Economics - Senior Research Proposal

Econometrics 2016 | Thesis Proposal

Effectiveness of Federal Tax Incentive Programs on Solar & Wind Energy Development and Subsequent Carbon Emission Reduction in the United States

Introduction

The threat of global warming has motivated efforts to increase renewable energy production such as wind and solar. When conventional energy like fossil fuel is replaced by renewable energy, it can reduce emission of greenhouse gases and slow down the impact of climate change (NRC, 2010). Theoretically, the ideal policy to mitigate greenhouse gas emission at the lowest cost is to implement a nationwide carbon emission tax or an emission trading mechanism (Abolhosseini and Hesmati, 2014; Murray et al., 2014; Palmer et al., 2011). However, political factors have limited the use of these approaches and forced U.S. government to employ alternative mechanisms to finance renewable energy development such as tax incentives, feed-in tariffs and renewable portfolio standard (Abolhosseini and Hesmati, 2014). This paper focuses on the largest tax-incentive programs for wind and solar in the U.S.: the production tax credit (PTC) and the investment tax credit (ITC). Both programs were allowed to expire multiple times and have recently been extended. The production tax credit (PTC), implemented since 1992 and extended through 2019, is worth 2.3 cents per kWh of electricity generated by wind resources. The duration of the credit is 10 years after commercial operation date of the facility, and the credit amount is phased down after December 31, 2016 (DOE). The Business Energy Investment Tax Credit (ITC), implemented since 2006 and extended through 2019, claims a 30-percent tax credit of initial investment for solar, offshore wind, and small wind turbines, with a gradual step down of the credits between 2019 and 2022 (DSIRE). The PTC and ITC are essentially subsidies from federal government to lower the cost of electricity generated from renewable resources, encouraging their substitution for fossil fuels. Bloomberg New Energy Finance (BNEF) forecasts that the net result of the recent ITC and PTC extension could be 37 gigawatts of new wind and solar capacity – a 56-percent boost to the industry over 5 years, catalyzing $73 billion in new investment. However, some research proposes that these subsidy programs may not be as effective as they seem. Although the solar and wind industry in the U.S. have experienced rapid growth in the last decade, billions of dollars in federal subsidies have not raised the share of solar and wind beyond ten percent in the nation’s electricity mix (BNEF). Meanwhile, the $19 trillion dollar in federal debt and a new conservative administration imply that there will be less, not more money spent on clean energy policy (U.S. Debt Clock, 2016). In reality, how effective are these federal tax incentives on driving the solar and wind market? What are other important factors besides the PTC and ITC that could explain the variation in renewable energy production amongst states? Are there enough empirical evidences to illustrate a negative relationship between carbon emission and renewable energy new installation resulted directly from the PTC and ITC? If such relationship indeed exists, how substantial is it compared to alternative policies that are less costly for federal tax payers such as the renewable portfolio standard (RPS), and/or other state characteristics such as income per capita and residents’ green demand? This paper would like to address these questions in order to help inform the renewable energy public policy and private decision-making process.  

Literature Review

There are several papers that discuss primary drivers of renewable energy production by state, but only a few has successfully identified a causal effect of the PTC and ITC on renewable energy production. Price (2002) suggests that the production tax credit had no significant impact on new wind installations when state RPS was taken into account. The paper asserts that the real boost to investment in renewable power more likely comes from market driven demand from green power programs, state mandates, and reductions in purchase price provided by investment tax exemptions and low-cost loans. On the contrary, several studies find that tax credit reduces the cost of renewable energy, particularly for wind, hence increases the amount of installed renewable generation capacity, but also imposes significant cost on the Treasury Department (Wiser, 2007; Metcalf, 2007; Metcalf, 2010). Mendoca et al. (2009) investigates the impact of tax policy on clean energy development and emphasizes the role of both PTC and ITC as “the most important symbolic and financial tool for the industry,” contributing to the unprecedented growth in the wind and solar markets by narrowing the cost parity between renewable and conventional sources (383). However, the paper does not construct an empirical model to examine the actual impact of the PTC and ITC on solar and wind new installation.

Regardless of findings on capacity, most previous literatures have not connected the changes in renewable generation with greenhouse gas emissions. Palmer et al. (2011) utilizes the Haiku electricity market model to evaluate the economic outcomes and climate benefits of three types of policies: cap-and-trade program (CTP), renewable portfolio standard (RPS), and tax credits. The author discovers that CTP is the most cost-effective approach at reducing CO2 emissions, while tax credit is the least cost-effective. Tax credits fail to provide any direct incentive for CO2-intensive electricity generation technologies to reduce generation or emissions, and actually work to encourage higher levels of overall consumption. In contrast, both CTP and RPS tend to raise electricity prices and provide incentives for electricity conservation.

Economic theory is aligned with Palmer et al., 2011. Fell et al. (2012) compares U.S. renewable energy policies in theory and suggests that tax policies do not incentivize investments in projects that bring the greatest value to society. Both the PTC and the ITC increase revenue accruing to renewable energy generators at the expense of tax payers, and decrease electricity prices. Since the credit is the same for any generator of the same technology, investors select projects with the highest market value and ignore the environmental value (the avoided emissions) because there is no advantage in choosing a project that reduces emissions more than another. In addition, the ITC reduces the cost of constructing a generator rather than providing a production subsidy, which skews investment toward more capital-intensive projects that may not necessarily be the most valuable. Overall, a large amount of subsidy for solar and wind generation can reduce electricity prices, increase consumption and emissions from fossil generators, and offset some of the environmental benefits of the policies.