PRESENT LAW AND BACKGROUND RELATING TO 

TAX CREDITS FOR ELECTRICITY PRODUCTION 

FROM RENEWABLE SOURCES 

Scheduled for a Public Hearing 

Before the 

SUBCOMMITTEE ON SELECT REVENUE MEASURES 

of the 

HOUSE COMMITTEE ON WAYS AND MEANS 

on May 24, 2005 

Prepared by the Staff 

of the 

JOINT COMMITTEE ON TAXATION 

May 19, 2005 

JCX-36-05 
ii 

CONTENTS 

Page

INTRODUCTION .......................................................................................................................... 1 

I. PRESENT LAW AND LEGISLATIVE HISTORY ............................................................. 2 

A. Present Law..................................................................................................................... 2 

B. Legislative History.......................................................................................................... 7 

II. DISCUSSION OF ISSUES ................................................................................................... 8 
1 

INTRODUCTION 

The Subcommittee on Select Revenue Measures of the House Committee on Ways and 

Means has scheduled a public hearing for May 24, 2005, on tax credits for electricity production 

from renewable sources. This document,1

 prepared by the staff of the Joint Committee on 

Taxation, provides a description of the present law and the legislative history pertaining to the 

present-law credit for the production of electricity from certain renewable resources (section 45 

of the Internal Revenue Code). This document also discusses issues related to section 45. 

 1

 This document may be cited as follows: Joint Committee on Taxation, Present Law and 

Background Relating to Tax Credits for Electricity Production from Renewable Sources (JCX-36-05), 

May 19, 2005. 
2 

I. PRESENT LAW AND LEGISLATIVE HISTORY 

A. Present Law 

In general

An income tax credit is allowed for the production of electricity from qualified facilities 

sold by the taxpayer to an unrelated person (sec. 45). Qualified facilities comprise wind energy 

facilities, “closed-loop” biomass facilities, open-loop biomass (including agricultural livestock 

waste nutrients) facilities, geothermal energy facilities, solar energy facilities, small irrigation 

power facilities, landfill gas facilities, and trash combustion facilities. In addition, an income tax 

credit is allowed for the production of refined coal. 

Credit amounts and credit period

In general

The base amount of the credit is 1.5 cents per kilowatt-hour (indexed for inflation) of 

electricity produced. The amount of the credit is 1.9 cents per kilowatt-hour for 2005. A 

taxpayer may claim credit for the 10-year period commencing with the date the qualified facility 

is placed in service. The credit is reduced for grants, tax-exempt bonds, subsidized energy 

financing, and other credits. The amount of credit a taxpayer may claim is phased out as the 

market price of electricity (or refined coal in the case of or refined coal production credit) 

exceeds certain threshold levels. 

Reduced credit amounts and credit periods

In the case of open-loop biomass facilities (including agricultural livestock waste nutrient 

facilities), geothermal energy facilities, solar energy facilities, small irrigation power facilities, 

landfill gas facilities, and trash combustion facilities, the 10-year credit period is reduced to five 

years commencing on the date the facility is placed in service. In general, for eligible preexisting facilities and other facilities placed in service prior to January 1, 2005, the credit period 

commences on January 1, 2005. In the case of a closed-loop biomass facility modified to co-fire 

with coal, to co-fire with other biomass, or to co-fire with coal and other biomass, the credit 

period begins no earlier than October 22, 2004. 

In the case of open-loop biomass facilities (including agricultural livestock waste nutrient 

facilities), small irrigation power facilities, landfill gas facilities, and trash combustion facilities, 

the otherwise allowable credit amount is 0.75 cent per kilowatt-hour, indexed for inflation 

measured after 1992. 

Credit applicable to refined coal

The amount of the credit for refined coal is $4.375 per ton (also indexed for inflation 

after 1992 and equaling $5.481 per ton for 2005). 
3 

Other limitations on credit claimants and credit amounts

In general, in order to claim the credit, a taxpayer must own the qualified facility and sell 

the electricity produced by the facility (or refined coal in the case of the refined coal production 

credit) to an unrelated party. A lessee or operator may claim the credit in lieu of the owner of the 

qualifying facility in the case of qualifying open-loop biomass facilities originally placed in 

service on or before the date of enactment and in the case of a closed-loop biomass facilities 

modified to co-fire with coal, to co-fire with other biomass, or to co-fire with coal and other 

biomass. In the case of a poultry waste facility, the taxpayer may claim the credit as a lessee or 

operator of a facility owned by a governmental unit. 

For all qualifying facilities, other than closed-loop biomass facilities modified to co-fire 

with coal, to co-fire with other biomass, or to co-fire with coal and other biomass, the amount of 

credit a taxpayer may claim is reduced by reason of grants, tax-exempt bonds, subsidized energy 

financing, and other credits, but the reduction cannot exceed 50 percent of the otherwise 

allowable credit. In the case of closed-loop biomass facilities modified to co-fire with coal, to 

co-fire with other biomass, or to co-fire with coal and other biomass, there is no reduction in 

credit by reason of grants, tax-exempt bonds, subsidized energy financing, and other credits. 

