Tax Extenders Would Make Energy Companies Dependent, Not Dominant

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Tax Extenders Would Make Energy Companies Dependent, Not Dominant

January 22, 2018 13 min read Download Report

Authors: Katie Tubb and Nicolas Loris


Competitive, free markets in the energy industry that promote choice and enhance energy security will best achieve President Trump’s goal of American energy dominance. However, Congress is defaulting to its tried-and-failed approach of picking winners and losers through special tax breaks. America has a diverse energy sector and the market incentive to supply affordable electricity and competitive transportation fuels, which is sufficient to spur private investment without any preferential treatment from the federal government. Such treatment has costly consequences on energy markets and consumer choice. The only way to truly level the playing field is to eliminate all subsidies for every energy resource. Congress should neither resurrect expired energy tax credits nor extend existing credits.

Key Takeaways

Energy Subsidies in the Tax Extender Act increase the burden on taxpayers by an estimated $8.8 billion.

Subsidies harm the very industries they are intended to help and distort energy markets and innovation.

The only way to truly “level the playing field” is to eliminate subsidies for all energy resources and technologies.

With the passing of the Tax Cuts and Jobs Act at the end of 2017, the Senate also introduced the Tax Extender Act of 2017 (S. 2256).[REF] The bill extends targeted temporary tax credits—many of which expired in 2016—for a variety of business operations, including more than a dozen for energy production and conservation. In fact, the bill rightly could be considered an energy tax bill, given that two-thirds of the 36 sections are energy-related.

By transferring the tax burden from these politically connected industries to individual American citizens, Washington is not only preserving unfairness in the tax code but also distorting the marketplace, which results in economic inefficiency and technological stagnation. Instead of addressing each tax provision on its own merits, Congress has traditionally manufactured crises around deadline events, such as the close of the fiscal year or the beginning of tax season, to justify moving all the provisions forward in one package of tax extenders.[REF]

Rather than relying on the tried-and-failed ways of the past, Congress should instead use this opportunity to improve the tax code further by letting the temporary credits expire as scheduled and end subsidies for all energy sources and technologies. Even if Congress were to let the tax measures being considered expire, the tax code still has many permanent tax subsidies for energy in need of sunsetting. Rather than picking winners and losers through the tax code, Congress should build off the success of the Tax Cuts and Jobs Act of 2017 and pursue pro-growth reform that encourages investment in new capital and reduces the burden on taxpayers.

Energy Tax Credits Under Consideration

Using the tax code to encourage energy development dates back more than a century. Even the temporary tax credits for so-called emerging technologies and alternative energy sources date back to the 1970s.[REF]

The Tax Extenders Act would extend temporary tax credits for an assortment of energy provisions that expired at the close of 2016. Each case is retroactively extended to include past investments made in 2017. Among the items extended are investment tax credits for hybrid solar lighting systems, fuel cells, geothermal heat pumps, combined heat and power systems, and small wind power. Credits would be put on a promised phase-out schedule similar to what was passed for wind and solar electricity in the omnibus package of December 2015. Congress would also extend preferential treatment to qualified fuel cell motor vehicles, alternative fuel refueling property, 2-wheeled plug-in electric vehicles, and second-generation biofuel and biodiesel. Congress also included credits for improving energy efficiency in homes and commercial buildings.

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However, the bill would not subsidize only renewable sources. Indian coal facilities would receive a two-year extension of a production tax credit. Tax credits for capturing carbon dioxide would more than double. Carbon- dioxide capture used for enhanced oil or naturalgas recovery would increase from $10 per ton to $35 per ton, and carbon capture and storage projects would receive a $50 per ton credit, up from $20 per ton.[REF]

Nuclear power is another short-term winner from the bill. The Energy Policy Act of 2005 created a production tax credit for new nuclear power reactors up to the first 6,000 megawatts of capacity brought online by 2020. That tax credit, which lasts for the first eight years of production, would be extended likely for the benefit of only two companies with reactors under construction. Both projects have experienced serious cost and budget overruns, and one company has received billions of dollars in loan guarantees from the Department of Energy.[REF]

