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Clean energy tax credits mostly go to the affluent. Is there a better way?

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One of the main ways US policy encourages the uptake of new clean energy and energy efficiency technologies is through the use of tax credits. There are tax credits for qualified windows, boilers, air conditioners, insulation, and more.

The US is something of an outlier in this. In the KPMG Green Tax Index — a ranking of countries according how much they use tax penalties and incentives to achieve sustainability goals — the US ranks number one. Notably, the US is 14th in the use of tax penalties. It is America's profligate use of tax incentives, mainly tax credits, that vaults it to number one overall.

Some new research brings troubling news about those tax credits. To put it bluntly: They are highly inequitable. Most of the money goes to relatively affluent consumers.

Let's look quickly at the research, touch on how the credits might be improved, and then discuss the political implications.

Clean energy tax credits mostly accrue to the affluent

The research was done by Severin Borenstein and Lucas Davis at the Energy Institute at HAAS, in UC Berkeley. (An early blog post on the conclusions is here. A slideshow summary is here. The full paper is here.) Borenstein and Davis use IRS tax return data to profile the recipients of federal clean energy tax credits. They focused on the five biggest:

Between 2006 and 2012 the largest categories of investments were energy-efficient windows ($4.0 billion), qualified furnaces ($2.4 billion), qualified air conditioners and water heaters ($2.4 billion), ceiling and wall insulation ($2.0 billion), and solar photovoltaic systems ($1.8 billion).

Here's what the spread looks like for residential energy credits:

residential energy credits
AGI = adjusted gross income.
(EI@HAAS)

I will spare you the graphs for the other credits, because they look more or less the same, with higher income filers claimed larger credits and a larger overall portion of the credit money.

Bottom line, of the $18 billion spent on federal energy tax credits since 2006:

The bottom three income quintiles have received about 10% of all credits, while the top quintile has received about 60%. The most extreme is the program aimed at electric vehicles, where we find that the top income quintile has received about 90% of all credits.

This is regressive. Is it more regressive than alternatives? Yes.

Other "tax expenditures" in general, and most other tax credits in particular, are also regressive. (The main exception is the earned income tax credit.) But they are not as regressive as these energy credits. A carbon tax that returns the revenue through tax or lump sum rebates is also less regressive.

Energy tax credits are also "horizontally inequitable," in that they exclude large number of people who might otherwise be eligible.

For one thing, they are "nonrefundable," which means they only pay out insofar as you have tax liability. They can't push your tax liability below zero. And if your federal income tax liability is already zero — like 40 percent of Americans — you're not eligible at all.

Also, energy tax credits exclude the entire rental market. Renters can't make capital investments in their homes, and landlords often face split incentives.

Both these features exacerbate the inequity of the credits, as they disproportionately exclude those with lower income.

This suggests a couple of obvious, immediate ways to improve energy tax credits. First, they should be made refundable. It's absurd that they aren't — there's no policy rationale for it. And second, there should be more attention to how to create incentives for landlords. (That's a complicated subject best saved for another post.)

What about broader implications? I would offer a few considerations in (somewhat unenthusiastic) defense of energy tax credits.

efficient appliances
Which is greener? Yeah, probably the green one.
(Shutterstock)

Not everything is a climate policy

The main point of the research, indeed something of an obsession among economists generally and EI @ HAAS economists specifically, is that energy tax credits are less effective than price-based instruments like a carbon tax. To most economists, climate policies are either a carbon price or "second best." We needn't rehearse all that again.

I'll just say that not everything is a climate policy, i.e., not everything should be judged on how cost-effectively it reduces net carbon emissions. A carbon tax targets that metric directly and is most likely to optimize for it. But in this fallen world of ours, so full of sin and temptation, policymakers sometimes target things other than economy-wide, technology-neutral, economically optimal means to social ends. Sometimes they want particular domestic industries or markets to grow, and carbon taxes are a roundabout means to that end. Instead, we get industrial policy, which is as old as industry itself.

(Is it helping those industries? The paper also compares sales of energy technologies before and after the credits are implemented and concludes they had little impact, but that conclusion seems more tentative to me.)

Not everything is redistributive

Borenstein and Davis conclude that "it would seem to be difficult to argue for these policies on distributional grounds." And that's true. But maybe they don't need to be justified on those grounds. Progressivity is a valuable overall goal for policy, but not every individual policy has to have progressive impacts. Certainly it's easy to imagine any number of policies (including, for example, a boost in the EITC) that could easily offset the regressivity of energy tax credits.

Beyond that, if the US had guaranteed health care, housing, and basic income, like the Scandinavian countries beloved by Bernie Sanders, the particular distributional effects of small-bore clean energy policies would probably be of much less concern. Sigh.

New markets tend to skew toward the wealthy

Almost any policy meant to stimulate fledgling markets is going to benefit better-off customers, because new technologies tend to be expensive, and better-off customers are the ones with money. Cellphones started out as a tool of the idle rich; now they are key to the economic well-being of hundreds of millions in the developing world. Solar panels, electric cars, and hyperefficient boilers are following the same path. But in the beginning, it's inevitably going to be wealthier people driving demand.

tesla dealership
It all starts here. Not for poor saps like you, I mean, but generally.
(Shutterstock)

What is the political alternative to tax credits?

Yes, tax credits kind of suck as policy, but ... compared to what?

The US conducts a lot of policy through the tax code, what author Suzanne Mettler calls The Submerged State, and it is unfortunate in the extreme — just a terrible way to conduct national business. (I wrote a long piece on tax expenditures once, if you want to dig in. See also the Center for American Progress's Tax Expenditures 101.)

The reason the US tops the world in tax incentives is that they are a perfect hack of our dysfunctional political economy. For decades, conservatives have demonized taxes and put in place balanced budget and paygo laws. Consequently, politicians aren't allowed to talk about raising taxes, except on the very rich.

However, if you give a favored company or industry a tax break, you're not raising taxes at all. You're lowering them! Now you can indulge in industrial policy and maintain your small-government bona fides at the same time. Sweet deal.

Of course, the impact on the federal budget is exactly the same. Whether it's a tax break or a direct subsidy, it's a federal expenditure; it leaves the feds with less revenue. But the semantics makes all the difference in a context where taxes are demonized.

Thus, more and more policy is channeled through tax expenditures. They are tucked away in the tax code; for the most part, only the industry that benefits from them even knows they exist (and works to maintain them). Because they're hidden, and because they are skewed to those with federal tax liability, they tend to be strongly regressive.

What's worse, many of the consumers who benefit from them don't even know it. The submerged state tends to act through private business, via taxes, and thus manifests to the consumer as the private sector. So people have no idea what government is doing for them (or to them).

iceburg
The submerged state. Metaphorically speaking.
(Shutterstock)

It's a bad scene, pretty much designed for rent seeking. But what are clean energy interests supposed to do, unilaterally disarm? US politics is more dysfunctional than ever. There's no carbon tax on the horizon. And even if there were, there would still be social and economic reasons to support growth in particular domestic markets.

Tax expenditures aren't even a "second best" policy. They're much farther down the list than that. But in the current political economy, they may be an "only possible" policy, in which case the relevant comparison is not a carbon tax, but nothing at all.