The credit for electricity produced from renewable sources is a component of the general 

business credit (sec. 38(b)(8)). Generally, the general business credit for any taxable year may 

not exceed the amount by which the taxpayer’s net income tax exceeds the greater of the 

tentative minimum tax or so much of the net regular tax liability as exceeds $25,000. Excess 

credits may be carried back one year and forward up to 20 years. 

A taxpayer’s tentative minimum tax is treated as being zero for purposes of determining 

the tax liability limitation with respect to the section 45 credit for electricity produced from a 

facility (placed in service after October 22, 2004) during the first four years of production 

beginning on the date the facility is placed in service. 

Qualified facilities

Wind energy facility

A wind energy facility is a facility that uses wind to produce electricity. To be a qualified 

facility, a wind energy facility must be placed in service after December 31, 1993, and before 

January 1, 2006. 

Closed-loop biomass facility

A closed-loop biomass facility is a facility that uses any organic material from a plant 

which is planted exclusively for the purpose of being used at a qualifying facility to produce 

electricity. In addition, a facility can be a closed-loop biomass facility if it is a facility that is 

modified to use closed-loop biomass to co-fire with coal, with other biomass, or with both coal 

and other biomass, but only if the modification is approved under the Biomass Power for Rural 

Development Programs or is part of a pilot project of the Commodity Credit Corporation. 
4 

To be a qualified facility, a closed-loop biomass facility must be placed in service after 

December 31, 1992, and before January 1, 2006. In the case of a facility using closed-loop 

biomass but also co-firing the closed-loop biomass with coal, other biomass, or coal and other 

biomass, a qualified facility must be originally placed in service and modified to co-fire the 

closed-loop biomass at any time before January 1, 2006. 

Open-loop biomass (including agricultural livestock waste nutrients) facility

An open-loop biomass facility is a facility using open-loop biomass to produce 

electricity. Open-loop biomass is defined as (1) any agricultural livestock waste nutrients, or (2) 

any solid, nonhazardous, cellulosic or lignin waste material which is segregated from other waste 

materials and which is derived from certain forest-related resources, solid wood waste materials, 

or agricultural sources. Eligible forest-related resources are mill residues, other than spent 

chemicals from pulp manufacturing, precommercial thinnings, slash, and brush. Solid wood 

waste materials include waste pallets, crates, dunnage, manufacturing and construction wood 

wastes (other than pressure-treated, chemically-treated, or painted wood wastes), and landscape 

or right-of-way tree trimmings. Agricultural sources include orchard tree crops, vineyard, grain, 

legumes, sugar, and other crop by-products or residues. However, qualifying open-loop biomass 

does not include municipal solid waste (garbage), gas derived from biodegradation of solid 

waste, or paper that is commonly recycled. In addition, open-loop biomass does not include 

closed-loop biomass or any biomass burned in conjunction with fossil fuel (co-firing) beyond 

such fossil fuel required for start up and flame stabilization. 

Agricultural livestock waste nutrients are defined as agricultural livestock manure and 

litter, including bedding material for the disposition of manure. 

To be a qualified facility, an open-loop biomass facility must be placed in service after 

October 22, 2004 and before January 1, 2006, in the case of facility using agricultural livestock 

waste nutrients and must be placed in service at any time prior to January 1, 2006 in the case of a 

facility using other open-loop biomass. 

Geothermal facility

A geothermal facility is a facility that uses geothermal energy to produce electricity. 

Geothermal energy is energy derived from a geothermal deposit which is a geothermal reservoir 

consisting of natural heat which is stored in rocks or in an aqueous liquid or vapor (whether or 

not under pressure). To be a qualified facility, a geothermal facility must be placed in service 

after October 22, 2004 and before January 1, 2006. 

Solar facility

A solar facility is a facility that uses solar energy to produce electricity. To be a qualified 

facility, a solar facility must be placed in service after October 22, 2004 and before January 1, 

2006. 
5 

Small irrigation facility

A small irrigation power facility is a facility that generates electric power through an 

irrigation system canal or ditch without any dam or impoundment of water. The installed 

capacity of a qualified facility must be not less than 150 kilowatts but less than five megawatts. 

To be a qualified facility, a small irrigation facility must be originally placed in service after 

October 22, 2004 and before January 1, 2006. 

Landfill gas facility

A landfill gas facility is a facility that uses landfill gas to produce electricity. Landfill gas 

is defined as methane gas derived from the biodegradation of municipal solid waste. To be a 

qualified facility, a landfill gas facility must be placed in service after October 22, 2004 and 

before January 1, 2006. 

