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A few months ago in the FY 2000 budget the President proposed a $3.6 billion package of

tax incentives over 5 years to encourage energy efficiency, reduce greenhouse gas emissions, and

develop renewable energy sources. The tax incentives are part of a larger package of

complementary initiatives. In addition to the $3.6 billion of tax incentives, the Administration

proposed to increase funding for R&D in energy efficient technology and renewable energy, a

new Clean Air Partnership Fund to boost state and local efforts to reduce greenhouse gases and

air pollution, substantial new funding to focus on the ways farms and forests can reduce and offset

greenhouse gas emissions, and $1.8 billion for global climate change research. The total package

for FY 2000, including the tax incentives, is over $4 billion.

This analysis focuses on the Administration’s proposed tax incentives and their effects on

tax revenues and greenhouse gas emissions.

DISCUSSION

Individuals and businesses underinvest in energy-saving technologies because the private

returns from those investments are lower than the total benefits to society. Examples of social

benefits include reduced air pollution and greenhouse gases in the atmosphere, and reduced

dependence on oil imports. When potential investors only consider the private benefits in making

decisions, they may underinvest in technologies that are worthwhile from the point of view of

society as a whole, but not profitable to the individual making the investment. Tax incentives are

an appropriate tool for addressing the failure of market prices to achieve the desirable level of

investment in energy-saving technologies because they can increase the private return from the

investment by reducing its cost. This increase in the private return induces additional investment

in energy-saving technologies. 

Tax incentives may also help to overcome market barriers that hinder investment in

energy-saving technologies, such as lack of information on the energy and environmental benefits

of certain products and the uncertainty regarding the return to the investment. Tax incentives

improve buyers’ awareness of highly energy efficient products and improve the return on

investments in those products. They encourage buyers to be early purchasers of advanced new

products and, in turn, encourage firms to innovate to supply them. By helping to assure future
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for investments that would have been made even absent the incentives and to facilitate tax

administration. If taxpayers claim a credit, it is for items that produce energy savings and

reductions in greenhouse gas emissions. 

The design of the tax incentives incorporate the following considerations:

(1) Superior energy efficiency compared to conventional equipment. The eligible

items should meet higher standards for energy efficiency than conventional

equipment or use renewable energy sources. This helps to ensure that tax benefits

promote energy efficiency and reduce greenhouse gas emissions.

(2) High threshold for eligibility. The eligible items should presently account for a

small share of the market. This minimizes windfalls for purchases that would have

been made even absent the credit. 

(3) High up-front costs compared to conventional equipment. The targeted

technologies have significantly higher purchase prices than conventional equipment

and, at current market prices, are not universally cost effective. These high upfront costs are another reason relatively few would be purchased without the

credit. 

(4) Commercially available. The items should be commercially available or near

commercialization. This ensures that the incentives encourage the deployment of

new technologies that private markets have already developed.

(5) Ease of administration. The items must be able to be defined precisely enough

so that the IRS can administer the incentives. This helps to ensure that tax benefits

are claimed only for items for which they are intended.

The tax incentives the Administration has proposed cover buildings and homes, vehicles,

renewable energy, and industrial equipment. 
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equipment that will improve the energy efficiency of both residential and commercial buildings. 

The items covered are electric heat pump and natural gas water heaters, electric and natural gas

heat pumps, advanced central air conditioners, and fuel cells. 

The credit would be 20 percent of the cost of super energy efficient models of the items

listed above, subject to a cap. It would be available for 4 years -- 2000 through 2003. A 10

percent credit would be available for electric heat pumps, central air conditioners and natural gas

water heaters that meet high efficiency standards, but not as high as the standards for the 20

percent credit. The 10 percent credit would be available for 2 years -- 2000 and 2001. 

Items eligible for the 20 percent credit are top-tier technologies that offer superior energy

efficiency compared to conventional equipment. For example, compared to typical units on the

market, the eligible advanced air conditioning systems and electric heat pumps are 40 percent

more efficient, and eligible electric heat pump water heaters and natural gas heat pumps are about

twice as efficient. Items eligible for this credit embody new, cutting-edge technologies that have

substantial purchase prices and are not universally cost effective. They generally account for less

than one percent of market sales. Therefore, few of the credits would be claimed for purchases

that would have been made even absent the credit. The 10 percent credit enables the credit to be

more widely available to highly energy efficient items, as well as state of the art technology,

during a phase in period. Some makes and models of qualifying items are currently available. 

