Fixing the nation's tax code is not only smart economic policy. It can also be good energy policy.
There is a longstanding, often-heated debate over how the federal government should treat energy subsidies in the tax code. While one side hauls the small pot of fossil fuel subsidies before the court of public opinion, the other accuses the wide array of renewable energy subsidies of tipping the scales.
Such arguments miss the point. The fundamental problem with the U.S. system of energy tax preferences is that it preserves the status quo, locking Americans into a system that keeps energy costs high and stifles innovation toward cleaner, safer, and cheaper energy alternatives.
Indeed, if a magic wand was waved and all $94 billion of existing energy subsidies were eliminated (exemptions of corporate tax for natural gas pipelines, investment tax credits for solar power, production tax credits for wind, etc.), the tax code would still be biased. That's because investments are taxed, while the costs of goods sold (like fuel) are not.
In other words, a business with high expenses (wages, cost of goods, etc.) can be more profitable than one that has the same lifetime costs and lifetime income, but which faces mostly capital costs.
The incentive under the current tax system is to narrow your taxable income with expenses, and to avoid capital investments that tie up your funds and don't offer a tax write-off. This affects the energy industry because the newest (and cleanest) sources of energy tend to be very capital intensive, and are thus less attractive as investments.
As an example, the nuclear power plant project that was just abandoned in South Carolina had an estimated capital cost of around $11.5 billion. But of course, the money invested in this venture is taxed. And given the statutory rate of that tax, an investment of $11.5 billion requires earnings of $17.7 billion -- $6.2 billion to pay the taxes involved, leaving $11.5 billion after taxes. Although the depreciation of the investment over time would narrow the tax base of the investment by 87 percent, the taxes paid for $11.5 billion of capital investment at a 35 percent tax rate are still $800 million – certainly not a sum to sneeze at.
Further, even when investors can deduct 100 percent of their investment under the current system, it can only be done over a period of anywhere between 3 and 50 years, discouraging investors who prefer near-term profits.
The solution is simple: Eliminate investments from the tax base in a reliable manner, via full and immediate expensing. I explained how this would work in recent research from the American Action Forum. Under full expensing, that tax for a new nuclear power plant is zero. The capital costs of a$11.5 billion nuclear power plant would be exactly $11.5 billion.
Meanwhile, ambitious projects like NetPower (a zero-emission natural gas power plant), NuScale (a small modular nuclear reactor that is 5,000 times less likely to have an incident than today's reactors), and others would no longer pay higher taxes than incumbents in the industry, on top of the costs of being early adopters.
Global energy demand is expected to climb 48 percent between 2012 and 2040, and addressing the energy-security and environmental concerns of tomorrow will require innovation-friendly policies today. History tells us that innovation takes time, and it takes even longer if policies stifle competitiveness and profitability.
Arguably, the greatest disadvantage of expensing is that it frontloads the loss of revenue from deducted investments, placing them all in the first year. But budget hawks should rest easy. At the proposed 20 percent corporate tax rate, full-expensing for projected new power plants over the next ten years would be $54 billion, nearly equal to the revenue we could raise by eliminating permanent energy tax breaks that would no longer be needed. For energy, at least, full-expensing can be a revenue-neutral policy that finally helps to stop penalizing innovators.
The bottom line is that the U.S. approach to energy innovation gets it exactly backwards, as if Henry Ford's first cars had been taxed and horses were subsidized in order to avoid losing access to horses. Tax reform offers an opportunity to break free of the energy status quo, and remove the roadblocks to a future of cleaner, safer, and cheaper energy alternatives.
Philip Rossetti is a data analyst at the American Action Forum who specializes in energy policy, with an emphasis on clean energy.
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