FROM THE OFFICE OF PUBLIC AFFAIRS

Mr. Chairman and Members of the Committee, I appreciate the opportunity to discuss with you today the Administration's climate change tax incentives.

As you know, a few months ago, in the Administration's budget for FY 1999, the President presented to the Congress his plan to begin addressing climate change. That plan includes $3.6 billion of tax incentives that will encourage energy efficiency and renewable energy sources. The proposed tax incentives are part of a larger package of technology initiatives. In addition to the $3.6 billion of tax incentives, the Administration proposed $2.7 billion for R&D and deployment of energy efficiency, renewable energy, and carbon-reducing technologies. These provide a total of $6.3 billion in new funding and tax incentives over five years. We believe that these initiatives will stimulate the development and use of technologies that can help to improve energy efficiency and reduce greenhouse gas emissions.

My comments today will focus on an explanation of the Administration's proposed tax incentives.

DISCUSSION

Individuals and businesses underinvest in energy-saving technologies because the private returns from those investments are lower than the benefits to society. Private incentives may be too low because the market prices that serve as the signals that influence investment decisions do not take into account the benefits to society attributable to energy savings. Investments in energy-saving technologies can reduce dependence on oil imports and slow the buildup of greenhouse gases in the atmosphere. Tax incentives are an appropriate method 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.

The proposed tax incentives are intended to reduce energy consumption and greenhouse gas emissions by encouraging the deployment of technologies that are highly energy efficient and that use renewable energy sources. Tax incentives can only be claimed for items that meet high standards for energy efficiency, use renewable energy sources, or reduce emissions of certain highly potent greenhouse gases. If the incentives are successful and are claimed by taxpayers, there will be energy savings and reductions in greenhouse gas emissions. If taxpayers do not take advantage of the incentives, however, there will be no revenue loss.

Specifically, we designed the incentives to take into account the following considerations:

(1) Superior energy efficiency compared to conventional equipment. The eligible items must meet high standards for energy efficiency or use renewable energy sources. This helps to ensure that scarce public resources are being used for the intended goal of reducing greenhouse gases.

(2) High threshold for eligibility. The eligible items must presently account for a small share of the market. This minimizes windfalls for purchases that would have been made anyway.

(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 up-front costs are another reason not many would be purchased without the credit.

(4) Commercially available. The items must 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 Internal Revenue Service can administer the incentives. This helps to ensure that incentives are claimed only for items for which they are intended.

We also targeted tax incentives to address certain emissions of highly potent greenhouse gases that in some cases have atmospheric lifetimes of thousands of years and a global warming potential as much as several thousand times greater than carbon dioxide, the most abundant greenhouse gas.

The tax incentives the Administration has proposed cover the four major greenhouse gas-emitting sectors of the economy: buildings, industry, transportation, and electricity.

Buildings

Buildings currently account for about one-third of energy consumption and the related greenhouse gas emissions. The proposed tax incentives for the buildings sector would encourage investment in a new generation of energy-efficient building equipment, highly energy-efficient new homes, and rooftop solar systems.

Tax credit for highly energy-efficient building equipment

A 20 percent tax credit would be provided for the purchase of certain highly energy-efficient building equipment. This credit encourages the purchase of equipment that will improve the energy efficiency of both residential and commercial buildings. The items covered are certain fuel cells, electric heat pump water heaters, natural gas water heaters, electric heat pumps, natural gas heat pumps, and advanced central air conditioners. Only very energy efficient equipment of each type would be eligible. The credit would be temporary -- for equipment purchased between January 1, 1999 and December 31, 2003 (fuel cells would be delayed one year). The revenue cost of this incentive is estimated to be $1.4 billion for FY 1999 - 2003.

The proposed tax credits reflect the considerations noted above. Eligible items embody new, cutting edge technologies, generally capturing less than 1 percent of market sales. Therefore, few of the credits would go for purchases that would have been made anyway. These top-tier technologies have substantial purchase prices and are not universally cost-effective, but 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. Eligible items are currently available. Energy efficiency standards are available for the eligible equipment so that items could be defined precisely enough for IRS to administer the credit.

Through 2008, we estimate that over 7 million taxpayers will purchase energy efficient equipment eligible for the credit. As noted above, eligible units are substantially more energy efficient than the typical units on the market.

Tax credit for new energy-efficient homes

Residences account for about one-sixth of US greenhouse gases and offer one of the largest sources of energy saving potential. Almost one million new homes and manufactured homes are built and sold each year. Some states and certain Federal programs require new houses to meet Model Energy Code standards for insulation and related construction standards, and for heating, cooling and hot water equipment. But the energy efficiency of new homes could be improved by 50 percent or more through the use of energy efficient building practices and more efficient heating and cooling equipment.