Trash combustion facility

Trash combustion facilities are facilities that burn municipal solid waste (garbage) to 

produce steam to drive a turbine for the production of electricity. To be a qualified facility, a 

trash combustion facility must be placed in service after October 22, 2004 and before January 1, 

2006. 

Refined coal facility

A qualifying refined coal facility is a facility producing refined coal that is placed in 

service after the date of enactment and before January 1, 2009. Refined coal is a qualifying 

liquid, gaseous, or solid synthetic fuel produced from coal (including lignite) or high-carbon fly 

ash, including such fuel used as a feedstock. A qualifying fuel is a fuel that when burned emits 

20 percent less nitrogen oxides and either SO2 or mercury than the burning of feedstock coal or 

comparable coal predominantly available in the marketplace as of January 1, 2003, and if the 

fuel sells at prices at least 50 percent greater than the prices of the feedstock coal or comparable 

coal. In addition, to be qualified refined coal the fuel must be sold by the taxpayer with the 

reasonable expectation that it will be used for the primary purpose of producing steam. 
6 

Summary of credit rate and credit period by facility type

Table 1.–Summary of Section 45 Credit for Electricity Produced 

from Certain Renewable Resources and Refined Coal 

Electricity produced from 

renewable resources 

Credit amount for 

2005 

(cents per kilowatthour; dollars per ton)

Credit period 

(years from 

placed-in-service 

date)1

Wind............................................................... 

Closed-loop biomass...................................... 

Open-loop biomass ........................................ 

 (including agricultural livestock 

 waste nutrient facilities) 

Geothermal..................................................... 

Solar ............................................................... 

Small irrigation power ................................... 

Municipal solid waste .................................... 

 (including landfill gas facilities 

 and trash combustion facilities) 

1.9 

1.9 

0.9 

1.9 

1.9 

0.9 

0.9 

 10 

 10 

 5 

 5 

 5 

 5 

 5 

Refined Coal 5.481 10 

1

 For eligible pre-existing facilities and other facilities placed in service prior to January 1, 2005, the credit period 

commences on January 1, 2005. In the case of certain co-firing closed-loop facilities, the credit period begins no 

earlier than October 22, 2004. 
7 

B. Legislative History 

The Energy Policy Act of 1992 created section 45 as a production credit for electricity 

produced from wind and closed-loop biomass for production from certain facilities placed in 

service before July 1, 1999. The Ticket to Work and Work Incentives Improvement Act of 1999 

added poultry waste as a qualifying energy source, extended the placed in service date through 

December 31, 2001, and made certain modifications to the requirements of qualifying wind 

facilities. The Job Creation and Worker Assistance Act of 2002 extended the placed in service 

date through December 31, 2003. The Working Families Tax Relief Act of 2004 extended the 

generally applicable placed in service date for wind facilities, closed-loop biomass facilities, and 

poultry waste facilities through December 31, 2005. The American Jobs Creation Act of 2004 

(“AJCA”) modified the provision to add as qualified facilities open-loop biomass (including 

agricultural livestock waste nutrients2

), geothermal energy, solar energy, small irrigation power, 

and municipal solid waste (both landfill gas and trash combustion facilities). The AJCA defined 

refined coal as a qualifying resource eligible for credit. The AJCA also made other 

modifications. 

At the time of passage of the credit in 1992, the House Committee on Ways and Means 

stated that “the credit is intended to enhance the development of technology to utilize the 

specified renewable energy sources and to promote competition between renewable energy 

sources and conventional energy sources.”3 The House Committee on Ways and Means further 

stated that the purpose of the original expiration date (June 30, 1999) was “to provide the 

committee with the opportunity to assess the effectiveness of the credit in encouraging the 

utilization of renewable energy sources.”4 

 2

 The definition of agricultural livestock waste nutrients subsumes poultry waste, so the Act 

repealed, prospectively, poultry waste facilities as a separate category of qualified facility. 

3

 House of Representatives, Rept.102-474, Part 6, “Comprehensive National Energy Policy Act,” 

H.R. 776, p. 42. 

4

 Ibid.
8 

II. DISCUSSION OF ISSUES 

Value of the production tax credit 

Electricity produced from renewable resources

For a taxpayer with a positive tax liability, the electricity production credit is equivalent 

to a subsidy that pays the taxpayer for each kilowatt-hour of electricity produced in addition to 

the price at which the producer sells the electricity. That is, a tax credit that reduced a taxpayer’s 

tax liability and therefore increases the taxpayer’s bottom line produces a benefit to the taxpayer 

similar to a direct subsidy that is paid to the taxpayer to improve the taxpayer’s top line.5 

