FEBRUARY 1, 2018
We’ve been hearing a lot lately about the economics of wind energy. In a recent earnings call, James Robo, CEO of NextEra Energy, predicted that within a decade the cost of wind generation would be more competitive “without incentives” than conventional sources like coal and natural gas. NextEra is one of the largest generators of wind and solar electricity.
Tom Kiernan, CEO of the American Wind Energy Association (AWEA), the $18 million lobbying arm of the wind industry, stated in 2016 that “wind is now the cheapest source of new electric generating capacity” in many parts of the United States. Kiernan is also fond of saying that the wind industry is getting out of the federal subsidy business altogether because of a provision in the PATH Act of 2015 that gradually phases down the industry’s main federal subsidy, known as the Production Tax Credit (PTC). In an interview defending the PTC from being modified in the recent tax reform law, Kiernan implied that the industry will no longer be receiving the federal subsidy because “we made a deal to drop our tax credit to zero over five years.” Tom is right, the subsidy phases down, but a closer look at the mechanics of the PTC shows that the wind industry will still be receiving billions in federal subsidies well beyond 2020.
Boosting a Nascent Industry
In 1992, Congress created the Production Tax Credit (PTC), which initially paid a 1.5-cent subsidy (indexed to inflation it is now 2.4 cents) for every kilowatt-hour of electricity produced by certain favored generation technologies. This subsidy, which has primarily gone to wind generators, lasts for 10 years. At the time of its creation, the PTC was meant to be temporary, but more than 25 years later it is still with us. While the original justification for the PTC was to boost a nascent industry, the PTC continues to subsidize a mature industry to the expected tune of nearly $24 billion from 2016-2020 according to the Joint Committee on Taxation. And that estimate will almost certainly be too low. Through legislation and IRS fiat, the PTC has been expanded and extended seemingly endlessly.
The Never-Ending Temporary Tax Credit
The PTC has expired and been extended multiple times since 1992. The original PTC terminated in 1999. On 10 subsequent occasions, Congress has extended the PTC, though rarely without controversy. On five of those occasions, 1999, 2002, 2004, 2014, and 2015, the PTC actually expired and had to be retroactively extended. Upon many of these extensions, Congress made tweaks to the PTC. Most often, these tweaks have expanded the types of generation technologies that are eligible for the PTC. Other changes include modifying the years of eligibility and when a project begins to qualify for the subsidy. Through all the changes the wind industry remained the dominant recipient of PTC subsidies.
The IRS’s First Big Gift
In 2013, in passing one of its many extensions of the PTC, Congress introduced a major change in how projects became eligible for PTC subsidies with the American Taxpayer Relief Act (ATRA). Prior to this change, a wind facility need to be “placed-in-service” in a given year in order to be eligible for that year’s PTC. After ATRA, a facility need only “begin construction” within the PTC time period to be eligible. The opportunity to game the system from this change is obvious. It can be a long time after construction begins for a project to come online, but this provision allows the project to lock in eligibility even if the tax credit were to expire well before the project actually gets built.
ATRA did not define what conditions were required to meet this “begin construction” language. That job was left to the IRS. An IRS controlled by the Obama administration, keen on expanding subsidies for its favored technologies by any means necessary. The IRS obliged, issuing guidance in 2013 which allowed wind developers to meet the “begin construction” standard if they commenced “physical work of a significant nature” OR incurred at least 5 percent of the total cost of the facility. This 5 percent safe harbor was described nowhere in the ATRA; the IRS invented it. The IRS additionally instructed that either of these options would be automatically satisfied if the facility were placed into service with two calendar years of the deadline to begin construction. So at that point, if the PTC expired at the end of 2013, a developer had until the end of 2015 to get his project built to automatically qualify for PTC subsidies, which remember then pay out for 10 years. But even that wasn’t all. If a project did not meet the 2-year deadline, it still had the opportunity to argue to the IRS that it had made continuous construction or continuous efforts the advance the project, which could extend the window for eligibility even further.
So much, so generous. But the IRS wasn’t done yet. In 2014, the IRS issued additional guidance on what actions would meet the “physical work” standard. In this list of actions, which was non-exclusive, the IRS included such minimal standards as beginning excavation for the foundation, pouring concrete pads, or even just starting construction of onsite roads for moving materials. This 2014 guidance then conclusively stated that beginning work on any of the listed actions would be deemed to be physical work of a significant nature. The sum of all this is that with just the barest of activity, a wind developer could lock in his eligibility for the PTC, even if the project was years away from actually generating electricity.
The IRS Giveaway Gets Even Bigger
In 2015, Congress passed another extension of the full PTC for 2015 and 2016, and then included a stepped down phase-out of the subsidies from 2017 through 2019, with each of those years qualifying for a reduced percentage of the PTC for 10 years. While that may seem like Congress intended to take a fiscally responsible action, the IRS had other ideas. In 2016, the IRS issued new guidancethat expanded the previous 2-year safe harbor to four full calendar years. This means that a project that “began construction” by the end of 2016, under the extremely lax definition discussed above, would have until 2020 to automatically qualify for the full PTC subsidy.
And that four years was not all. The IRS included a loophole to extend the time frame even further by providing a long list of delays that that would be accepted to expand the eligibility window. This list includes: severe weather, delays in getting permits, and supply shortages, among many others. The 2016 guidance also describes extremely generous aggregation terms. This “aggregation rule” allows a huge facility with numerous turbines to fully qualify for subsidies even if only a handful of turbine sites had actually begun work. So for example a facility with a planned 100 individual turbines would qualify as beginning construction even if only a few foundations had been prepared.
This 2016 guidance was so lax—so generous to the wind industry—that it seemed calculated to contradict the express intent of Congress to terminate the PTC, leaving developers with tactics to extend their subsidies well into the future.
Does It Ever Really End?
For many years Congress continued to extend PTC subsidies, though each time there was substantial debate about whether to continue subsidizing wind. In 2015, Congress finally decided that enough was enough and opted to phase out PTC subsidies. The IRS under the Obama administration, however, at every opportunity expanded and relaxed the already generous terms of the PTC. These actions have all been taken through unilateral guidance documents from the IRS, not through changes to the law or even through the public regulatory process. The result is that the PTC is even more expensive than intended and will last even longer than Congress ever contemplated, distorting energy markets for years to come and artificially harming competing generation sources like nuclear and coal. The cumulative effect of the IRS guidance is that despite the “phase out” in 2019, the federal government will still be paying PTC subsidies and distorting markets at least into the 2030’s.