Energy Sector Tax Credits

Abstract

President Joe Biden’s recently unveiled a tax plan to accompany his $2 trillion infrastructure proposal that takes direct aim at fossil fuel subsidies in favor of clean energy incentives. The “Made in America Tax Plan” is set to raise the corporate income tax rate from 21% to 28% and replace fossil fuel subsidies with clean energy incentives. The plan outlines several clean energy tax credits, including a 10-year extension of wind, solar, and battery tax credits, but does not specify which fossil fuel subsidies could face the chopping block. 

Key Points

  • Joe Biden released the “American Jobs Plan” on March 31st, 2021 with a major focus on reaching his decarbonization targets and meeting climate goals. The plan includes several plans to extend renewable energy tax credits while eliminating fossil fuel related tax legislation.

  • Tax incentives related to the oil and gas industry began in 1913 as automobiles and the need for fuel began growing. The original tax provision allowed companies to write off dry holes and intangible drilling costs during their first year of exploration. Currently the top two tax benefits for oil and gas development are 1) deductions for excess percentage over cost depletion, and 2) expensing exploration and development costs.

  • Excess of percentage over cost depletion allows producers to deduct a fixed percentage of gross revenue as capital expenses each year, without regard to how much they have invested [2]. Independent producers are able to deduct 15% of gross revenue from oil and gas properties as percentage depletion. Alternatively, conventional cost depletion only allows for deductions of actual costs as the resource is depleted.

  • Exploration and development costs that include labor and materials can be entirely expensed by oil and gas producers from income during the year they were incurred. Integrated oil companies may deduct 70% of the same costs in the first year and amortize the remaining 30% over the next 5 years.

  • Biden’s “Made In America” tax plan did not specify which fossil fuel tax breaks would be targeted, but the U.S. Treasury estimates the changes will increase government tax receipts by over $35 billion during the next 10 years. Likely fossil fuel tax targets are the intangible drilling cost deduction and the percentage over cost depletion deduction. The two deductions comprised nearly 47% of fossil fuel tax benefits in 2018.

  • Alternatively, the proposed tax plan has created subsidies and tax benefits to support his green energy initiatives. Biden’s Fiscal Year 2022 budget of $1.52 trillion includes a policy to make standalone energy storage projects eligible for the federal investment tax credit (ITC). In his $2 trillion infrastructure proposal, the “American Jobs Plan,” he has also included $6.5 billion in loans for clean energy, storage, and transmission projects in rural communities and $15 billion for climate research and development projects.

  • The proposed tax plan also has sections addressing the advancement of clean electricity production by providing a 10-year extension of the production tax credit and investment tax credit for clean energy generation created from wind, solar, and storage in advanced batteries. A tax incentive would also be created for long-distance transmission lines that move electricity from clean energy generators.

  • Currently the federal investment tax credit (ITC) provides a 26% credit for residential and industrial solar installations and is set to phase out in the next two years. The new tax legislation would delay the phasedown from 26% to 10% until 2030. Also, under the Consolidated Appropriations Act of 2021 the renewable energy tax credits for fuel cells, small wind turbines, and geothermal heat pumps now feature the same gradual step down in the credit value as those for solar energy systems.

  • The new proposed tax plan will replace U.S. fossil fuel subsidies and tax breaks with those for clean energy sources. The major issue with reducing tax incentives for oil and gas production to help the government pay for renewable technology is that the renewable energy sources are not yet developed enough to support all of the U.S. domestic energy needs. Rather than focus energy tax credits on specific energy sectors, it may be more beneficial for national energy security and economic recovery to aim for all industries helping to generate domestic energy independence.

