Tax Policy for Energy Efficient Upgrades

A proposal for more efficient energy-efficient tax credits

Abstract: Tax credits for fuel efficiency and clean energy typically drain tax revenue needed for other priorities. A new approach linking an expanded capital gains tax base to a new energy-efficient or clean energy tax credit reducing capital taxes will stimulate clean energy-efficient technology and increase tax revenue relative to current law.

Introduction: Existing tax credits designed to promote the use of clean energy and energy efficient homes are expensive to taxpayers. This post describes issues with existing tax credits and proposes changes to the tax code that would achieve important environmental goals at lower cost to taxpayers.

Existing Home Energy Tax Credits:

The existing tax code provides homeowners two types of tax credits, the residential clean energy credit, and the energy efficient home improvement credit, for qualifying energy-related home expenditures. Go here for a discussion of the two credits.

The residential energy credit gives a tax credit for 30 percent of the cost of clean energy technologies -- geothermal heat pumps, small wind turbines, solar energy systems, fuel cells and battery storage technology. There is no annual limit, the credit is available for both primary and secondary residences, and excess credits can be carried over to future taxes.

The energy-efficient home improvement credit applies to home upgrades, which reduce energy use at homes – windows and skylights, doors, insulation, water heaters, furnaces, boilers, central air conditioners, electric panels, and energy audits. The 30 percent credit has an annual limit of $3,200, the tax credit only applies to work on primary residences, and any excess credit cannot be applied to future taxes.

Go here for additional details on these tax credits.

We consider modifications to the tax code that would stimulate greater growth of clean energy and fuel efficiency at lower cost to taxpayers and a lower diversion of funds from other priorities.

Proposed Tax Code Modifications:

The proposed changes reduce the role of annual energy-efficient and clean energy tax credits, expand the number of people paying capital gains taxes on properties, and create an energy-tax credit for the reduction of capital gains taxes on properties. Some of the proposed changes to capital gains taxes were described here.

The proposed plan incentivizes many people to make investments in clean energy and fuel efficient technologies by promising reductions in the future capital gains on the sale of property.

Key changes:

· Reduce annual tax credit on the residential energy credit and energy-efficient tax credits to around 10 percent of the cost of the investment.

· Reduction in amount of gain exempted from capital gains tax,

· Reduction in capital gains tax rate, (Any reduction in rates increases realizations of gains),

· Elimination of 1031 exchanges,

· A small tax on unrealized gains at death,

· Create a tax credit of around half the increased cost from choosing energy efficient or clean-energy technology to reduce capital gains on property sales.

The lower immediate tax credit could reduce expenditures by some people who want to limit the immediate cash outflow from the investment, but other more long-term investors will be persuaded to make investments because of the greater likelihood of capital gain tax relief.

Many people who are planning to sell their home in a relatively short amount of time have little incentive to invest in clean energy or energy-efficient home improvements because they will not stay in the home long enough to recoup the investment.

The reduction in capital gains obtained by applying the new tax credit to the capital gains will encourage people who are planning to sell their property to invest in new clean or fuel efficient technology. The tax credit against the capital gains will only be available for people who choose clean or fuel-efficient technology.

The provisions of this proposal increase the number of people who pay capital gains taxes on property and could benefit from the new tax credit for clean or energy-efficient technology that will reduce the capital gain.

The proposal expands the capital gains tax base in several ways.

· It decreases the tax rate on capital gains encouraging more people to sell assets.

· It reduces the amount totally exempted from the tax thereby increasing the number of people paying some tax.

· It repeals 1031 exemptions which currently allow people to defer taxes

· It encourages asset sales and gain realizations by taxing unrealized gains at death

The tax on unrealized gains at death will also be reduced by investments in clean energy or fuel efficient technology, creating an additional incentive for clean investments.

This proposal links a new tax credit for fuel efficient and clean energy to proposals expanding the capital gains tax base.

The tax credit for fuel-efficient and clean-energy investments motivates investment.

The expansion of the capital gains tax base and the reduction in annual energy-efficient credits increases tax revenue relative to current law.