Two tax credits that take effect in January 2025 incentivize the generation of electricity from any technology with zero emissions. Simplifications to the federal interpretation of these tax credits could facilitate a smoother rollout.
The technology-neutral tax credits for electricity generation and energy storage (sections 45Y and 48E of the US tax code) have the potential to be the most impactful elements of the Inflation Reduction Act for reducing greenhouse gas emissions. These tax credits replace a menagerie of tax credits for specific technologies (e.g., wind turbines and solar panels) with one seemingly simple qualification: whether the technology has zero emissions. Moreover, instead of having ever-changing expiration dates, these tax credits will remain available to investors until the emissions from the power sector are reduced by a set amount. Assuming the credits are durable against changes in the makeup of Congress, this condition provides invaluable certainty for investors and project developers and avoids the boom-and-bust cycle that sometimes was seen with the prior regime of tax credits.
However, things are never as simple as one might like. In a series of earlier issue briefs, I discussed some of the challenges facing the US Department of the Treasury in the implementation of these tax credits. Recently, I submitted comments to Treasury responding to the guidance proposed by the agency for the implementation of these credits and touched on a number of questions that the agency asked. In this blog post, I highlight two of these questions: one about the definition of combustion and gasification, and a second about the use of life-cycle analysis.
But first, some background.
How the Tech-Neutral Tax Credits Work
The tech-neutral tax credits provide either a production tax credit or an investment tax credit for technologies that generate electricity. (In addition, the tech-neutral tax credits provide an investment tax credit for energy storage, which I will not discuss here.) A production tax credit allows electricity generators to subtract from tax payments a set amount of money per unit of electricity generated over the first 10 years that a generator is in operation. An investment tax credit allows project developers to subtract from tax payments 30 percent of the capital cost of an electricity-generation facility. (These values assume that certain wage and apprenticeship requirements are met and that the facility does not qualify for any bonus tax credits.)
A facility is eligible for these tax credits if it has zero (or negative) associated emissions. The tax credit divides facilities into two types: combustion and gasification (C&G) technologies and other technologies. If a technology is not C&G, then the only emissions that count toward eligibility are the emissions at the facility itself. For C&G technologies, however, the law requires consideration of the total life-cycle emissions associated with the production of electricity. This requirement leads to the two fundamental questions about the implementation of this tax credit. First, what is a C&G technology? Second, how should Treasury determine life-cycle emissions?
What Counts as Combustion and Gasification?
With respect to C&G technologies, the Inflation Reduction Act refers to “a facility which produces electricity through combustion or gasification.” Both “combustion” and “gasification” have definitions that are fairly standard, but there’s a problem: Gasification doesn’t produce electricity. Instead, gasification is a process for converting hydrocarbon fuels into a gas that contains carbon monoxide and hydrogen. That gas then can be used to make electricity, though in a separate process from gasification.
The simplest reading of the statute would render the inclusion of “gasification” in the statute meaningless. However, a principle of statutory interpretation is that “every word within a statute is there for a purpose,” so Treasury has to make a determination about what the inclusion of “gasification” in the statute means. Under the Chevron deference, a legal doctrine which empowered federal agencies to interpret ambiguous laws, Treasury would have a lot of leeway in interpreting this language. But due to the recent Supreme Court decision in Loper Bright Enterprises v. Raimondo, Treasury must follow the “best reading” of the statute, which courts determine.
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Why is the interpretation of “gasification” important? One way to produce hydrogen is by gasifying coal, a process which produces a lot of greenhouse gas emissions. One then can take that hydrogen and produce electricity using a fuel cell, a process which doesn’t involve combustion and doesn’t produce any greenhouse gas emissions. The simplest reading of the statute, under which “gasification” is meaningless, would let an electricity generator take advantage of the tax credits in this situation, even though emissions from coal gasification are closely linked to the associated electricity production.
In my view, the best reading of the statute—taking into account the intent of the tax credits to subsidize zero-carbon electricity generation—would classify this method of hydrogen production as a C&G technology, which would make coal gasification (without carbon capture) ineligible to receive the tax credits.
