TCS Daily

An Energy-Efficient Tax Code

By Ben Lieberman - March 25, 2002 12:00 AM

Taxpayers struggling to figure out their 1040s by April 15th might have a few choice terms to describe this annual ordeal, but "efficiency enhancing" is probably not one of them. Congress, in contrast, sees things a little differently - both the Democratic and Republican energy bills have proposed to use the tax code to promote the efficient use of energy. However, if the track record is any guide, these measures may actually harm consumers taking advantage of them.

Along with the many special interest tax breaks that go directly to the producers of politically-favored energy sources and energy-using products, Washington is proposing a number of measures that affect individual taxpayers. This includes hefty tax credits for the purchase of products ranging from residential solar or wind power systems to a variety of alternative vehicles. The Democratic version of the energy bill, now pending in the Senate, differs from the Republican-backed House bill passed last August, but both contain such provisions.

To consumers, the hype can sound almost too good to be true - save money on your energy bills and your tax bills, all the while doing something good for the planet. And, unlike tax deductions, which merely reduce taxable income, tax credits reduce one's tax burden dollar for dollar. In fact, given the thousands of dollars in available credits, a typical household buying a solar system and a green car in the same year might effectively reduce its tax bill to zero.

The assumption underlying this use of the tax code is simple. Presumably, these energy saving and/or pollution reducing products, despite their clear advantages, cannot manage to catch on without a little help. Thus, the federal government needs to step in and use tax incentives to encourage the public to make the right energy choices.

Unfortunately, it has been tried before, particularly in the 1970s in response to the "energy crisis," and the results were disappointing. It turned out that many of these alternative products weren't catching on for good reason, and the tax breaks only served to entice people into what was still a purchase they later regretted.

Take residential solar energy. In theory, a nation with solar panels on millions of houses won't have to generate as much energy by other means, such as coal or natural gas-fired power plants. And homeowners can reduce their utility bills by taking advantage of the "free" energy from the sun. This is why the Bush administration and Congress have proposed to revive the 15 percent tax credit on residential solar equipment, instituted in 1978 by Jimmy Carter but later killed by Ronald Reagan in 1986.

In reality, even subsidized solar still ends up being a large investment for a small payoff. In fact, a recent Department of Energy (DOE) program to promote residential rooftop solar actually paid half the cost of solar panels - a far sweeter deal than any currently under consideration by Congress. Still, with the government picking up half the tab on a $5,600 two-panel photovoltaic system, the energy generated each year, a modest $73 worth, provides a paltry rate of return of less than 3 percent. Add to that the ongoing expense and annoyance of maintenance and repairs, and it is little wonder the solar equipment industry doesn't do a brisk repeat business.

The history of tax-favored wondercars is no less problematic. For nearly thirty years, self-anointed energy experts in government, academia, and environmental organizations have declared the internal combustion engine wasteful and passé. They, along with some opportunistic manufacturers, have prevailed upon Congress to provide tax credits for alternatives. The emphasis has changed over time, as the zeal for electric battery-powered cars has faded a bit in recent years (though not before thousands were induced into buying these high-priced but low-range lemons), and hydrogen fuel cells have emerged as the latest craze.

Both the Democratic and Republican packages propose to provide generous tax credits (up to $4,000 for certain qualifying cars, and more for SUVs and trucks) and extend the coverage to all manner of energy sources, including electric, fuel cell, gasoline-electric hybrids, and compressed natural gas. Nonetheless, the buyer should still beware -- just because the experts declare some alternative car the next great thing doesn't make it so, and the mere fact that Uncle Sam is picking up part of the tab is no guarantee of customer satisfaction.

Indeed, the history of energy-related tax breaks yields a rule with very few exceptions - if the government has to induce taxpayers into buying something, then it probably wasn't such a hot idea in the first place.

Ben Lieberman, J.D., CPA, is a senior policy analyst with the Competitive Enterprise Institute, In Washington, DC.

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