Measured at a rate per kilowatt-hour, the direct subsidy equivalent of the electricity production 

tax credit is c/(1-t), where c is the credit rate per kilowatt-hour and t is the taxpayer’s marginal 

tax rate.6

 If the taxpayer is a corporate taxpayer with a marginal tax rate of 35 percent, the 

subsidy equivalent of the 1.5 cents-per-kilowatt-hour base credit amount is approximately 2.3 

cents per kilowatt-hour of electricity produced. The subsidy equivalent amount of the 2005 level 

of the credit (1.9 cents per kilowatt-hour) is approximately 2.9 cents per kilowatt-hour. For 

producers of electricity from qualifying renewable sources this “subsidy” would be in addition to 

the wholesale price they receive from the sale of power. Data on wholesale prices are not readily 

available. However, the Department of Energy reports data on retail prices. The Department of 

 5

 Under general income tax principles, such a subsidy paid to the taxpayer would be includable in 

taxable income as part of revenue. For the purposes of the subsequent discussion, it is assumed that such 

a subsidy is part of the taxpayer’s taxable income. 

6

 To see that c/(1-t) is the direct subsidy equivalent of the electricity production tax credit, the 

analysis will focus on marginal after-tax profit. As such, the analysis can disregard all fixed costs of 

production at a qualifying facility. Let R denote the revenue per kilowatt-hour from the sale of electricity 

and let X be the variable cost expense of generating one kilowatt-hour of electricity. Let c be the credit 

rate per kilowatt-hour of electricity produced. Finally let t be the taxpayer’s marginal tax rate. 

If the taxpayer qualifies to claim the electricity production tax credit, the taxpayer’s after-tax 

profit per kilowatt-hour of electricity production is given by equation (1). 

(1) (R-X) • (1-t) + c = marginal after-tax profit. 

Now assume that instead of a tax credit the taxpayer is paid a subsidy, S, per kilowatt-hour of electricity 

produced. The taxpayer’s marginal after-tax profit per kilowatt-hour of electricity production under this 

scenario is given by equation (2). 

(2) (S+R-X) • (1-t) = marginal after-tax profit. 

If one asks what value of S yields the same marginal after-tax profit as the electricity production 

tax credit, c, by equating equations (1) and (2), one finds that the subsidy equivalent to the production tax 

credit is: 

S = c/(1-t) 
9 

Energy reports that the national average retail price of electricity for 2004 was 7.57 cents per 

kilowatt-hour, with the average for residential customers of 8.94 cents per kilowatt-hour and the 

average for industrial customers of 5.11 cents per kilowatt-hour.7 Thus, the tax credit for 

production of electricity is equivalent to a subsidy equal to nearly 37 percent of the average retail 

price of electricity. As electricity prices vary by region, the rate of subsidy is higher in some 

parts of the country and lower in other parts of the country. 

An alternative way to assess the value of the credit to the taxpayer should be to think of 

the credit as part of the taxpayer’s stream of receipts across the life of the taxpayer’s investment 

in the renewable energy project. In this view, the value of the credit to the taxpayer is equal to 

the value of the payment the taxpayer would have to receive annually per kilowatt-hour of 

electricity produced over the life of the project to produce a revenue stream that is equal in 

present value to the revenue produced by the credit over the life of the project (recognizing that 

generally the credit only produces revenue for the first ten years of the project and nothing 

thereafter). Assuming that a qualifying investment in a renewable energy production facility has 

a 20-year life, the 1.9 cents per kilowatt-hour production tax credit claimable by the taxpayer for 

the first ten years, but not thereafter, is equivalent to a cash subsidy of 1.66 cents per kilowatthour payable on all production throughout the 20-year life of the investment.8

 In this view of the 

value of the tax credit, the tax credit is equivalent to a subsidy equal to 22 percent of the average 

retail price of electricity. 

Refined coal

The same calculations as those described above can be applied to calculate a revenue 

subsidy equivalent of the $5.481 per ton credit applicable to refined coal. This credit amount is 

equivalent to an increase in revenues of $8.43 per ton of coal to a taxpayer producing refined 

coal. 

Investment in renewable energy electricity production capacity

Are investments in renewable resource electric generation facilities competitive?

As with any investment decision, a potential investor in a renewable resource electric 

generation facility compares expected revenues to expected costs. A taxpayer will invest in a 

 7

 Energy Information Administration, Monthly Energy Review, March 2005, Table 9.9. The 

reported average retail prices include any State and local sales or excise taxes applicable to electricity 

within various jurisdictions. 

8

 This value is determined, as in the previous computation, assuming the taxpayer is a corporate 

taxpayer with a marginal tax rate of 35 percent. The present calculation also assumes that production of 

electricity is equal in all years of the facility’s assumed 20-year life. The stream of cash receipts is 

discounted at a real interest rate of three percent. A real discount rate of three percent may be 

conservative. From the investor’s perspective it would be more appropriate to use the investor’s real cost 

of capital, which generally would exceed three percent. Under discount rates greater than three percent 

the cash equivalent 20-year subsidy calculated here would exceed 1.66 cents per kilowatt-hour. 
10 

facility to produce electricity from renewable resources if the return from the investment is better 

than, or comparable to, returns that the taxpayer can expect from alternative investments of 

comparable risk. Because of the different technologies involved, the expected capital and 

operating costs of different generation facilities may vary substantially by type of facility. In 

addition, because any generation facility sells electricity into a market in which the demand for, 

and price of, electricity can vary by time of day or season, different generation facilities may 

receive different levels of revenue per unit of power produced. 