The Costs of Energy Tax Extenders and Missed Opportunities

The tax extenders, which are nothing more than handouts to the energy industry, carry significant costs to American taxpayers. These measures would divert an estimated $8.8 billion in tax revenue, increasing the burden on taxpayers.[REF]

The Tax Extenders Act misses opportunities to improve the tax code—and protect taxpayers—by failing to get rid of long-standing existing energy favoritism. For example, in previous drafts of the Tax Cuts and Jobs Act,[REF] the House of Representatives eliminated oil subsidies like the enhanced oil recovery credit and marginal well production credit. Although what constitutes an actual subsidy for the oil and gas sector is often overstated, these are targeted tax credits that specifically benefit the energy sector.[REF] Yet the Tax Extenders Act fails to address these problems and further extends energy subsidies to a litany of other industries.

Another modification in the Tax Cuts and Jobs Act would have curtailed the abuse of targeted credits. Subsidized projects for the energy investment and production credits merely needed to have begun construction by the credit expiration date to qualify. The House version of the Tax Cuts and Jobs Act capped the production tax credit and required “a continuous program of construction” for a company to be eligible.[REF] These small changes would have reduced the taxpayer burden by $12.3 billion over 10 years.[REF] The Tax Extension Act only minimally improves the qualifications by requiring construction to begin by the credit’s expiration in 2022 and to be online by 2024 in order to qualify.

Market Distortions from Tax Credits

Subsidies do no service to these energy technologies and companies. Based on political agendas rather than market realities, these tax credits for specific energy resources and technologies manipulate private-sector investment, provide unhealthy price advantages, distort incentives to innovation, and create competition for subsidies rather than competitive companies. What the market needs is more companies that are not dependent on federal policies and taxpayers in order to succeed.

Investment Manipulation. Private capital is limited. Technologies that do not receive subsidies appear more expensive, risky, or unpromising. In shifting the financial risk of energy projects indirectly to the taxpayer through the tax code, the government discourages private investments in projects that lack the government’s blessing but may have more commercial promise. A dollar invested in a company benefiting from a tax credit cannot simultaneously be invested in another company, creating opportunity costs where potentially promising but unsubsidized technologies may not receive investment.

Government subsidies demonstrably distorted private-sector investment in the wind and solar energy industries. Dramatic boom and bust cycles have been created by expirations and extensions of the tax credits. Less competitive companies make up part of an inflated industry, which shrinks according to actual market demand once a tax credit expires.[REF]

Price Advantages. Moreover, targeted tax credits provide one technology a government-created price advantage over an unsubsidized competing technology. Companies that do not receive any preferential treatment consequently will lobby for one, demanding a level playing field. The end result is a hodgepodge of tax credits that benefit select technologies that Members of Congress support because it particularly benefits their district, state, or political ideologies.

The case of renewable electricity tax credits is an excellent example of the distortions price advantages have had in electricity markets. In the intermediate- to long-run, the tax credits undercut electricity markets, making it difficult for otherwise affordable and reliable nuclear, coal, or natural gas power plants in particular to compete. Because wind-electricity producers can depend on a tax credit of roughly $22 per megawatt, they can bid negative prices into electricity markets and still make a profit.[REF] Low natural gas prices and regulatory policies targeted at coal and nuclear power (like the Clean Power Plan) made the effects of subsidies for renewables more obvious.