Introduction

The energy landscape is constantly changing with the times, and in a year of upending altercations, 2021 is no different. With a global focus on clean energy, the United States is leading the charge in combating the climate crisis with executive actions and now financial support. Joe Biden’s American Jobs Plan, released on March 31st, recognizes that if the United States wants to hit decarbonization targets and meet climate change goals, cutting off government support for fossil fuels is a logical first step. With the U.S. government’s backing, domestic energy production has created a litany of tax incentives for both investors and small producers, and oil is no exception. Biden’s plan takes aim at tax preferences, loopholes, and laws that allow fossil fuel companies to dodge costs associated with mitigating pollution. In addition, his administration has signaled support for broad-based extensions to clean energy tax credits as part of the ambitious plans for fighting climate change. These include a call to decarbonize the electric grid by 2035 and carbon neutrality by 2050. The shift to renewable energy is a key part of the global effort to reduce emissions of earth-warming gases and slow down climate change, but many argue that clean energy growth would not be possible without financial support from the government. With a new Commander In Chief leading the country in his Clean Energy Revolution, President Biden has released a “Made in America” tax plan proposing to extend tax credits for renewable energy while simultaneously ending tax benefits for fossil fuels.  

History of Energy Tax Benefits 

The history of tax breaks for the oil and gas industry began in the early 1900s from the United State’s love affair with the automobile. In 1913, a new tax provision allowed oil companies to write off dry holes as well as all intangible drilling costs in their first year of exploration [2]. Now, for more than a century, federal energy tax policy has focused on increasing domestic oil and gas reserves and production through several major tax benefits available to oil and gas investors found nowhere else in the tax code. It is important to recognize that the bulk of these tax perks only available to the oil and gas industry are not actually unique because other sectors get their own exclusive set of deduction benefits. Opponents typically argue against the top two benefits which are excess of percentage over cost depletion and expensing of exploration and development costs. Excess of percentage over cost depletion allows producers to deduct a fixed percentage of gross revenue as capital expenses each year, without regard to how much they have invested [2]. By contrast, conventional cost depletion allows deduction of actual costs as the resources are depleted. Federal tax law allows independent producers, but not integrated companies, to deduct 15% of gross revenue from their oil and gas properties as percentage depletion [2]. The second major tax incentive are exploration and development costs that include labor and materials. These can be expensed entirely by independent oil and gas producers from income the year they were incurred, while integrated oil and gas companies may deduct 70% of these costs in the first year and recover the remaining 30% over the next five years [2]. Other tax subsidies for fossil fuels include: publicly traded partnerships, allowing pass-through oil and gas partnerships to publicly list their shares; amortization of geological and geophysical expenditures associated with oil and gas exploration; accelerated depreciation of natural gas infrastructure; investment credits for clean coal facilities; and energy production credits for coal [2]. As the world begins to transition to technologies emitting less pollution to generate electricity and fuel vehicles, President Joe Biden wants to end many of these fossil fuel subsidies. While cutting off funding seems to be a fairly straightforward path, it could be difficult given the Democrats have the slimmest majority possible in the Senate, and some Democrats come from states that produce fossil fuels. 

Waning Benefits for Fossil Fuels

The “Made In America” tax plan did not specify which tax breaks for fossil fuel companies would be targeted, but it did say the subsidies undermine long-term energy independence, the fight against climate change, and “harm air and water quality in U.S. communities, especially communities of color” [3]. The U.S. Treasury stated the tax plan would “end long-entrenched subsidies to fossil fuels,” and estimates such actions would increase government tax receipts by more than $35 billion over the next 10 years [4]. The fossil-fuel focused tax provisions most likely up for elimination are two deductions that help lower taxes for exploration-and-production companies. One is the intangible drilling cost deduction discussed above, which allows oil-and-gas producers to deduct most of the costs associated with discovering leases and preparing pads. The second is the percentage over cost depletion deduction, which helps oil-and-gas companies lower taxable income. Michael Threet, partner at law firm Haynes and Boone, notes that both of these have come up on the chopping block in previous administrations but have always survived. That being said, the two deductions together comprised 46.9% of fossil-fuel tax benefits in 2018, and the Congressional Research Service and the Joint Committee on Taxation has estimated that ditching intangible drilling cost deductions alone could generate $13 billion over 10 years [4,5]. However drastic the cuts to fossil-fuel tax provisions turn out to be, the actual impact on oil production and the environment may not be as dramatic as the White House might hope. In a 2018 paper that the tax plan cites, Gilbert Metcalf, economics professor at Tufts University, estimated that eliminating the two tax benefits for fossil fuels alongside another one known as the domestic manufacturing deduction wouldn’t substantially decrease domestic oil and gas production or greenhouse gas emissions in the long run [4]. While the impact on actual hydrocarbon production could be limited, such a move would certainly mark the end of an era of the U.S. Treasury support for an industry that has supported energy independence and national security over the past century.