A taxpayer contemplating an investment in a renewable resource electric generation 

facility is in competition with other providers of electricity. The revenues the taxpayer can 

expect from the sale of electricity into the grid generally will be determined by the price received 

for the lowest-cost source of electricity, absent regulatory intervention.9

 In some parts of the 

country electricity produced from combined cycle natural gas turbines are considered to be the 

low-cost provider of incremental increases in electricity production. In other parts of the 

country, coal-fired power plants may be the low-cost provider of incremental increases in 

electricity production. The Department of Energy has estimated “levelized costs” of new 

conventional and renewable generation facilities in the absence of the production tax credit.10 

 9

 See the discussion below relating to existing State renewable energy programs. 

10 The “levelized cost” is the cost per kilowatt-hour of electricity produced accounting for all 

capital costs, including the return to investors, fuel costs, and operating and maintenance costs. The 

“levelized cost” further assumes capacity utilization rates that vary by facility type. For example, coalfired facilities generally have a higher capacity utilization rate than do wind facilities, as the wind does 

not always blow sufficiently for the wind facility to produce near its rated capacity. The projections of 

levelized costs also assume technological improvements occur between the present and the year of the 

projection, 2010. 

While the Department of Energy calculations do not assume the availability of the production tax 

credit for 2010, in calculating the costs of geothermal and solar facilities the Department of Energy 

analysis assumes that investors may claim the investment tax credit allowed under sec. 48 for such 

facilities. Energy Information Administration, Department of Energy, Annual Energy Outlook 2005. 
11 

Table 2.–Levelized Costs of New Conventional and 

Renewable Generation, Department of Energy 

Conventional Source Cost in Cents Per 

Kilowatt-Hour1

Combined cycle (natural gas)................. 

Combustion turbine (natural gas)........... 

Coal ........................................................ 

4.7 

7.0 

4.3 

Renewable Source

Geothermal............................................. 

Photovoltaic ........................................... 

Solar thermal .......................................... 

Open-loop biomass ................................ 

Wind....................................................... 

4.4 

21.0 

12.6 

5.1 

4.8 

1 Projected 2010 costs per kilowatt-hour in 2003 cents per kilowatt-hour under the 

Energy Information Administration reference case. 

Source: Energy Information Administration, Annual Energy Outlook 2005. 

In an independent analysis, the California Energy Commission derived estimated 

levelized costs for new conventional and selected renewable generation facilities.11 Table 3, 

below, reproduces the estimates of the California Energy Commission. The estimates of 

levelized costs are comparable for solar and geothermal facilities. However, while the reported 

estimates for wind are close in magnitude (4.8 cents per kilowatt-hour in the Department of 

Energy analysis and 4.93 cents per kilowatt-hour in the California Energy Commission analysis), 

they are not directly comparable. The California Energy Commission calculation reduces the 

capital and operation and maintenance costs of a wind facility by an investor’s ability to claim 

 11 The estimates of the California Energy Commission make different assumptions than those of 

the Department of Energy with respect to such factors as the price of natural gas, the useful life of certain 

facilities, and capacity utilization factors. The California Energy Commission estimates also assume that 

all such facilities would be located in California. Like the Department of Energy analysis, the California 

Energy Commission assumes investors in geothermal and solar generation facilities would claim the 

investment tax credit for such facilities allowed under sec. 48 of the Code. California Energy 

Commission, Final Staff Report: Comparative Cost of California Central Station Electricity Generation 

Technologies, (Prepared in support of the “Electricity and Natural Gas Report” under the Integrated 

Energy Policy Report Proceeding Docket 02-IEP-01), June 5, 2003. 
12 

the production credit under section 45.12 The Department of Energy analysis does not reduce 

capital and operation and maintenance costs in its reference case. Other differences include the 

quality of the wind resource (national siting for the Department of Energy, California siting for 

The California Energy Commission), the year in which the facility is placed in service (2010 for 

the Department of Energy, 2003 for the California Energy Commission), the available 

technology embedded and cost of equipment when the facility is placed in service, and access to 

the transmission system. 

Table 3.–Levelized Costs of New A Conventional and Renewable 

Generation, California Energy Commission 

Conventional Source Cost in Cents Per 

Kilowatt-Hour1

Combined cycle (natural gas).................... 

Simple cycle (natural gas)......................... 

5.18 

15.71 

Renewable Source

Wind.......................................................... 

Hydropower .............................................. 

Solar thermal (parabolic trough) ............... 