Energy efficiency standards exist for the designated classes of equipment so that eligible items

could be defined precisely enough for IRS to administer the credit.

The revenue cost of this incentive is estimated to be $1.5 billion for FY 2000 - 2004. The

credit for building equipment will increase purchases of energy efficient building equipment by

nearly 10 million items through 2009. 

Tax credit for energy efficient new homes

Residences account for about one-sixth of US greenhouse gases and offer one of the

largest sources of energy saving potential. Over one million new homes and manufactured homes

are built and sold each year. Some states and certain Federal programs require new houses to

meet certain energy code standards for insulation and related construction standards, and for
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3 years -- 2000 - 2002; and (3) $2,000 for homes that use 50 percent less energy than the IECC

standard. This credit would be available for 5 years -- 2000 - 2004. The revenue cost is

estimated to be $0.4 billion for FY 2000 - 2004.

Again, the threshold for eligibility for the credit was set at high levels of energy efficiency. 

The largest credit would be available for new homes at the top tier of energy efficiency. Energy

used in those homes would be reduced by 75 percent to 85 percent compared to existing housing

and by over 50 percent compared to typical new housing. The credit is estimated to result in

purchases of over 250 thousand new energy efficient homes through 2009. 

Tax credit for solar energy systems

Solar energy systems accounted for 0.02 percent of electricity generation in 1996. These

systems produce no greenhouse gas emissions and have the potential to reduce energy costs for

businesses and individuals. The tax credit for the purchase of rooftop photovoltaic (PV) systems

and solar water heating systems would make these systems more affordable and encourage their

purchase. The credit would be 15 percent of the cost of a qualified investment up to a maximum

credit of $2,000 for PV systems and $1,000 for solar water heating systems. The tax credit for

PV systems would be available for 7 years -- 2000 - 2006, and the tax credit for solar water

heating systems would be available for 5 years -- 2000 - 2004. The revenue cost of this incentive

is estimated to be $0.1 billion for FY 2000 - 2004.

This incentive will help to achieve the President’s goal of one million solar roofs by 2010. 

Heat and electricity produced from solar energy systems produce no greenhouse gases. The

credit is estimated to save 3 billion kilowatt hours of electricity production through 2009.

Vehicles 

Cars and light trucks (including minivans, sport utilities, and pickups) currently account

for 20 percent of greenhouse gas emissions. These vehicles also account for about 20 to 40

percent of urban smog-forming emissions and 40 percent of U.S. oil consumption. Almost all of

these vehicles use a single gasoline-fueled engine.
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begins to phase down in 2002 and phases out in 2005. The President’s proposal would extend the

tax credit at its $4,000 maximum level through 2006.

The proposal also would provide tax credits of $500 to $3,000 for certain hybrid vehicles,

depending upon requirements for the vehicle’s design performance. A qualifying hybrid vehicle is

a road vehicle that can draw propulsion energy from both of the following on-board sources of

stored energy: (1) a consumable fuel, and (2) a rechargeable energy storage system. These

credits would be available for 4 years -- 2003 - 2006. The credits -- available for all qualifying

vehicles, including cars, minivans, sport utility vehicles, and pickup trucks -- would be:

(a) $500 if the rechargeable energy storage system provides at least 5 percent but less than 10

percent of the maximum available power;

(b) $1,000 if the rechargeable energy storage system provides at least 10 percent and less than

20 percent of the maximum available power;

(c) $1,500 if the rechargeable energy storage system provides at least 20 percent and less than

30 percent of the maximum available power, and

(d) $2,000 if the rechargeable energy storage system provides 30 percent or more of the

maximum available power.

If the vehicle actively employs a regenerative braking system, the amount of the credit

shown in (a) through (d) above would be increased by the following amounts:

(i) $250 if the regenerative braking system supplies at least 20 percent but less than 40

percent of the energy available from braking in a typical 60 miles per hour (mph) to 0 mph

braking event to the rechargeable energy storage system.

(ii) $500 if the regenerative braking system supplies at least 40 percent but less than 60

percent of such energy; and

(iii) $1,000 if the regenerative braking system supplies 60 percent or more of such energy.
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Renewable energy

Wind and biomass currently account for about 2 percent of electricity generation from

renewable sources. These renewable energy sources produce virtually no net greenhouse gas

emissions. To make electricity produced from wind and biomass price competitive with other

forms of electricity generation, the proposal would extend the present tax credit for wind and

biomass for five years, expand eligible biomass sources, and allow a credit for electricity produced

from cofiring biomass with coal.

