U.S. Tax Policy Effect on Greenhouse Gases Report Summary and Critique

by Akin Gump Strauss Hauer & Feld LLP
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Congress asked the National Research Council, National Academy of Science, the National Academy of Engineering and the Institute of Medicine to study the effect of U.S. tax policy on carbon and other greenhouse gas emissions.  The full report of June 20 is available here. Below are key excerpts from the report.  The report is relatively pessimistic with respect to tax policy improving greenhouse gases; however, as explained below the report used flaw assumptions for the cost of wind and natural gas that skewed its conclusions.

The excerpts from the report are divided into four topics: percentage depletion, renewable energy tax credits, renewable energy portfolio standards (RPS) and the availability of accelerated depreciation for equipment generally (e.g., manufacturing equipment, computers).

Excerpts from the Report

Effect of Favorable Percentage Depletion for oil, gas and Coal on Greenhouse Gasses

  • From a fiscal point of view, the oil depletion allowance was not motivated by concerns about climate change when it was enacted in 1926.  From the point of view of climate change, this is not an effective subsidy for reducing emissions.
  • The impact on CO2 emissions of removing the [favorable] percentage depletion allowance is small under all … scenarios.
  • The treatment of depletion in the oil and gas sector is complicated by the fact that the depletion allowance depends on firm size (small independent, large independent and major producer).
  • The primary impact of removing the percentage depletion tax preference is to increase the cost of natural gas production and, hence, natural gas prices.  All sectors reduce their natural gas consumption.  However, the biggest impact occurs in the power sector because substitution of other fuels is easiest there.
  • In the Cost-Depletion scenario, where [less favorable] cost depletion replaces the percentage depletion allowance, capital recovery is slower, resulting in higher drilling costs, and reducing incentives to explore and develop new supply.  Less investment in drilling would be expected to reduce domestic production and raise the price of natural gas.
  • As intuition would suggest, the primary impact of the move to [less favorable] cost depletion from percentage depletion is to increase the cost of natural gas production and prices, with the High-Macroeconomic-Growth scenario showing the largest difference and the Low-Natural-Gas-Prices scenario showing the least difference.
  • To a first approximation, the depletion allowance produces no impact on greenhouse gas emissions.  … Both theoretical and empirical work suggests that market and behavioral failures (e.g., externalities, principal-agent issues, and informational barriers) can cause underinvestment in residential energy efficiency, and that government intervention can help.

Effect of Energy Tax Credits on Greenhouse Gas Emissions

[The report’s generalities sound relatively favorable for renewable energy tax incentives.]

  • The committee’s analysis of the tax provisions for renewable electricity indicates that they lower CO2 emissions.
  • To the extent that the PTC/ITC encourages the substitution of electricity from wind or solar power for electricity from fossil fuels, CO2 emissions are expected to decrease.
  • Removal of the renewable electricity credit raises the price of natural gas and electricity, which increases the cost of energy to consumers.
  • In NEMS-NAS analysis, investment tax credits and cash grants are both treated as a percentage reduction in the capital cost of the technology and are therefore identical.  Under current law, most of these provisions have expired or are scheduled to expire; however, under the committee’s methodology, they are extended through 2035 in the baselife analysis for each scenario.

[The report’s summary of its empirical conclusions regarding renewable energy tax incentives reflect a conclusion the tax incentives provide minimal reductions in greenhouse gasses.]

  • If the revenue lost as of a result of the PTC/ITC is divided by the reduction in CO2 emissions, just under $250 in revenues are lost per ton of CO2 reduced.  While this does not represent the social cost of reducing the ton of CO2 emissions (because revenue losses are not a dead-weight loss …), the fiscal cost per ton of CO2 reduced is high relative to other, more efficient approaches [emphasis added].
  • [Existing energy tax credits] lower the cost of electricity generated from renewable resources, encouraging their substitution for fossil fuels and thereby tend to reduce GHG emissions.  The committee’s analysis indicates that these provisions do lower CO2 emissions under the macroeconomic conditions in the AEO11 reference and high GDP growth cases, but the impact is small, about 0.3 percent of U.S. CO2 in the reference case [emphasis added]. 

[It is not clear to me how the impact of energy tax credits can be “small,” when the report concludes that due to not extending energy tax credits through 2035]

utilities will add more than twice as many combustion turbines and nearly 50 percent more natural gas combined cycle plants while retiring 25 percent fewer coal-fired plants (compared to base line projections where the PTC/ITC are still available). [Further, gas] replaces most of the reduced renewable generation in the No-ITC/PTC scenario, and coal and nuclear power contribute modestly in some instances.  In the Low-Gas-Price scenario, more nuclear power plants that were on the cusp of retirement in the Reference scenario remain in use, and as a result the increase in CO2 emissions is close to the Reference scenario.