Figure 1: Tax Incentives For Fossil Fuel Energy Sources [9]

Surging Benefits for Renewables 

In an effort to steer the country towards a green-based economy and energy infrastructure, Biden has created subsidies and tax benefits to propel his green movement. President Joe Biden’s $1.52 trillion budget request for Fiscal Year 2022 includes a policy to make standalone energy storage projects eligible for the federal investment tax credit (ITC), a move advocates say will unleash new capital for renewable energy [6]. The budget request also included new spending on storage as part of the administration’s goal to decarbonize the energy sector by 2035. Currently, the renewable energy tax credits are only eligible for energy storage if it is integrated with other ITC-eligible solar installations. As a result, there has historically been little incentive to invest in additional technology to make renewable energy more consistent and reliable for customers. In addition, Biden’s $2 trillion infrastructure proposal, or the American Jobs Plan, included the storage ITC proposal along with $100 billion in power grid investments [6]. The request includes $6.5 billion in loans for clean energy, storage, and transmission projects in rural communities but also incorporates $15 billion in climate research and development projects, including utility-scale energy storage [6]. A key portion of his tax plan would advance clean electricity production by providing a 10-year extension of the production tax credit and investment tax credit for clean energy generation, such as wind, solar power, and energy storage for advanced batteries. It also creates a tax incentive for long-distance transmission lines to ease movement of electricity from clean energy generators. “A federal tax credit for energy storage would have a transformative impact, promoting private sector investment and helping monetize the value of energy storage technology,” said Gregory Wetstone, president and CEO of the American Council on Renewable Energy [5]. A preliminary analysis found that a 30% storage ITC enacted this year would increase the U.S. storage forecast by 20-25% over the next five years. The ITC currently provides a 26% credit for residential, commercial and large-scale utility solar installations. It was set to begin phasing out over the next two years, and Biden’s infrastructure proposal would extend the phasedown for an additional 10 years [5].

Figure 2: Tax Incentives For Renewable Energy Sources [10]

Biden’s moves significantly build upon the existing credits currently in place for clean, green, renewable energy in the United States. As discussed previously, the ITC is a dollar-for-dollar credit for expenses invested in renewable energy properties, most often solar developments. The Consolidated Appropriations Act of 2016 extended the ITC through 2019 as a 30% credit for qualified expenditures but dropped to 26% for facilities that began construction in 2020. It fell further to 22% for those beginning construction in 2021, and it was planned to become a permanent 10% credit in 2022 [7]. Thanks to Biden’s new tax plan, the phasedown from 26% to 10% has been delayed until 2030. Another program, the Section 1603 Treasury program, is a technology-neutral finance mechanism that allows solar and other renewable energy project developers to receive a direct federal grant in lieu of the Section 48 ITC they were otherwise entitled to receive. The program was part of the American Recovery and Reinvestment Act (ARRA) of 2009 allowing taxpayers and small businesses to maximize the return and value of tax incentives by providing access to capital and streamlining financing costs [7]. The payment is made after the energy property is placed in service, and the program applies to solar, wind, biomass, combined heat and power, fuel cells, geothermal, incremental hydropower, landfill gas, marine hydrokinetic, microturbine, and municipal solid waste [7]. In addition, another provision of the American Recovery and Reinvestment Act of 2009 (ARRA) was Section 48C, which provided $2.3 billion in tax credits for manufacturing facilities related to renewables. It is a competitive credit, requiring an application to the Treasury Department for investing in the manufacturing of renewable energy equipment, not the generation of it. The credit is 30% of the equipment’s cost while the initial $2.3 billion remains unallocated [7]. Most recently, under the Consolidated Appropriations Act of 2021 the renewable energy tax credits for fuel cells, small wind turbines, and geothermal heat pumps now feature the same gradual step down in the credit value as those for solar energy systems. The act includes a 30% tax credit for systems placed in service by December, 31st, 2019, a 26% credit for those in service between 2020 through 2022, and a 22% credit for new systems in service in 2023. These incentives, in addition to President Biden’s new tax and investment incentives, are poised to pave a path towards the administration’s carbon neutrality goals by 2050. 

