Congress Pushes US Energy Transition Through Tax Credits — But Will It Work?

If left to market forces, commodities and industries tend to be more efficient and grow faster. This Economics 101 maxim now enjoys solid bipartisan support rejuvenating the supply chain, manufacturing, and utilization of solar panels in renewable power plants to fuel the energy transition of the 21st century.

The marketization of solar power plant investments is one of the most vital public-private partnerships (PPP) of the 21st century, and the recently passed Inflation Reduction Act (IRA) will supercharge these efforts. “This is one of the most important pieces of industrial legislation since FDR’s New Deal,” says Richard Dovere, Chief Investment Officer of EDP Renewables North America Distributed Generation (EDPR NA DG), “There are multiple avenues of support – solidifying more established technologies such as wind and solar while providing PPP commercialization paths for other technologies such as storage, hydrogen and carbon capture.”

Wind and solar power plant additions comprised 76% of the new U.S. power generation in 2021, creating thousands of jobs. By 2030, the IRA is expected to cultivate 1.3 million new jobs and strengthen the U.S. economy. The primary policy tool which enabled this growth is the energy investment tax credit (ITC) and the production tax credit (PTC), which were enhanced in the 2022 IRA.

“The ITC dates back to the Kennedy administration, but broadly applied to investment in equipment then, while the father of the PTC is Senator Grassley (R-IA) who pushed it through Congress in 1992 looking to grow the wind industry in his state of Iowa… However, after the IRA these tax credits are supercharged relative to their antecedents,” says David Burton, a tax partner with the legal firm Norton Rose Fulbright.

These tax credits are available to businesses and certain types of individuals that invest in renewable energy systems. The amount of the tax credit is a dollar-for-dollar reduction in the income taxes an eligible taxpayer owes to the IRS.

Investment in renewable energy projects in the United States has increased significantly over the last 15 years. According to data from the U.S. Energy Information Administration (EIA), total investment in renewable energy projects in the U.S. grew from around $6 billion in 2005 to approximately $40 billion in 2019. In that same period, the cost of new renewable energy projects plummeted, with solar and onshore wind costs falling by more than 85% and 60% during the last decade. This resulted in renewables being the lowest-cost option to produce in many markets and bodes well for the Biden administration’s Climate Action initiative, America’s energy security, and global environmental health.

Energy Innovation Policy and Technology LLC, a non-partisan thinktank, forecasts the IRA’s $370 billion in climate and clean energy investments could help cut U.S. greenhouse gas emissions up to 43% below 2005 levels by 2030, while Resources for the future projects that IRA will save an average U.S. household up to $220 annually on electricity bills while protecting against volatile fossil fuel price swings.

“These initiatives also provide price certainty,” Mr. Dovere commented, “once we hit a critical mass, a renewable grid will be less subject to the hefty price fluctuations seen in energy over the last 10, 20, and 50 years. It will be a bumpy ride along the way, as all transitions are, but the IRA sets us on a path to a cleaner, lower-cost future.”

These legislative measures address economic and environmental concerns by providing a market-driven solution that is politically expedient and sustainable. From the conservative angle, these tax credits lower taxes burdens on businesses, while liberals appreciate the environmental policy gains to spur the energy transition.

“The US is somewhat unique in the world in opting to spur clean energy through tax credits. The rules here are more complicated than in many countries, but the US tax system provides a convenient mechanism to spur investment,” Mr. Burton explained.

Public and private markets welcomed these policy changes. Since the IRA passed, more than $40 billion of new investments in renewables were announced, including $28 billion in US-based manufacturing, which also enjoys a large allocation of tax credits in the IRA. Despite their successes, tax credits for clean energy projects are not a panacea, and further investment is needed.

The IRA for the first time allows the sale of federal energy tax credits, which is referred to as transferability. “Transferability is key for the IRA because there was not going to be enough appetite in the traditional tax equity market to monetize all the enhanced credits. However, we are waiting on the IRS to issue rules to fill in the details that will determine how user-friendly and, accordingly, how successful transferability is as a policy,” says Mr. Burton.

The incentives in the IRA are not the only policy mechanisms that support solar project development. State-level Renewable Portfolio Standards (RPS) and Renewable Energy Certificates (REC) programs also provide localized economic investment incentives. The combination, and optimization, of these incentive programs, along with power sales to homes and businesses, provide the revenue streams necessary to return the project investment.

While the market shift towards renewable energy will benefit the environment and the American economy, the large price tag of the IRA is substantial and should be implemented thoughtfully. The deadlocked new Congress is unlikely to either do much to support clean energy or roll back the enhancements in the IRA or ITCs / PTCs. It would serve the new Congress well to realize that the invisible hand of the market works best when complemented with policies that do not seek to curb the earnings of businesses. Bi-partisan action is necessary to fully exploit the benefits of the IRA or ITCs/PTCs to the American nation.