  • Given the small changes in generation in the No-ITC/PTC scenario changes to overall emissions from the domestic electric power sector also are small.  … The impact on CO2 emissions, however, increases over time, reflecting the change in generation capacity.  
  • The impact on CO2 emissions of removing the PTC/ITC is larger in the High-Macroeconomic-Growth scenario:  The increase in CO2 emissions over the period 2031-2035 is twice as large in the High-Macro-Growth scenario as in the Reference scenario, increasing CO2 emissions from the power sector by 0.8 percent.
  • The impacts of removing the PTC/ITC on electricity demand in the NEMS-NAS model appear paradoxical.  This results from the intricacies of the treatment of end-use (household and other) generation. 
  • Compared to the Reference scenario, electricity prices increase by 0.2 cents per KWh or 1.8 percent by 2035 when tax credit are removed. 

Interaction with State Renewable Energy Portfolio Standards

  • In other words the increase of CO2 emissions, the result of removing the PTC/ITC tax credits, are about twice as large if RPS mandates are not in effect.
  • The finding on the role of the RPS is important.  It indicates that the regulatory mandates constrain production and emissions.  As a result, the impacts of tax policies on emissions are reduced, in this case by half, when the regulatory mandates are considered.
  • NEMS-NAS model results indicate a greater impact of removing the PTC/ITCs in the situation when there are no state RPS.  For the No-RPS scenario, there is an increase of 0.5 percent in both cumulative and average annual emissions from the energy sector over the period 2010-2035.

Effect of Accelerated Depreciation on Greenhouse Gas Emissions

[The excerpts below are discussing accelerated depreciation in general, not merely the accelerated depreciation for renewable energy asset.]

  • Accelerated depreciation is one of the largest tax expenditures in the federal income tax code (although, as indicated above, the cost of the preference is imprecisely estimated).
  • The impact of removing accelerated depreciation on total emissions of GHGs is essentially zero in the case when revenues are recycled through lower tax rates.  While national output is higher by about 0.38 percent, the emissions intensity of the economy declines by 0.49 percent.  The net effect on GHG emissions of -0.17 percent is essentially zero and probably not within the resolution of the model.
  • The impact of removing accelerated depreciation on overall GHG emissions is probably negative, but the amount depends upon the fate of the revenues.  If the revenues are returned by lowering tax rates, then the overall impact on GHGs is essentially zero.  In contrast, if they are returned through lump-sum rebates, then GHGs are probably lower because the lower emissions intensity is combined with lower economic growth, and overall emissions are calculated to fall by about 2 percent.

Critique of the Report’s Methodology

As noted by the American Wind Energy Association’s (AWEA) blog, the report uses a methodology containing an assumption that natural gas prices remain at historic 2011 lows and wind turbine prices from 2011 that are relatively high:

[The] report attributes small pollution reductions to the PTC largely become of some quirky out-of-date assumptions that led the report’s model to build a very small amount of additional wind under the PTC.

[The] report relies on out-of-date 2011 assumptions from … which include extremely high capital cost for wind and low gas prices.  So the model wrongly assumes that wind can’t compete even with the PTC, which largely explains why the reports model builds only 15 gigawatts (GW) of wind between now and 2015.

In reality, … the U.S. wind industry installed over 13 GW of wind last year alone.

AWEA’s full blog post is available here.

The report’s use of the 2011 wind turbine prices is particularly galling when between 2008 and 2013 the levelized cost of energy from wind in the U.S. has fallen 50 percent as discussed in my blog post here.

Further, natural gas prices in 2011 were at historic laws and have risen since then.  For natural gas prices to stay at 2011 lows, there would have to be no voluntary or involuntary regulation of shale gas production methods, and the natural gas price must not increase as a result of exports.  Regulation of the production of shale gas production continues to be discussed in multiple forums and natural gas export permits have been granted as described here.

Finally, the International Monetary Fund (IMF) has determined that the U.S. provides hundreds of billions of dollars in post-tax subsidies to the fossil fuel industry by not making it bear the health and environmental costs of using fossil fuels. The IMF’s report is available here. The report from the National Research Council and the collaborating science academies makes no effort to include those costs in its analysis of the cost of fossil fuels.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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