The 2022 Inflation Reduction Act (IRA) includes more than two dozen clean energy tax credits. These tax breaks–estimated by the Congressional Budget Office to cost more than $260 billion over ten years–aim to encourage the deployment of clean energy technologies. One significant change the IRA made to the clean energy tax credits is to make them refundable and transferable. Refundability enables entities to receive direct payments, while transferability allows them to sell their tax credits to other entities for cash. This change therefore allows companies to fully utilize the tax subsidies’ benefits and effectively incentivize investment in clean energy technologies.
Before the IRA passed, clean energy credits were non-refundable, and entities with little or no tax liability could not use them. Clean energy developers without tax liability would have to transfer the credits to a third-party investor in exchange for equity financing for a particular clean energy project. Emerging technologies in the tax equity market–unlike mature clean technologies like solar and wind – are not particularly attractive. They are riskier and require more capital investment than mature technologies, which makes it challenging for them to use the tax credits. As a result, the tax equity market might create barriers for clean technology innovation.
The IRA made it easier for companies with no tax liability to receive the benefit from the credit. In effect, companies’ tax liability can be negative, meaning that companies with no tax liability would get tax refunds. Moreover, companies interested in purchasing tax credits aren’t necessarily required to invest in a clean energy project. This enables mature and nascent clean technology developers to fully utilize the tax subsidies.
Tax credits are not an ideal approach to mitigating climate change. Still, making them refundable and transferable improves them. Rendering clean energy tax credits refundable and transferable would match the tax benefits with the timing of the economic activity. If the credits are carried forward to be used in the future when the entities have tax liability, clean energy developers would be unable to fully utilize the benefits due to time value of money and inflation.
Making the tax credits refundable and transferable is similar to what lawmakers did in the Safe Harbor Leasing provision in the 1981 Economic Recovery Tax Act, which significantly accelerated depreciation deductions for new investments. In response to the concern that companies without taxable income couldn’t fully benefit from the larger depreciation deductions, the tax reform allowed companies to sell their depreciation deductions and investment tax credits to other companies for cash. The provision was designed to encourage economic growth and provide investment incentives for companies with no tax liability.
Decarbonizing the U.S. economy and meeting President Biden’s ambitious climate goals would require deploying a great variety of clean energy technologies. Refundability and transferability are therefore a positive development towards realizing these goals, as they would enable clean energy developers to fully utilize the tax subsidies. This, in turn, would help accelerate the deployment of much-needed clean energy technologies.
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