Solar thermal (parabolic trough ...............

 with thermally enhanced storage) 

Geothermal (flash)2 ................................... 

Geothermal (binary)2................................. 

4.93 

6.04 

21.53 

17.36 

4.52 

7.37 

1

 Costs per kilowatt-hour are reported in 2002 dollars. 

2 A “flash” facility is one at which steam can be extracted from the geothermal resource to 

directly turn a turbine. At a “binary” facility the heat is extracted from the hot water pumped from the 

geothermal resource and is used to heat water or another liquid to its boiling point to produce steam to 

turn a turbine. 

Source: California Energy Commission, Final Staff Report, p.2. 

 12 Ibid, p. 8 and p. R-3. 
13 

The production performance of renewable resource facilities is often very site specific, 

for example depending upon the seasonality of wind, the average amount of daylight, or the 

ability to obtain a steady supply of open-loop biomass material. With these caveats in mind, the 

Department of Energy and the California Energy Commission estimates in Tables 2 and 3, 

above, suggest that in some locations wind and geothermal facilities may be cost-competitive 

with conventional facilities.13 However, this does not necessarily mean all such facilities are 

profitable investments in the absence of the production tax credit or other market intervention. 

While the Department of Energy and the California Energy Commission have estimated 

costs, they have not estimated the likely revenues from the sale of electricity generated by such 

facilities. The market for electricity pays premiums for the ability of a producer to provide 

power at certain times of peak demand (by day and by season). The market may also pay more 

for power that can be counted on as part of base-load capacity. As a weather-dependent source, 

investors in wind facilities may receive less favorable pricing for electricity than do investors in 

conventional generation or geothermal or open-loop biomass. However, as calculated above, the 

production tax credit is equivalent to a significant increase in revenues for the producer. If 

investors in wind facilities (1.9 cents per kilowatt-hour credit for ten years of production), 

geothermal facilities (1.9 cents per kilowatt-hour credit for five years of production), and openloop biomass facilities (0.9 cents per kilowatt-hour credit for five years of production) can expect 

to contract for prices close to those of natural gas facilities or coal facilities, the existence of the 

production tax credit may make investments in renewable resource electric generation facilities 

attractive to potential investors. 

Termination of eligibility for the production tax credit and investment risk

Different types of renewable energy electricity production facilities require different 

amounts of lead time from site selection to local permitting and acquisition of key components 

for the facility through to completion of construction. While analysts generally agree that the 

construction period required to bring a wind turbine on line is less than the development of a 

geothermal field and production facility, when all aspects of project development are considered 

it can take more than one year to initiate and complete a wind project. As described in Part I.B. 

above, after initially providing a period of greater than five years to place credit-eligible 

investments in service, the Congress has extended the place-in-service date requirement for 

potentially qualifying facilities on three occasions, each of which occurred after the expiration 

date provided under prior law. Each extension provided a place-in-service period of less than 

three years. As a consequence, since 1999 the investment climate for potentially qualifying 

projects has been more uncertain than previously. Increased uncertainty regarding whether an 

 13 In a 1999 survey of the existing literature relating to the costs of renewable resources for 

electricity generation, the analysts concluded that “[c]current cost estimates are close to the average cost 

of generation from conventional sources.” However, while unclear, it appears these analysts may have 

reached this conclusion assuming that the production tax credit offset capital and operating costs of wind 

facilities. James McVeigh, Dallas Burtraw, Joel Darmstadter, and Karen Palmer, “Winner, Loser, or 

Innocent Victim? Has Renewable Energy Preformed As Expected?” Resources for the Future, Discussion 

Paper 99-28, June 1999, p.11. 
14 

investment will be credit eligible may discourage some taxpayers from exploring the 

development of qualifying facilities. 

Growth of production of electricity from renewable resource electric generation 

facilities

The production credit for electricity from qualified facilities has been available to 

taxpayers since 1993 (applicable to facilities placed in service after 1993), but until the passage 

of the AJCA the credit was available only with respect to wind facilities, closed-loop biomass 

facilities, and poultry waste facilities. In practice, investors have only found it profitable to 

invest in wind facilities. Since 1993, the year before qualified wind facilities became eligible for 

the credit, the annual production of electricity from wind has more than quadrupled.14 See 

Figure 1 below. Figure 1 reveals that the most rapid growth did not occur in the first five years 

after the credit was created, but over the past six years.15 Over the past decade technological 

gains have been made in the design and efficiency of wind turbines. Figure 1 suggests that the 

credit was not solely responsible for the growth in production of electricity from wind, but it is 

not possible from available data to identify the extent to which the credit, technological 

improvements, the price of alternative production sources (e.g., fossil fuel facilities), State 

regulation, or other factors contributed to the growth of wind power. Nevertheless, even with 

this significant growth, wind power accounted for less than four-tenths of one percent of total net 

generation of electricity in the United States in 2004.16 

 14 Energy Information Administration, Monthly Energy Review, March 2005, Table 7.2a. 

15 As noted above, the tax credit for production from wind facilities was enacted in 1992, 

effective for facilities placed in service after 1993. The Energy Information Administration reports that in 

1998, six years after the credit was enacted effective for new facilities in 1994 and thereafter, the 

production of electricity from wind was 3,026 million kilowatt-hours compared to a production of 3,006 

million kilowatt-hours in 1993. Ibid.

