Tax Credits and the Development of Renewable Energy in California

The Policy in Brief

Economic Instrument: Tax credits for renewable electricity generation.

Problem: The environmental problems of relying on fossil fuels and nuclear power generation, and the need for enhanced energy security by diversifying supply.

Goal: To stimulate solar, wind, geothermal, biomass and other renewable electric generation technologies.

Description: An innovative policy framework combining regulatory and fiscal inducements has made California's renewable energy sector the most successful in the world.

Administering Institutions: Various US federal and Californian agencies.

Key Stakeholders: Federal and state governments, electric utilities, energy users, renewable energy developers and the environmental community.

An Overview

California leads the world in non-conventional renewable electricity generation. This enviable position was, in large part, due to a combination of tax credits and regulatory reforms designed to stimulate renewable energy production. Renewable electric generation in California has benefited from federal and state tax credits and a state property tax exemption. Introduction of the credits was primarily motivated by energy security concerns, but support for their continuation in the 1980s and 1990s has increasingly been based on environmental concerns. Credits have been available for both electric and non-electric applications of renewable energy including commercial and residential uses, but this case examines only the commercial electricity sector.

These credits function like a regular investment tax credit. They reduce the income tax liability of individual and corporate taxpayers who invest in eligible renewable energy projects. With a credit rate of 10%, a taxpayer who invests $10,000 receives a $1,000 income tax credit. Federal credits reduce federal income tax payments, and state credits reduce state tax payments.

Typically, credits are only available if tax is actually owed in the current year, but can be carried forward or back to reduce a future or past year's tax liability. A different type of credit, this time based on production, was introduced in the 1992 National Energy Policy Act. The production credit promoted wind and biomass electricity generation across 10 year blocks of time. The 1992 Act also made permanent the 10% investment credit for solar and geothermal electric generation.

During the early 1980s, income from solar and wind energy development was subsidized rather than taxed. This resulted from the combined effect of the federal and state credits together with various other generous tax breaks available at the time. In addition to tax credits, solar electric generating plants in California have benefited from a state property tax exemption, adopted in 1980, which further lowers their tax burden. Substantial investment therefore was attracted to renewable energy in California. This included several well-publicized wind energy projects of dubious technical merit developed by tax shelter experts. The federal Tax Reform Act of 1986 repealed numerous special breaks and loopholes in the national tax code that had led to widespread tax shelter activity throughout the economy. The federal and state tax credits promoting renewable reached a plateau between 1981 and 1986 in the size of credits and the number of technologies covered.

Most electricity in the US is generated by integrated electric utilities that also transmit, distribute and sell power within exclusive service territories. With the 1978 passage of the national Public Utilities Regulatory Policies Act (PURPA), this traditional monopoly over generation has eroded somewhat. PURPA required utilities to buy power from independently owned renewable energy plants and cogeneration facilities at a price equal to the utility's own cost of meeting the same energy need.

California moved more aggressively to implement PURPA than any other state. The California Public Utilities Commission (CPUC) reduced the regulated profit rate of Pacific Gas and Electric, the state's largest utility, as a penalty for early resistance to PURPA requirements. This action prompted California's three investor-owned utilities to cooperate in earnest with the fledgling renewables industry. The CPUC also facilitated development of several standard power purchase contracts ensuring that small developers could obtain reasonable terms from the larger utilities at greatly reduced transaction costs.

Some Further Reading

Gale, Robert, Stephan Barg and Alexander Gillies. (1995). Green Budget Reform: An International Casebook of Leading Practices, Winnipeg, International Institute for Sustainable Development.

Johansson, T.B. et. al. (ed.) (1993). Renewable Energy: Sources for Fuels and Electricity, Washington, DC, Island Press.

Lotker, Michael (November 1991). Barriers to the Commercialization of Large-Scale Solar Electricity: Lessons Learned from the LUZ Experience, Scandia National Laboratory.

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