Current law provides a tax credit of 1.5 cents per kilowatt hour (adjusted for inflation

after 1992) for electricity produced from wind and “closed-loop” biomass (organic material from

a plant which is planted exclusively for purposes of being used at a qualified facility to produce

electricity). The current tax credit covers the first ten years of production from facilities placed in

service before July 1, 1999. The President proposes a 5-year extension of this tax credit, to cover

facilities placed in service before July 1, 2004. 

The proposal also would extend and expand the tax credit for electricity produced from

biomass. It would:

- Extend the current biomass credit for 5 years. The present credit is 1.5 cents per

kilowatt hour tax credit (adjusted for inflation after 1992) and is scheduled to

expire after June 30, 1999.

- Expand definition of eligible biomass for the 1.5 cent credit to include certain

forest-related resources and agricultural and other sources, broadening eligible

biomass beyond closed loop biomass. This change would be available for facilities

placed in service after June 30, 1999 and before July 1, 2004.

- Include cofiring biomass and coal. This proposal adds a 1.0 cent per kilowatt hour

tax credit for electricity produced by cofiring biomass in coal plants after the date

of enactment and before July 1, 2004. Only the portion of electricity associated

with biomass is eligible for the credit. 
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combined heat and power (CHP) systems. These systems use the thermal energy that is otherwise

wasted in producing electricity by more conventional methods. These systems increase energy

efficiency, lower the consumption of primary fossil fuels and reduce greenhouse gas emissions

compared with conventional methods. 

To encourage and accelerate investment in CHP equipment, an 8 percent tax credit would

be provided for eligible CHP investment. A qualified system would be required to produce at

least 20 percent of its total useful energy in the form of both thermal energy and electric or

mechanical power, and would have to meet certain efficiency standards. The credit would apply

to property placed in service during the 3 years -- 2000 - 2002. The revenue cost of this

incentives is estimated to be $0.3 billion for FY 2000 - 2004.

The threshold for eligibility for the credit was set high. Eligible CHP systems should

reduce input energy requirements by about one-third compared to conventional systems. The

credit is estimated to increase cogeneration electrical capacity by more than 1.2 gigawatts through

2009.

Revenue effects 

As noted above, the proposed tax incentives are intended to stimulate the diffusion of 

highly energy efficient technologies in the marketplace and the adoption of technologies that use

renewable energy sources. They are intended to provide a temporary boost to the markets by

reducing the cost of eligible items and thereby making their purchase more cost effective for

consumers and businesses. As the eligible items become more widely accepted in the market, and

producers gain experience in supplying them, the energy-efficient products would become viable

without tax incentives. For that reason, the proposed incentives are temporary and generally are

available for two to five years. 

Because of their short duration, the incentives lose revenue primarily over the ten-year

period FY 2000 to 2009. Table 1 shows the estimated revenue losses for the proposed tax

incentives for the five-year period FY 2000 through 2004 and for the ten-year period FY 2000
1The revenue cost from the production tax credit for wind and biomass extends beyond

FY2009 because the credit would be available for the first ten years of production from facilities

placed in service prior to July 1, 2004. The credit for CHP investment also has minor delayed

revenue effects because of changes in depreciation deductions which extend beyond the budget

window. 

Provide tax credit for energy-efficient building equipment -1.5 -1.5

Provide tax credit for new energy-efficient homes -0.4 -0.5

Provide tax credit for solar energy systems -0.1 -0.4

Vehicles

Extend tax credit for electric or fuel cell vehicles and provide

tax credits for certain hybrid vehicles -0.9 -6.0

Renewable Energy

Extend tax credit for electricity produced from wind and

biomass, expand eligible biomass sources, and include coalbiomass cofiring -0.3 -0.8

Industry

Provide tax credit for combined heat and power systems -0.3 -0.4

TOTAL* -3.6 -9.5

*Total may not add due to rounding.