16 Ibid.
15 

Source: Energy Information Administration. 

Since the inception of the credit, other sources of renewable energy, many of which are 

now eligible under present law, have been more significant sources of renewable energy than 

wind power. Figure 2, below, reports the annual production of electricity from wood (including 

wood, black liquor, and other wood waste), waste (including municipal solid waste, landfill gas, 

sludge waste, tires, agricultural byproducts, and other biomass), and geothermal. These three 

categories accounted for 1.9 percent of total net generation of electricity in the United States in 

2004.17 Electricity generation from solar power, both solar thermal and photovoltaic sources, has 

been substantially less, but growing. Electricity generation from solar sources totaled 251 

million kilowatt-hours in 1990 and 579 million kilowatt-hours in 2004.18 

 17 Ibid.

18 Ibid.

Figure 1.–Electricity Generation from Wind, 1989-2004

(millions of kilowatt-hours)

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

First year for credit 

eligible facilities 

Year

Millions of kilowatt-hours 
16 

Source: Energy Information Administration. 

The largest source of electricity generated from renewable resources is hydroelectric 

power. In 2004, conventional hydroelectric power produced 269, 637 million kilowatt-hours of 

electricity. This comprised 6.8 percent of total net generation of electricity in the United States 

in 2004. Since 1975, electricity from conventional hydroelectric power has varied between a 

peak production of 356,453 million kilowatt-hours in 1997 and a trough of 216,961 million 

kilowatt-hours in 2001.19

Production tax credit and the efficiency of investment decisions

The electricity production tax credit is economically equivalent to an open-ended 

subsidy, available to any taxpayer with no requirement to make an application to a government 

agency for the subsidy.20 If a taxpayer believes that the sum of electricity prices plus the credit 

 19 Ibid. 

20 Of course, building codes and other regulations may require government approval for a 

proposed investment in a qualifying facility, but a taxpayer does not require approval before claiming the 

implicit subsidy offered by the credit. 

Figure 2.–Electricity Generation from Other Renewable Sources, 1989-2004

(millions of kilowatt-hours)

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Wood

Waste

Geothermal

Year
17 

creates a profitable rate of return, the taxpayer will invest in a qualifying facility. In theory, 

investors should invest in qualifying facilities up to the point where the return from additional 

investment in qualifying facilities is no greater than the return on alternative investments. With 

the tax credit equal for all taxpayers and because qualifying renewable energy sources are not 

uniformly available at equal cost, the credit is more valuable to investors in certain facilities in 

certain geographic locations, than for investors with similar facilities in other geographic 

locations. For example, sustained winds are stronger in some parts of the country than in other 

parts of the country. Assuming that in neither of two locations would a wind facility be 

profitable in the absence of a subsidy, and that the cost of construction and operation and access 

to the electricity grid are equivalent in the two locations, an investment in a qualifying wind 

facility should be more profitable in the windy location than in the less windy location. One 

would expect investment to occur in the most profitable locations first. In this sense, the tax 

credit mechanism is efficient in that potential investors will attempt to exploit the most profitable 

opportunities to produce electricity from qualifying renewable resources first. As a result, the 

investors will provide the most amount of qualifying renewable electricity with the least amount 

of investment. 

However, a tax credit is not likely to be a fully efficient subsidy mechanism from the 

perspective of the government’s fisc. The credit amount is invariant for any specific category of 

qualified facility. While two investments may both be estimated to be profitable enough to merit 

investment by prospective investors, because of one’s access to relatively inexpensive qualified 

renewable energy resources compared to the other, the one proposed investment is likely to be 

more profitable than the other proposed investment. By providing the same uniform credit, the 

government pays more subsidy than is necessary to bring the one investment in a qualified 

facility on line. For example, there may be some potential qualifying facilities that would be 

profitable investments in the absence of any subsidy, but they may claim the credit. As several 

States have enacted “renewables mandates,” requiring that electricity providers include a 

minimum amount of electricity from renewable sources as a condition of sale to consumers, this 

source of inefficiency (paying for production that will happen regardless of the credit) will 

grow.

21

Production tax credit and externalities

A subsidy, such as the credit, can promote economic efficiency when there is a 

divergence between the private costs of an activity and the social costs of the activity. Such a 

divergence is called an “externality.” Analysts commonly identify pollution as an externality 

because pollution imposes costs on society in terms of environmental degradation and health 

costs that are not reflected in the cost of producing the good or service that creates the pollution. 