Conclusion

In the end, Biden’s current tax plan replaces U.S. fossil fuel subsidies with clean energy incentives. In absolute terms, tax benefits available to fossil fuels have been much smaller than those available to renewable energy in recent years. In 2018, tax provisions supporting fossil fuels added up to $3.2 billion, while those for renewable energy totaled $9.8 billion, according to the Congressional Research Service [4]. Tax benefits for fossil fuels have been around much longer, matching the maturity of the industry. The deduction for intangible drilling costs began in 1913, while percentage depletion was created in 1926. So while tax provisions for renewable energy are significantly higher, the two main tax credits for renewable energy were introduced in 1992 and 2006. It has also been far easier to single out tax benefits for renewable energy as subsidies because they come in the form of technology-specific tax credits. There are undoubtedly tax breaks oil and gas utilize that renewables don’t. For example, master limited partnerships, which are tax-advantaged vehicles, are available to hydrocarbon production but not renewable energy. However, what many of Biden’s incentives are doing is addressing the central role storage will play in allowing renewable energy sources to reliably supply customers across the country while highlighting the fact that subsidizing domestic production of fossil fuels is counter to his policy goal of reducing fossil fuel use to counter global climate change. 

Figure 3: Fossil Fuel Subsidies Planned Decrease Under Biden [11]

A major problem is renewable energy is not developed enough to support domestic energy needs. The renewable energy industry argues that long-term extensions are needed to comprehensively fight climate change, but it seems laughable that they claim the industry is the cheapest and fastest growing form of energy on one hand while they are lobbying the government for 10 more years of subsidies with the other. Overall, it appears for the foreseeable future that federal assistance is needed to be a viable industry. If there are tax credits for producing energy they should be aimed at all industries helping to generate domestic energy independence and reliability. Targeting specific industries with subsidized tax incentives and punitively removing them from others only undermines the nation’s economic recovery and energy security while jeopardizing private sector jobs. 

References

[1] https://www.motherjones.com/politics/2014/04/oil-subsidies-energy-timeline/ 

[2] https://www.taxpolicycenter.org/briefing-book/what-tax-incentives-encourage-energy-production-fossil-fuels 

[3] https://home.treasury.gov/system/files/136/MadeInAmericaTaxPlan_Report.pdf 

[4] https://www.wsj.com/articles/big-oils-influence-shrinks-as-tax-perks-face-axe-in-biden-plan-11618398180 

[5] https://www.reuters.com/article/us-usa-treasury-tax-energy/biden-tax-plan-replaces-u-s-fossil-fuel-subsidies-with-clean-energy-incentives-idUSKBN2BU2HL 

[6] https://www.utilitydive.com/news/biden-budget-infrastructure-plan-would-create-standalone-storage-tax-credi/598257/  

[7] https://www.novoco.com/resource-centers/renewable-energy-tax-credits/retc-basics/about-renewable-energy-tax-credits  

[8] https://www.energystar.gov/about/federal_tax_credits/renewable_energy_tax_credits 

[9] https://www.taxpolicycenter.org/briefing-book/what-tax-incentives-encourage-energy-production-fossil-fuels 

[10] https://www.taxpolicycenter.org/briefing-book/what-tax-incentives-encourage-alternatives-fossil-fuels-0 

[11] https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/biden-takes-aim-at-fossil-subsidies-pushes-clean-energy-incentives-in-tax-plan-63576296

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