Takeaways from the New Federal Guidance on the Tax Credit for Energy Communities

The Biden administration has released new guidance on which areas in the United States qualify as so-called “energy communities.” RFF Fellow Daniel Raimi discusses what’s notable about this guidance.

Resources: Can you summarize the new guidance that the US Department of the Treasury and the US Internal Revenue Service have released? What’s notable about it?

Daniel Raimi: The new guidance gives developers of clean energy projects a better understanding of which areas in the United States will be eligible for an additional 10 percent tax credit for clean energy projects under the Inflation Reduction Act. These areas are known as “energy communities.”

The guidance is especially clear for areas that are eligible for the tax credit under the criteria for coal communities. But a lot of uncertainty remains for developers, because the final determination of which communities will be eligible under the employment criteria of the law is not yet finalized, and the criteria won’t be finalized until new employment data are released in the coming weeks. That said, the potential area that could qualify under the employment criteria alone is very large. On first glance, it looks like more than half of the United States could be eligible, because more than 0.17 percent of local employment comes directly from fossil fuels. However, this footprint will shrink because, to be eligible, areas also need to have an unemployment rate that’s above the national average from the previous year.

You and your coauthor Sophie Pesek have observed that the definition of an energy community in the Inflation Reduction Act is so expansive that it is unlikely to target the communities that will be hardest hit economically by a transition away from fossil fuels. How does the new guidance compare with this observation: Will funding reach the communities that it would help the most?

If the goal of the “energy communities” policy was to provide a bonus tax credit of 10 percent across large swaths of the United States, then I think the policy has done that. If the goal of the policy was to specifically target the most vulnerable energy communities, I don’t think it’s accomplished that goal.

The first thing to know is that whole communities already have experienced dramatic declines in coal-fired power and coal mining around the United States; this definition certainly covers those hard-hit coal communities.

At the same time, the definition covers lots of other places in the United States that are not heavily dependent on fossil fuels and historically have not been dependent on fossil fuels. For example, the map that the US Department of Energy released yesterday indicates that San Francisco potentially is eligible for this bonus tax credit. I don’t think anyone would consider San Francisco to be an energy community, as much as I love San Francisco. The expansiveness of the definition dilutes some of the economic boost that coal communities might experience, because a project developer might be able to get the same tax credit in a coal community as in San Francisco. This imprecision will steer at least some investment away from the hardest-hit communities.

Does the federal government have enough funds to support projects across all eligible areas of the United States, if energy developers take good advantage of the tax credit?

The energy communities tax credit is a 10 percent bonus credit on top of what, in most cases, is a 30 percent tax credit for clean energy projects. You could say that the energy community policy is increasing the total potential bill of several major provisions within the Inflation Reduction Act by 25 percent. It’s not going to make or break the bank in terms of the long-term costs, but because the definition of an energy community is so geographically extensive, I would expect that the tax credit would result in tens of billions of additional dollars in government spending, some of which will benefit the hardest-hit energy communities and some of which probably will not.

How do you think parties who are interested in using the tax credit will react to the new guidance?

I think they’ll be happy to have the certainty about the coal communities. After hearing from experts within the US Department of Energy and the US Internal Revenue Service, my understanding is that, once a project qualifies as being in an “energy community,” that designation will apply to the project until 2032, even if the local fossil fuel employment rate dips below 0.17 percent or the local unemployment rate falls below the national average. But for communities that want to attract investment in clean energy projects or developers that are trying to identify the most promising locations for projects, uncertainty remains about whether new projects will qualify for the tax credit in any given year, particularly since national- and local-level unemployment rates can change dramatically from year to year.

Do the US Department of the Treasury and the US Internal Revenue Service have the data they need to decide on an annual basis who is eligible for the tax credit under the employment criteria?

Yes, these data exist. The Treasury Department has indicated that it will use data from the US Census Country Business Patterns set, which my RFF colleague Sophie Pesek and I have argued was the most appropriate data set to use for this particular analysis.

However, the provision for energy communities includes another eligibility criterion for which data do not exist. Communities qualify for the tax credit if they receive 25 percent or more of their tax revenue from the production, transportation, storage, and processing of fossil fuels. Those data simply don’t exist; local and state governments do not collect data that are categorized in that way. In the new guidance, the Treasury Department essentially says that it’s looking for suggestions for how we can collect these data. But I don’t see how that’s possible without major changes in the way that local governments collect and aggregate data on their tax revenues.

That said, this lack of data on tax revenues probably is not going to make a huge difference, because any community that receives 25 percent or more of their tax revenue from fossil fuels almost would have 0.17 percent or more of their workforce employed in coal, oil, or gas. So, they would be eligible under the employment criterion, even if data don’t exist for the tax criterion.

Will the energy community tax credit provide enough support for affected communities? Would you recommend any policies that can complement the credit?

We’ve known for a long time that clean energy development will not be a one-for-one replacement for jobs and tax revenue that comes from the coal, oil, and natural gas industries. Substantial needs persist to diversify job opportunities, diversify tax revenue streams, and develop other economic sectors that can sustain these communities for the long term. In some communities, that economic sector might be clean energy, but in many communities, it probably will be something else. Maybe it’s some type of new manufacturing, the recreation economy, or remediation of pollution in and around fossil energy infrastructure. Supporting clean energy in communities that have been dependent on fossil energy will be helpful, but clean energy won’t be a silver bullet to provide economic stability in today’s fossil energy communities over the long term.

Editor’s note: A previous version of this article suggested that communities that are eligible for the tax credit under the employment criteria would be determined as eligible or ineligible for the tax credit on an annual basis—essentially, that the tax credit could switch on and off for project developers every year. This is not the case. The current version of this article correctly states that if a community is deemed eligible under the employment criteria, and a project developer takes advantage of the tax credit, then the energy community will retain the designation of an energy community until 2032.