By subsidizing non-polluting, or less polluting activities, the tax credit for production of 

electricity from renewable sources can produce a more economically efficient outcome. To be 

fully efficient, however, the subsidy should be equated to the incremental social benefit created 

by displacing a polluting source with a less polluting source. The incremental social benefit is 

the net change in all types of pollution from the current source of production to the renewable 

 21 See discussion below relating to State renewable energy programs. 
18 

source of production. With a credit at a uniform rate applicable to multiple technologies, ranging 

from wind power to burning paper mill residues, it is unlikely that the subsidy provided by the 

credit will equal the incremental social benefit produced by each separate technology. 

Some analysts have argued that there is social benefit meriting subsidy in the potential for 

domestic renewable resources to displace foreign energy sources, principally petroleum. 

Petroleum-fired electricity generation accounted for approximately 3.0 percent of net electricity 

generation in the United States in 2004, and the amount of petroleum consumed in electricity 

production was approximately 3.4 percent of refined petroleum products produced in the United 

States in 2004.22 If a credit-eligible facility displaces electricity produced at an unsubsidized 

facility, market economics dictate that it generally would be the highest cost producer that is 

displaced. It need not be the case that a petroleum-fired electricity generating facility is the 

highest-cost producer. In addition, if a petroleum-fired electricity generating facility ceases 

production, thereby reducing the demand for petroleum, it need not be the case that the reduction 

in demand for petroleum leads to a reduction in imported petroleum. As the demand for 

petroleum falls, market economics dictate that it generally would be the highest-cost suppliers 

that are displaced. The highest-cost suppliers of petroleum may be domestic producers. 

State renewable portfolio standards, mandates, or renewable goals and the production tax 

credit

As of the close of 2003, the Department of Energy had identified 15 States with programs 

to encourage the development of renewable energy for electricity generation.23 The Department 

of Energy analysis divides these programs into three types: renewable portfolio standards; 

renewable energy mandates; and renewable energy goals. In general, a renewable portfolio 

standard requires that a specified share of electricity generation (or sales) is attributable to 

renewable resources. A mandate requires the construction of specified amounts of new 

renewable-source generation capacity. Goal-based programs are voluntary. Table 4, below, lists 

those States with such programs as characterized by the Department of Energy analysis.24

 22 Energy Information Administration, Monthly Energy Review, March 2005. 

23 Thomas Petersik, “State Renewable Requirements and Goals: Status Through 2003,” Energy 

Information Administration, Department of Energy, www.eia.doe/oiaf/analysispaper/rps/index.html, July 

21, 2004. 

24 The Department of Energy analysis list two States with two different types of programs. 
19 

Table 4.–State Renewable Energy Programs 

as of December 31, 2003 

Renewable Portfolio Standard Program 

 Arizona 

 California 

 Connecticut 

 Maine 

 Massachusetts 

 Nevada 

 New Jersey 

 New Mexico 

 Wisconsin 

Mandate Program 

 Iowa 

 Minnesota 

 Texas 

 Wisconsin 

Goals Program 

 Hawaii 

 Illinois 

 Minnesota 

 Pennsylvania 

Source: Thomas Petersik, “State Renewable Requirements 

and Goals: Status Through 2003,” Energy Information 

Administration. 

There is variation across the different State programs in terms of the energy resources 

that qualify as renewable for purposes of the program, the amount of renewable electricity 

generation the State program hopes to attain, and the mechanics of the program. Regardless of 

the design of the State program, there is interaction with the production tax credit. The 

Department of Energy analysis concludes that, of the renewable energy capacity constructed in 

these States, wind facilities comprised more than 90 percent. In particular, 49 percent of the new 

capacity consisted of wind facilities constructed as part of the Texas State mandate.25 Generally, 

such wind projects would have been eligible for the production tax credit. The interaction of 

these State programs and the production tax credit may help explain the growth in electricity 

generated from wind facilities documented in Figure 1, above. 

According to the Department of Energy, States use several approaches to pay for the 

construction and operation of renewable electricity generation facilities brought on line under 

 25 Petersik, “State Renewable Energy Requirements and Goals: Status Through 2003.” 
20 

these programs. Some States pass the costs on to all utility ratepayers in the form of higher rates 

for all electricity. Other States apply a charge on selected categories of sales. Still other States 

encourage consumers to voluntarily pay higher prices for electricity from renewable sources. 

Under any of these approaches, the production tax credit allows the electricity provider to offer 

the renewable electricity at a lower price than the provider otherwise would charge in order to 

cover costs. The analysis above suggested this reduction might be on the order of 2.9 cents per 

kilowatt-hour. The existence of the production tax credit reduces the burden on consumers in 

those States that have established such programs. Because the production tax credit reduces the 

revenues of the Federal government, it could be said that taxpayers at large pay more in taxes to 

reduce the burdens on electric utility customers in those States with such programs.