To encourage the purchase of new highly energy-efficient homes, a tax credit would be provided equal to one percent of the purchase price (up to a maximum credit of $2,000) of new homes that use at least 50 percent less energy for heating, cooling and hot water than the Model Energy Code. The full credit would be available for homes purchased between January 1, 1999 and December 31, 2003, and would phase out in 2006. The revenue cost of this incentive is estimated to be $0.2 billion for FY 1999 - 2003.

Again, we have set a high threshold for eligibility for the credit. Eligible houses would be very energy efficient compared to present standards. Energy used in housing eligible for the credit would be reduced by 75 percent to 85 percent compared to existing housing and by over 50 percent compared to new housing.

Tax credit for rooftop solar systems

Solar energy systems, which accounted for .02 percent of electricity generation in 1996, have the potential to reduce greenhouse gas emissions and energy costs for businesses and individuals. The tax credit for the purchase of rooftop photovoltaic (PV) systems and solar water heating systems solar systems would make these systems more affordable and encourage their purchase. The credit would be 15 percent of qualified investment up to a maximum credit of $2,000 for PV systems and $1,000 for solar water heating systems. The credit would be available from January 1, 1999 to December 31, 2003 for solar water heating systems, and to December 31, 2005 for rooftop PV systems. The revenue cost of this incentive is estimated to be $0.1 billion for FY 1999 - 2003.

This tax initiative 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.

Industry

The proposed tax incentives for industry would promote energy efficiency by encouraging investments in combined heat and power systems that make effective use of energy that is otherwise wasted in producing electricity by more conventional methods. Tax credits are also provided to encourage the replacement of certain electricity circuit breakers that are prone to leak a potent greenhouse gas and the purchase of equipment that recycles certain greenhouse gases used in the semiconductor industry.

Tax credit for combined heat and power (CHP) systems

CHP systems use 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 carbon emissions as compared with conventional methods.

To encourage and accelerate investment in CHP equipment, a 10 percent tax credit would be provided for investments in CHP systems that meet certain energy efficiency requirements. 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 between January 1, 1999 and December 31, 2003. The revenue cost of this incentive is estimated to be $0.9 billion for FY 1999 - 2003.

Current cogeneration capacity is nearly 45 gigawatts. The credit should increase that capacity by about ten percent. Eligible CHP systems should reduce input energy requirements by about one-third compared to conventional systems. This saving is achieved by capturing the current waste heat that is created during the generation of electrical energy and using that waste heat in a thermal application. This saves fuel costs and generates fewer greenhouse gas emissions.

Tax credit for replacement of certain circuit breaker equipment

Certain older, large power circuit breakers used in the transmission and distribution of electric power are particularly prone to leak sulfur hexafloride (SF6). This equipment, using a dual pressure technology that was no longer produced after 1985, is particularly prone to leak as the seals corrode over time. The purpose of the tax incentive is to encourage utilities to replace the old equipment with new equipment. To prevent the old equipment from being sold to another utility in the US or abroad, the old equipment must be certified by an appropriate third party to have been destroyed.

To encourage the replacement of leaky circuit breakers, a 10 percent credit would be provided for the cost of new equipment. The credit would apply to new equipment placed in service between January 1, 1999 and December 31, 2003. The revenue cost of this incentive is estimated to be less than $50 million for FY 1999 - 2003.

Tax credit for perfluorocompound (PFC) and hydrofluorocarbon (HFC) recycling equipment

PFCs and HFCs are among the most potent greenhouse gases because of their extreme stability in the atmosphere and strong absorption of radiation. Because of the rapid anticipated growth of the semiconductor industry, the use of these gases is expected to grow at rates of 20 to 30 percent per year for the next ten years. A 10 percent tax credit would be provided for the purchase of equipment to recycle and recover PFCs and HFCs used in the production of semiconductors. The credit would apply to equipment placed in service between January 1, 1999 and December 31, 2003. The revenue cost of this incentive is estimated to be less than $50 million for FY 1999 - 2003.

These two tax credits are targeted toward emissions of very potent greenhouse gases that in some cases have atmospheric lifetimes of thousands of years and a global warming potential as much as several thousand times greater than carbon dioxide.

Transportation

The proposed tax initiatives in the transportation sector include tax credits for the purchase of highly fuel-efficient cars and light trucks, and an incentive to encourage public transportation and vanpools.

