This report focuses specifically on federally subsidized or supported debt designed to promote investment in renewables and energy efficiency. Understanding what types of debt instruments currently are and previously have been available, the degree of federal subsidization contained within these instruments, and what types of investments have resulted from these programs, will help policymakers evaluate if and how these tools can be used in the future to promote renewables and efficiency. Energy tax policy in the United States has tended toward this alternative approach, providing a number of tax credits and other tax preferences for investments in renewables and energy efficiency. Federally Tax-Favored Financing

Federally subsidized financing offers an alternative to direct tax incentives for renewable energy and energy efficiency projects. In recent years, various forms of federally subsidized financing have been available to promote investments in renewable energy and energy efficiency. Bonds are private activity bonds and not tax-exempt if both of the following conditions are met:
[use test] more than 10% of the proceeds of the issue are to be used for any private business use ,... [and] [security test] if the payment on the principal of, or the interest on, more than 10% of the proceeds of such issue is (under the terms of such issue or any underlying arrangement) directly or indirectly secured by any interest in: (1) property used or to be used for a private business use, or (2) payments in respect to such property. Tax credit bonds that subsidize investments in renewables and energy efficiency, through both the issuer and investor tax credits, are discussed in the following sections. Clean Renewable Energy Bonds (CREBs)

Clean renewable energy bonds (CREBs) have been made available to tax-exempt entities investing in renewables that are not able to take advantage of other tax incentives. CREBs, as tax credit bonds, reduce the cost of financing for renewable energy projects receiving a CREB allocation. As Table 1 indicates, CREB financing has been used to finance 1,727 renewable energy projects totaling $3.4 billion. Like tax-exempt bonds, BABs have been used to finance various types of projects. Since their introduction, 7.3% of BAB proceeds have been used to fund electric and public power projects. Tax-Favored Bonds: Economics Issues

Policymakers can subsidize investment in qualified projects such as renewables by allowing access to tax-favored financing. Comparison of Tax-Exempt Bonds, CREBs, and BABs

Below is an illustrative example of the variation in subsidy provided by the different types of bonds, highlighting how the subsidy changes across different types of investors. Tax-exempt bonds are economically inefficient if the loss in federal revenue exceeds the subsidy provided to issuers. Thus, the inefficiency associated with tax-exempt debt, where the loss in revenues to the federal government exceeds the subsidy to borrowers, is eliminated with the use of tax-credit bonds. For example, CREB financing is not currently an option for tax-exempt entities considering undertaking a renewable energy investment. BABs were no longer available as of December 31, 2010. In markets that may fail to consider the full costs associated with fossil energy sources, renewables may be disadvantaged. Requiring that some level of electricity be produced using renewable resources would drive markets to invest more in renewables and may lead to energy efficiency investments. Further, the use of tax-credit bonds addresses some of the economic efficiency and equity concerns that have been raised with respect to the use of tax-exempt bonds in the past. The goal of tax favored financing is to reduce the cost of borrowing for those investing in renewables and efficiency, making it easier for such projects to attract investors. In this case, tax favored bonds may reduce a project's borrowing costs, rewarding bond issuers at taxpayer expense without creating additional renewable energy capacity.
Tax policy is one tool available to promote the use of domestic renewable energy resources. Tax-subsidized financing, specifically tax-favored bonds, reduce the cost associated with making oftentimes capital intensive investments in renewables and energy efficiency. This report provides an overview of the various federally tax-favored financing options available for renewable energy and energy-efficiency investments. This report also highlights the economic foundations for subsidizing renewable energy investment and comments on economic issues specific to tax-favored financing.
Various forms of federally tax-favored bonds have been used to subsidize investments in renewables and efficiency. Some of these bonds, such as the Clean Renewable Energy Bonds (CREBs) and Qualified Energy Conservation Bonds (QECBs), are tax-credit bonds available only for investments in renewables or efficiency. CREBs alone have been used to finance 1,727 renewable energy projects, through $3.4 billion in CREB allocations. Other types of tax-favored bonds, such as tax-exempt governmental bonds or private activity bonds and Build America Bonds (BABs), are more widely available but have been used for energy-related projects. More than $10 billion worth of BABs have been issued to finance electric and public power projects (although it is not clear what share of this issue is dedicated to renewables).
The magnitude of the subsidy afforded by the different types of federally tax-favored financing differs from both the perspective of the bond issuer and the investor. An example, where a hypothetical CREB, BAB, and tax-exempt bond is used to finance the same project, illustrates how policymakers can adjust bond terms to manipulate the subsidy provided to issuers and investors.
Tax incentives promote investment in renewables and energy efficiency by reducing the cost of such investments relative to fossil energy alternatives. Investments in renewable energy generation capacity, especially wind, have led to an increasing share of renewables in the nation's overall energy portfolio. Subsidizing investments in renewables using tax policy, however, may not be the most economically efficient mechanism for increasing the use of renewable energy and promoting energy efficiency. Subsidizing renewables through tax incentives leads to federal revenue losses, requiring that federal revenues be raised by some other, potentially distortionary, form of taxation.
Tax-exempt bonds may not be the best tool for subsidizing investment in renewables when evaluated in terms of economic efficiency and equity. With tax-exempt bonds, federal revenue losses may exceed the subsidy provided to issuers, and thus be an inefficient subsidy. Tax-exempt bonds also provide a larger subsidy to taxpayers in higher tax brackets, raising equity concerns. Tax-credit bonds, as an alternative, represent a tax-subsidization option that is not subject to the inefficiencies and inequities associated with tax-exempt debt.
While tax-subsidized financing has been a popular tool in recent years for promoting investment in renewables and efficiency, a number of these bonds are not currently available as options for project investors. Specifically, all available CREB financing has been allocated, and projects were unable to issue BABs after December 31, 2010. Whether these programs have successfully promoted renewable energy investment, and should be extended, may be an issue the 112th Congress will want to consider.