The estimated revenue cost of the tax incentives increases from $3.6 billion over the first

five years to $9.5 billion over the ten-year period, with more than half the revenue cost ($5.9

billion) occurring in the five year period between FY 2005 and 2009. Table 1 shows that the

increase in the cost of the program over the second five years is largely attributable to the tax

credits for hybrid vehicles, which take effect in 2003. The cost of the tax credit for wind and

biomass also increases in the second five years because the credit applies to ten years of

production from eligible facilities. The tax credit for solar systems increases in the second five

years primarily because the tax credit for photovoltaics is available through 2006. In addition, in
2Business taxpayers that are unable to use credits in the tax year in which they are earned

because of insufficient tax liability or limitations on the use of credits can generally carry the

credits back one year and forward 20 years. 

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The proposed incentives encourage businesses and consumers to increase their investment

in highly energy efficient items, new technologies, and renewable energy sources relative to

investments in those items that would have been made absent the credit. The investments induced

by the credit are long-lived and, therefore, produce energy savings and greenhouse gas reductions

for many years after the investment is undertaken. For example, an energy-efficient new home

can generate energy savings for several decades. The increase in the market penetration of energy

efficient technologies, new technologies, and renewable energy sources can transform markets. 

By improving the acceptance of those technologies in the marketplace and in some cases lowering

the production costs of the targeted items, the credit can move the market toward those

investments, influencing purchases even after the credits are no longer in effect. 

Table 2 shows the estimates of reductions in greenhouse gas emissions attributable to the

increase in investment in items induced by the credit through 2009 over the lifetime of those

investments. For example, the tax credit for energy efficient new homes would increase purchases

of highly energy efficient new homes compared to new homes constructed using conventional

methods. The energy savings from the new home would reduce greenhouse gas emissions over

the lifetime of the structure and its components, and these benefits would extend well beyond

2009. The estimates do not reflect the effects on emissions attributable to investment that would

have occurred absent the credit, or the benefits attributable to investments undertaken after 2009

that may be attributable to the tax incentives. Thus, the estimates do not take into account the

incentives’ long-term effects on markets for energy saving items and renewable energy sources

that can produce significant benefits in the future. Therefore, the estimates may understate the

effect of the incentives on emissions reductions.

Table 2 shows that the cumulative reduction in greenhouse gas emissions attributable to

the tax incentives is estimated to be between 100 and 150 million metric tons of carbon equivalent
3According to the Department of State, Climate Action Report, July 1997, US greenhouse

gas emissions are estimated to be 1,446 MMTCE in 2000, 1,742 MMTCE in 2005, 1,837

MMTCE in 2010, 1,998 MMTCE in 2020.

gas emissions

(MMTCE)*

Homes and Buildings

Provide tax credit for energy-efficient building equipment 28 - 42

Provide tax credit for new energy-efficient homes 7 - 10

Provide tax credit for solar energy systems 2 - 3

Vehicles

Extend tax credit for electric or fuel cell vehicles and provide tax

credits for certain hybrid vehicles 36-54

Renewable Energy

Extend tax credit for electricity produced from wind and biomass,

expand eligible biomass sources, and include coal-biomass cofiring 15 - 23

Industry

Provide tax credit for combined heat and power systems 12 - 18

TOTAL** 100-150

* Millions of metric tons of carbon equivalent over the lifetime of equipment purchased through

2009.

**Total may not add due to rounding.

In addition to reductions in greenhouse gas emissions, the incentives may generate other

benefits to society, such as reductions in other pollutants, and reduce vulnerability to oil supply

disruptions. Those benefits were not quantified, and thus the total benefits of the proposal are

likely understated. The proposals also may produce private benefits, such as energy savings for

consumers and businesses. The present value of energy savings for consumers and business over

the lifetime of items purchased through 2009 is estimated to be between $22 billion and $33

billion.
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benefits of the proposal should increase significantly in the years beyond the ten-year budget

window, and those distant effects, by their very nature, are the most difficult to predict. The

estimated impact on energy savings and emissions reductions will hinge on forecasts about the

long-term increase in market share which is very difficult to predict. For example, the highly

efficient building equipment eligible for the proposed 20 percent tax credit currently captures less

than one percent of market sales. With the credit in place, that share of the market will likely

increase significantly in the short-term. After the credit has expired the share of the market for

highly energy efficient building equipment will still be much larger than it was before. But

whether it will double, or triple, or increase by a factor of ten is unclear. Moreover, the proposed

incentives may also generate other benefits to society, such as reduced air pollution and

vulnerability to oil supply disruptions.

The Administration’s proposed tax incentives represent sound policy that can produce

significant environmental benefits over the next ten years and for decades to come. The proposals

represent investments that will generate long-term benefits for the Nation.