Tax credits for highly fuel efficient vehicles

Cars and light trucks (including minivans, sport utilities, and pickups) currently account for 20 percent of greenhouse gas emissions. Tax credits for highly fuel efficient vehicles will help to move vehicles that are ultra efficient from the laboratory to the highway. Thus this credit complements the research Partnership for a New Generation of Vehicles (PNGV program) that will develop a production prototype of a family car with three times the fuel economy of today's comparable car (about 80 miles per gallon) by 2003-2004.

Two tax credits would be provided:

• A $4,000 credit for a vehicle with triple the base fuel economy for its class. This credit would be available for purchases of qualifying vehicles beginning January 1, 2003. The credit amount would be phased down to $3,000 in 2007, $2,000 in 2008, and $1,000 in 2009, and would be phased out in 2010.

• A $3,000 credit for a vehicle with twice the base fuel economy for its class. The $3,000 credit would be available for purchases of qualifying vehicles beginning January 1, 2000. The credit amount would be phased down to $2,000 in 2004, $1,000 in 2005, and would be phased out in 2006.

These credits would be available for all qualifying vehicles, including cars, minivans, sport utility vehicles, pickup trucks, and electric vehicles. The revenue cost of this incentive is estimated to be $0.7 billion for FY 1999 - 2003.

Again, we have set a very high threshold for obtaining these credits. Eligible vehicles must be two or three times as efficient as today's comparable vehicles. Tripling a car's fuel economy reduces its emissions of carbon dioxide by 67 percent; doubling a car's fuel economy reduces its emissions of carbon dioxide by 50 percent.

Equalize the tax treatment of parking and transit benefits

Under present law, qualified transportation fringe benefits provided by an employer are excluded from income. Qualified transportation fringe benefits include parking, transit passes, and vanpool benefits. Beginning in 1998, parking is excludable from gross income even when provided in lieu of other compensation payable to an employee. Transit passes and vanpool benefits, however, are only excludable if provided in addition to, and not in lieu of, any compensation otherwise payable to an employee. In 1998, the amount of employer-provided benefit that is excludable from income per month is $175 for parking and $65 for vanpool and transit benefits.

This initiative would equalize the tax treatment of parking benefits and transit and vanpool benefits. To encourage public transportation and vanpools, employers would be allowed to provide tax free transit and vanpool benefits in lieu of compensation, up to the same amount that they can provide for parking beginning January 1, 1999. The revenue cost of this incentive is estimated to be $0.1 billion for FY 1999 - 2003. A similar provision is contained in the Surface Transportation Revenue Act of 1998.

Electricity

Extension of tax credit for electricity produced from wind and biomass

Wind energy systems accounted for about .09 percent of electricity generation in 1996. What is deployable today is the result of successful R&D in the past. To encourage the production of electricity from wind and certain biomass, a 5-year extension is proposed for the present 1.5 cent per kilowatt hour tax credit (adjusted for inflation after 1992). The present credit, which applies to facilities placed in service before July 1, 1999, would be extended for five years. The revenue cost of this incentive is estimated to be $0.2 billion for FY 1999 - 2003.

This tax credit helps to make electricity from these systems competitive with other forms of electricity generation. Electricity produced from wind energy systems produces no greenhouse gases.

CONCLUSION

Our goal has been to design a package of tax incentives to achieve reductions in greenhouse gases and to increase energy efficiency. The tax incentives have well-defined goals. Eligible items offer superior energy efficiency, use renewable energy sources, or reduce emissions of some of the most potent greenhouse gases. If taxpayers claim a credit, it is for items that produce energy savings and reductions in greenhouse gas emissions. If taxpayers do not take advantage of the credits, there is no revenue loss.

The impact of the incentives in this package on greenhouse gases will likely 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. That is why the Administration has chosen not to make speculative estimates about the potential benefits. I would like to illustrate this point with one example. I stated earlier, with respect to the tax credit for highly energy-efficient building equipment, that the affected equipment presently captures less than one percent of market sales. With the credit in place, we expect this fraction to increase significantly in the short-run. We also expect that after the credit has expired the share of the market for highly efficient building equipment will be much larger as a result of the credit. But whether it will double, or triple, or increase by a factor of 10 is unclear. The estimated impact on emissions reductions will hinge on assumptions about the long-term increase in market share which is very difficult to predict.

In conclusion, Mr. Chairman, we believe that the Administration's proposed tax incentives represent sound policy that will have long-term benefits. We look forward to working with the Congress on this matter.