In the guidance proposed by Treasury, the agency considers a technology to be C&G if a “fundamental transformation” of a fuel through combustion or gasification occurs at any point in the production of that fuel. One reason to interpret the statute this way is to avoid providing tax credits when electricity is generated from coal or natural gas, the electricity generates hydrogen through electrolysis, and the hydrogen then generates electricity through a fuel cell.
While not providing the tax credits in this situation may make sense from the point of view of policymakers, reaching so far back in the supply chain of the fuel raises questions about whether this interpretation is the “best reading” of the statute. In my comments, I suggest an alternative reading of the statute that does not require a full analysis of the fuel supply chain.
My reading starts with the perspective that the word “gasification” must have meaning in the statutes. This perspective naturally leads to the idea that electricity generation with on-site combustion or gasification must be classified as a C&G technology. However, if having gasification colocated with electricity production qualifies that electricity generation as a C&G technology, then one should also recognize that there is nothing special about the colocation. What is important isn’t where the combustion or gasification occurs but instead how the fuel that is used to make electricity is produced. So, the best reading of the statute may be to look solely at fuel production, no matter where it occurs.
If the fuel production involves combustion or gasification, then the electricity production would be classified as C&G and need to undergo a full life-cycle analysis, but the entire supply chain would not need to be considered. This definition of C&G would render ineligible for tax credits the scenario in which hydrogen is generated by gasifying coal but would allow producers to receive a tax credit in the scenario in which the hydrogen is generated by electrolysis, no matter the origin of the electricity used.
How the US Department of the Treasury Conducts Life-Cycle Analyses
Once one has decided which power plants need to be assessed with life-cycle analysis, the next question is how to do the analysis.
The Inflation Reduction Act, through which the tech-neutral tax credit was enacted, defines life-cycle analysis in part by referring to language in the Renewable Fuel Standard, a program administered by the US Environmental Protection Agency, which states that life-cycle analyses “includ[e] direct emissions and significant indirect emissions.” The guidance proposed by Treasury hews closely to this text. However, the explanation in the proposal states that Treasury and the US Internal Revenue Service believe that this language requires an approach that “considers the consequential … impacts of increased demand for the input feedstocks or fuels used in electricity production.”
If the goal is to quantify how the generation of electricity affects emissions, this guidance from Treasury is the right approach—but taking this approach is hard to do. For example, renewable natural gas can be produced with manure from dairy farms. A subsidy that incentivizes such production could lead to an increase in the production of milk as a byproduct. A full consequential analysis would entail modeling dairy markets, which are not a central feature of most energy and economic models.
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In my comments, I encourage Treasury to look for simplifications in conducting life-cycle analyses. One possible simplification is to look at changes in the production of goods that are significantly smaller than the overall market for those goods. The interactions between these changes generally are small, and one simply can sum the emissions effects of each individual change to obtain a good approximation of the total change in emissions. Treasury could provide a database of these small effects, which are called marginal emissions rates, that electricity generators could reference to determine their life-cycle emissions rates.
For example, in the case of renewable natural gas that is produced with manure, Treasury and its partners could model the impact on dairy markets of a small increase in the production of renewable natural gas on dairy markets. From there, they could estimate the associated emissions. One could apply this estimate of the associated emissions broadly rather than estimate the specific emissions effects of every electricity generator. This method would be transparent and relatively straightforward, even as it may sacrifice some accuracy.
Good (and Fast) Over Perfect
The guidance proposed by Treasury puts forth a defensible path for the implementation of the two tech-neutral tax credits in the Inflation Reduction Act, 45Y and 48E, but the proposal is fraught with complications. In my comments, I propose simplifications for the definition of combustion and gasification and for the process of life-cycle emissions analysis. I believe these simplifications are consistent with the best reading of the Inflation Reduction Act. However, interpreting the meaning of life-cycle emissions in these tech-neutral tax credits, and in the tax credit for the production of clean hydrogen, has been a significant quagmire that has led Treasury to delay issuing the guidance for all of these tax credits. I believe that these difficulties warrant a reexamination of the use of life-cycle analysis in future policy, so that similar problems can be mitigated in the future.
