.
  • Encourage Foreign Investment in Infrastructure: Reduce taxes on foreign investment in U.S. infrastructure contained in the Foreign Investment in Real Property Tax Act (FIRPTA) and/or exempt foreign pension funds from the FIRPTA tax on gains on the sale of U.S. real estate and infrastructure (FY14 Administration Budget Proposal).
  • Private Activity Bonds: Authorize additional private activity bonds for infrastructure projects.
    For example, eliminate the state volume cap on private activity bonds for water projects or increase the current $15 billion limitation on transportation projects to $19 billion (FY14 Administration Budget Proposal).
  • Direct Subsidy Bonds: Provide direct subsidy bonds to, for example, provide a 28% interest rate subsidy to the issuer for infrastructure projects (FY14 Administration Budget Proposal). Bonds could be limited to public issuers or could be available for public-private partnership issuances.
  • Tax Credit Bonds: Provide tax credit bonds to provide a 28% tax credit to the bondholder of infrastructure bonds. Issuances could be limited to state infrastructure bank transportation projects.

Many of these infrastructure provisions focus on the need for federal incentives for greater investment in U.S. energy, transportation and water infrastructure, while retaining or increasing state and/or local control over such projects.

State and Local Preparation and Reaction

The potential changes described above would have varied and in some cases very significant impacts in different state and local jurisdictions across the country. Billions of dollars could be rerouted or redeployed, an outcome in some ways analogous to a complete revision or replacement of the State Energy Program (SEP). The private sector will scramble to ascertain the bottom line and to act accordingly. Officials who understand these changes and the impacts they may have will be in a better position to serve and react, and to craft policies that complement the new landscape.

Elizabeth Bellis is Counsel to the Energy Programs Consortium, a nonprofit organization based in Washington, D.C. She serves as Director of EPC’s Qualified Energy Conservation Bond Program. Prior to her work with EPC, Elizabeth was a tax attorney with Debevoise & Plimpton LLP in New York.