This report provides an introduction to the general tax equity financing mechanism. To facilitate the presentation of the tax equity approach to subsidization, three categories of tax credits that either currently use or have recently used this mechanism are examined: the low-income housing tax credit (LIHTC); the new markets tax credit (NMTC); and two energy-related tax credits—the renewable electricity production tax credit (PTC) and energy investment tax credit (ITC). This report does not evaluate the economic rationale for subsidizing the activities targeted by these tax credits, and does not analyze whether these subsidies increase net investment in these activities. Instead, this report focuses on explaining the structure and functioning of tax equity arrangements. Tax Equity Investments

T ax equity investment is not a statutorily defined term, but rather identifies transactions that pair the tax credits or other tax benefits generated by a qualifying physical investment with the capital financing associated with that investment. These transactions involve one party agreeing to assign the rights to claim the tax credits to another party in exchange for an equity investment (i.e., cash financing). The exchange is sometimes referred to as "monetizing," "selling," or "trading" the tax credits. Importantly, however, the "sale" of federal tax credits occurs within a partnership or contractual agreement that legally binds the two parties to satisfy federal tax requirements that the tax credit claimant have an ownership interest in the underlying physical investment. Select Case Studies

While several current federal tax credits use the tax equity financing mechanism, no two credits do so in the same manner. For existing programs and new tax policies that could involve tax equity transactions, consideration of various options might ask whether the use of tax equity markets is an efficient and effective means of delivering federal financial support. At first glance, it may appear that the government would get more "bang for its buck" by structuring the subsidy delivery mechanism to eliminate investors. However, such a conclusion overlooks one role that tax equity investors often play in addition to providing financing: tax equity investors evaluate the quality of projects before investing, as well as provide continuing oversight and compliance monitoring. Effectively, the tax equity mechanism outsources a portion of the oversight and compliance monitoring to the investors in exchange for a financial return. There may be value to the federal government in being able to rely on outside investors to provide oversight and monitoring. It could be argued, though, that for some tax equity programs that have a government entity overseeing participant compliance, the monitor role of investors is redundant. The options are with respect to the general tax equity approach. Due to important differences in the underlying structure of various current or future credits, some options may be better suited for particular credits than others. Careful consideration on a case-by-case basis is part of evaluating the appropriateness of each option. A straightforward way to accelerate the credits would be to shorten the time period over which they are claimed.
This report provides an introduction to the general tax equity financing mechanism. The term tax equity investment describes transactions that pair the tax credits or other tax benefits generated by a qualifying physical investment with the capital financing associated with that investment. These transactions involve one party agreeing to assign the rights to claim the tax credits to another party in exchange for an equity investment (i.e., cash financing). The exchange is sometimes referred to as "monetizing," "selling," or "trading" the tax credits. Importantly, however, the "sale" of federal tax credits usually occurs within a partnership or contractual agreement that legally binds the two parties.
Three categories of tax credits that either currently use or have recently used this mechanism are presented in this report to help explain the structure and function of tax equity arrangements. These include the low-income housing tax credit (LIHTC); the new markets tax credit (NMTC); and two energy-related tax credits—the renewable electricity production tax credit (PTC) and energy investment tax credit (ITC). While these credits all use the tax equity financing mechanism, no two credits do so in the same manner. The economic rationale for subsidizing the activities targeted by these tax credits is not evaluated. Instead, this report focuses on explaining the structure and functioning of tax equity arrangements, analyzing the delivery of federal financial support using this mechanism, and discussing various policy options related to tax credits that rely on tax equity.
Four policy options are presented to help Congress should it consider modifications to an existing tax equity program, or create a new one. The options are with respect to the general tax equity approach and include making the credits refundable, converting the credits to grants, allowing for the direct transfer of credits, and accelerating the credit claim periods. This list of options is not exhaustive. Due to important differences in the underlying structure of various current or future credits, some options may be better suited for particular credits than others. Careful consideration on a case-by-case basis is part of evaluating the appropriateness of each option.
Consideration of various options might ask whether the use of tax equity markets is an efficient and effective means of delivering federal financial support. At first glance, it may appear that the government would get more "bang for its buck" by delivering subsidies more directly, without a role for tax equity markets. However, such a conclusion overlooks one role that tax equity investors play in some industries in addition to providing financing: they evaluate the quality of projects before investing, as well as provide continuing oversight and compliance monitoring. Effectively, the tax equity mechanism outsources a portion of the oversight and compliance monitoring to investors in exchange for a financial return. On the one hand, there may be value to the federal government in being able to rely on outside investors to provide oversight and monitoring. On the other hand, for some tax equity programs that have a government entity overseeing participant compliance, the monitor role of investors may be redundant. There also may be ways to improve the current delivery approach.