Powering Strong Communities

How Public Power Could Benefit from a Direct-Pay Tax Credit

Arguably, tax credits — predominantly the investment tax credit and production tax credit — are the most powerful federal tools used to incentivize wind, solar, geothermal, and nuclear power development in the U.S. According to the most recent Joint Committee on Taxation estimate, the ITC and PTC alone are worth nearly $15 billion annually.

While the ITC and PTC are described as “tax breaks,” they are really intended to serve as a payment from the federal government to encourage investments in clean energy. In fact, the Rhodium Group, a leading independent researcher, estimates that the ITC and PTC, coupled with provisions to retain existing non-emitting energy resources such as hydropower and nuclear power, could cut the power generated from fossil fuels by 50% in just 10 years.

However, tax-exempt entities, including public power utilities, are excluded from these spending programs because they cannot benefit from either the ITC or PTC for a facility that they own. The same is true of any company without enough tax liability to take full advantage of tax credits, but for-profit companies can at least jointly own qualifying facilities with a “tax equity” partner that can monetize the ITC or PTC. However, a public power utility cannot enter this sort of transaction as a co-owner of the facility. Instead, public power utilities only indirectly benefit from the ITC and PTC by entering long-term power purchase agreements with taxable entities that can claim these credits. The problem is that the transactional costs of such agreements can be high, and only a portion of the value of the tax credit is generally considered to be passed on to the purchaser, thus muting the incentive.

Market-wide policy objectives, such as addressing climate change, require tax-based energy incentives that accommodate tax-exempt electric utilities, which collectively serve nearly 30% of retail customers in the U.S. The American Public Power Association has long argued that public power utilities should either have access to the ITC and PTC or receive some form of comparable benefit. At the urging of APPA and the National Rural Electric Cooperative Association, Congress has tried this several times over the years, but the latest proposal — refundable, direct-payment tax credits — shows the most promise.

This would be a two-step approach. The first step is to allow projects owned by public power utilities to qualify for the ITC and PTC. It sounds simple, but this is a critical step in changing the tax code that requires a fair amount of due diligence to make sure lawmakers get it right.

Next is making sure public power utilities can do something with these tax credits. The dominant approach currently being discussed in Washington would allow any project owner to elect for the IRS to deem that the owner has paid taxes in an amount equal to any tax credits it has earned. In turn, the owner relinquishes any right to those credits in the future. This might sound like a distinction without a difference, but swapping a credit against taxes paid for a deemed payment of taxes would allow a public power utility to then file a tax return with the IRS for refund of that deemed payment of taxes.

This is like the federal gasoline excise tax. State and local entities are exempt from the excise tax, but the excise tax is baked into the price paid at the pump. So, every year, thousands of governmental entities file a simple Form 8849 — Claim for Refund of Excise Taxes — with the IRS to get refunded. The mechanism by which public power utilities would claim a refund of “deemed” tax payments related to the ITC and PTC has yet to be decided, but a simple, single-use form akin to Form 8849 would be appropriate. 

The implications of this policy change are huge. Rather than a project developer and its tax-equity investors retaining a portion of the value of the ITC and PTC, every penny would stay with the utility to either pass on to customers in the form of lower rates or be available for use in building additional projects. For a $400 million utility-scale project, a 30% ITC would provide a lot of pennies to pass on.

Even where projects continue to be developed by third-party owners, public power utilities should be able to strike a better deal on the resulting power purchase agreement, knowing they can always do it themselves.

Perhaps more revolutionary will be the effect on smaller utilities and smaller projects. A simple, directly payable tax credit means public power utilities don’t have to go hat in hand to developers and tax-equity investors, hoping that their projects are large enough to garner interest. They can also develop projects on public spaces that they might otherwise be leery of having an outside party develop. In other words, this will unleash public power utilities and joint action agencies to develop more clean generation.