Federal Energy Efficiency Tax Credits: A Policy That Sounds Better Than It Is

Posted on 05-04-2018

By Nick McClure and Huiru (Ruth) Kang

Energy efficiency has been a national policy priority in the United States for decades. Since the 1970s, politicians of diverse ideological perspectives have advanced policies aimed at reducing energy use. For more than the last decade, the U.S. has attempted to increase household efficiency through the Federal tax code. The Energy Policy Act of 2005 introduced a tax credit for energy efficient home improvements, such as roofs and insulation, and appliances, such as water heaters and heating and cooling systems. With some adjustments over the years, the credit has been extended six times, most recently in the Bipartisan Budget Act of 2018, and has provided approximately $12.7 billion to households since 2008. 

Policy makers, interest groups, and the public alike view the benefits of investing in energy efficiency as an axiom: more is always better. Environmentalists view energy efficiency investment as a means to reduce greenhouse gas emissions. National security strategists portray efficiency investment as pathway to energy independence. Households view see it as way to lower heating and lighting bills. The views are so widely held that the most recent extension of the tax credit—and an estimated $500 million—seemingly didn’t garner debate among policy makers or the attention of the media. Issues related to greenhouse gas emissions, energy independence, and household-level decision making could all warrant government involvement, yet the current tax credit fails to deliver its ascribed benefits. 

Despite typical household views on energy efficiency investment always yielding benefits, a project such as installing a more efficient water heater, should be undertaken only if it the cumulative energy savings produce a positive return. Although researchers have observed that households do not invest in all profitable efficiency projects, the tax credit doesn’t address the primary reasons why not all profitable projects are pursued. For example, energy efficiency investments will probably not be made in the more than 43 million rented housing units in the U.S. because tenants receive the benefits of lower utility bills, while landlords bear the cost. This is because the tax credit is only available to tax filers who own their home. 

The tax credit also fails to directly address issues related to climate change or national security. McKinsey and Company estimate that several gigatons of carbon dioxide emissions can be abated at a negative cost through greater energy efficiency in residential building materials, appliances, and lighting. However, the tax credit only addresses carbon dioxide emissions to the extent that it reduces electricity use among households powered by coal-fired or other carbon-producing power plants. Because the credit is available to all households, it reduces overall electricity use, irrespective of fuel source. Similarly, a reduction in energy consumption could increase U.S. energy independence if energy imports are reduced, but the tax credits primarily lowers electricity use, which is powered by domestic fuel sources. 

The credit has other drawbacks. Most notably, the distribution of the benefits is highly regressive. In 2013, the top 15% of tax filers by adjusted gross income received nearly 55% of the total amount granted. Further, the credit, at least in earlier years, allowed for fraud as evidenced by a 2011 report by the US Treasury Department Inspector General for Tax Administration, which was unable to confirm if 30% of credit recipients even qualified for the credit. More broadly, many recipients would have made investments regarding of the credit and simply received it as free money, as is the case for most recipients of similar credits in Europe.

Despite its popularity, as evidenced by repeated extensions, the energy efficiency tax credit is a blunt tool that has likely done little more than transfer money to middle- and upper-income households, many of whom would have invested in more efficient home improvements anyway. If policy makers are to continue the credit, they, at a minimum, should allow the it to be refundable so lower-income households benefit. However, a better policy would be to end the tax credit and redirect the money to basic research in areas like energy storage, which would aid the shift to renewables and make the electric grid more reliable. 

Nick McClure is a Master of Public Administration student at the University of Pittsburgh, Graduate School of Public and International Affairs. His research and professional interests center on state and local public finance issues related to energy, infrastructure, and the environment. 

Huiru (Ruth) Kang is a Master of Public Administration student at the University of Pittsburgh, Graduate School of Public and International Affairs. Her research interests include international cooperation on clean energy, energy poverty alleviation, and climate change.

About the blog: The GSPIA Energy and Environment blog provides commentary and analysis that furthers understanding of E&E issues of public interest. Its primary contributors are GSPIA faculty and students. 

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