The federal production tax credit, which has driven rapid growth in wind power installations in the United States, is set to expire at the end of the year. Congress should take this opportunity to change the credit system so that it does more to spur innovation.
The subject of the tax credit has been in the news lately, and is bound to come up several times between now and the end of the year, because so much money is at stake. Earlier this month the website The Hill cited a congressional analysis from the Joint Committee on Taxation that said that extending the period under which a wind farm can qualify for the credit by just one year would cost $6.1 billion over the next 10 years. (The way the credit works is that any wind farm built before it expires would get paid the credit for the wind power it produces over several years.) A five-year extension would cost $18.5 billion.
The goal of subsidies for new energy technologies should be to promote the development of those technologies to the point that subsidies aren’t needed. (That might sound obvious, but it’s a controversial stance. Many argue that certain things deserve more-or-less permanent subsidies. Fossil fuels are subsidized because they’re arguably important to society, and the same argument is made for low-carbon sources that could help slow climate change.)
One thing that might help is to make the production tax credit more predictable. Since it was introduced over 20 years ago, it has been allowed to lapse several times, and last year it very nearly expired, only to be extended for a year at the last minute. This leads to a potentially wasteful boom-and-bust cycle as wind developers rush to take advantage of the credit while it’s available.
It’s a mistake, though, to make the tax credit permanent. That would provide little incentive to innovate. Wind farm developers will simply keep buying the same wind turbines that have been shown to make a profit in the past, or ones that are only incrementally better.
A better approach would be to establish the production tax credit for a fixed time, and then decrease the size of the credit on a predictable schecule. That way it becomes clear that new technologies will be needed to keep wind farms profitable. And because turbine makers can be reasonably confident that the bottom won’t suddenly drop out of the market, they can justify investments in longer-term R&D projects that could make wind power considerably cheaper or more reliable.
This approach of predictably decreasing a tax credit or subsidy seems to have worked in the past—it’s the approach taken with hybrid vehicles, for example, which can now earn Toyota a profit without the help of a subsidy.
Another option is to specifically require innovation as a condition of getting the tax credit. The idea, which has been discussed in the past, was most recently suggested yesterday in a report released by the Information Technology and Innovation Foundation. Such a requirement might involve tying the credit to specific cost and performance targets, which would be changed as technology improves and would be set up, say, based on the needs of utilities.
Without such a requirement, wind farm developers (and those who fund them) will choose established technology with a track record that makes it easy to predict return on investment. There will only be incremental improvements, ITIF argues, rather than major changes that might allow wind to stand on its own in the long term.
Some will argue that incremental improvements are enough to make wind power and other renewables competitive with fossil fuels. Indeed, wind power is already competitive in many cases, largely as a result of seemingly small changes like lengthing turbine blades and making towers taller. Breakthoughs aren’t always needed.
But we should also appreciate how far wind and solar still need to go to replace fossil fuels.One challenge is that wind and solar are intermittent, and accommodating that at a large scale will be expensive (see “Wind Turbines, Battery Included Can Keep Power Supplies Stable”). We shouldn’t just hope that we’ll solve these problems by deploying existing technology with gradual improvements. We should modify the tax credit to prompt more innovation.