Tax incentives are a critical renewable energy subsidy tool that can take the form of investment tax credits, and depreciation tax shields. When combined, these tax incentives can reduce the cost of renewable energy by more than 50%.
In order to better understand how these tax incentives work, we will take a look at:
- Investment tax credits.
- Example of investment tax credits in the United States.
- Depreciation tax shields.
- Example of depreciation tax shields in the United States.
- How much of a difference can taxation policies make?
Investment tax credits. An investment tax credit is a dollar-for-dollar reduction in the income tax that someone claiming the credit would otherwise pay the government. This type of tax credit is typically implemented at the national level rather than the state or provincial level.
Renewable energy investment credits have the effect of reducing the levelized cost of electricity (LCOE), and decreasing the payback period of the renewable energy system.
Example of investment tax credits in the United States. The solar investment tax credit (ITC) in the United States is designed to promote the growth of solar energy across the country. The ITC has helped annual solar installation increase by over 1600% between 2006-2016.
The solar investment tax credit takes a form of a 30% tax credit for eligible commercial and residential solar panel systems. The 30% investment tax credit will remain until the end of 2019, lower to 26 percent in 2020, and lower to 22 percent in 2021. After 2021, the investment tax credit will discontinue for residential installations, and be maintained at 10% for commercial and utility-scale installations.
Depreciation tax shields. A depreciation tax shield allows you to deduct expenses from taxable income. The amount by which depreciation shields the taxable entity is the applicable tax rate, multiplied by the amount of depreciation. For example, if the applicable tax rate is 25% and the amount of depreciation is $100,000, then the depreciation tax shield is $25,000.
Depreciation tax shields also have the effect of reducing the levelized cost of electricity (LCOE), and decreasing the payback period of the renewable energy system.
Example of depreciation tax shields in the United States. The most common depreciation tax shield in the United States is the Modified Accelerated Cost Recovery System (MACRS). MACRS allows the taxpayer to deduct expenses from their taxable income for a certain number of years. Eligible solar energy equipment qualifies for a cost recovery period of five years.
Other renewable energy technologies such as wind energy property, geothermal, and fuel cells also qualify under the five year MACRS scheme.
How much of a difference can taxation policies make? Investment tax credits and depreciation tax shield are powerful tools to reduce the cost of renewable energy. To illustrate this, we will take a look at an example for commercial scale silicon solar cells.
Levelized cost of electricity comparison (*DBB is another depreciation tax shield)
As can be seen from the table above, tax incentives play a large part in reducing the cost of renewable energy.
It is essential that governments continue offering tax incentives until solar panels, and other renewable technologies, become mainstream.