Distortion of Incentives to Innovation. Taxpayer-funded subsidies distort the incentives that drive innovation. Preferential tax treatment reduces the necessity for an industry to make their technology cost-competitive because the tax credit shields a company from recognizing the actual price at which their technology is economically viable. For economical projects, the tax credit is a windfall to the company. Even if they disagreed on principle, these competitive companies would be at a competitive disadvantage if they refuse to accept a credit.[REF]

Competition for Subsidies. Lucrative tax credits for renewable electricity technologies have incited others in the energy sector to lobby for their own. In recent months, nuclear power companies have requested production tax credits from state and federal governments. Groups representing energy technologies like biofuels and fuel cells that were “orphaned” in the last tax extenders package have used this latest version to lobby for a re-extension of credits just like the ones granted to wind and solar companies. Subsidized industries continue to expend resources to lobby for more subsidies even as their technologies mature.[REF]

Diverse and Competitive Energy Markets Need No Government Intervention

Ample opportunity exists for new, innovative technologies to enter the market. In 2015, U.S. energy consumers spent $1.1 trillion on energy, an average of more than $3,500 per person.[REF] The profit incentive to supply affordable power or a competitive transportation fuel is enough to spur private investment without any preferential treatment from the federal government. Accordingly, companies spend billions of dollars in research and development (R&D) to lower costs, meet consumer demands, and capture larger market shares. The National Science Foundation estimates that R&D in electrical equipment, appliances, and components totaled $4.1 billion in 2013, the overwhelming majority of which came from the private sector. Automobile R&D totaled $16.7 billion, the vast majority again from the private sector.[REF]

To encourage technological innovation, Congress should reverse any regulatory barriers that stifle new energy sources, not prop them up at the expense of taxpayers with targeted subsidies which are in fact barriers to entry for unsubsidized technologies and companies.

Using the tax code to drive energy revolutions ignores how energy markets function. As prices change, so does private investment. As gas prices change, for instance, private investments may concentrate more heavily on battery-, biofuel-, natural gas-, or propane-powered vehicles. Price increases incentivize increased oil exploration and production. Furthermore, if energy-efficiency financing for installing items such as new windows or better insulation will save families and businesses money, they can make those investments on their own. When the savings outweigh the costs, families secure reduced energy bills and businesses gain a competitive advantage.[REF]

As prices fluctuate over the short- and long-term, the private sector will better meet customer energy needs without the federal government’s thumb on the scale. The dynamic flow of investments and consumer behavior is best determined by the marketplace, not policymakers trying to predict or outsmart the market.

Brightening the Future for Energy Markets

Unlike targeted tax credits, some pro-growth tax policies do reward economic growth in a neutral way. Immediate expensing allows companies to deduct the cost of capital purchases at the time they occur rather than deducting that cost over many years based on cumbersome depreciation schedules. The Tax Cuts and Jobs Act expands the 50 percent bonus depreciation for new capital investments to 100 percent (full expensing) for five years.[REF]

Immediate and full expensing for all new plant and equipment costs—for any industry or type of equipment—would allow newer equipment to come online faster, which would improve energy efficiency and overall economic efficiency. The current system of depreciation raises the cost of capital and discourages companies from hiring new workers and increasing wages for existing employees. As Congress builds off the success of the Tax Cuts and Jobs Act, it should make immediate full expensing permanently available for all business investments, including all energy investments.

Free markets better allow for the supply of affordable energy, innovation, and a clean environmentthan any central planning approaches that manipulate how people produce and use energy. Allowing energy tax credits to expire at the end of last year was a step in the right direction. Congress should build off that momentum and the success of the Tax Cuts and Jobs Act to eliminate all targeted tax credits for all energy sources and technologies. Eliminating the preferential treatment in the tax code would drive energy innovation, competition, and job creation, resulting in a healthier, robust energy sector independent of the federal government.

Katie Tubb is a Policy Analyst in the Thomas A. Roe Institute for Economic Policy Studies, of the Institute for Economic Freedom, at The Heritage Foundation. Nicolas D. Loris is Herbert and Joyce Morgan Research Fellow in Energy and Environmental Policy in the Roe Institute.


Katie Tubb
Katie Tubb

Former Research Fellow

Nicolas Loris
Nicolas Loris

Former Deputy Director, Thomas A. Roe Institute