TL/DR –
The Tax Cuts and Jobs Act provisions that are set to expire at the end of 2025 have sparked a debate about future tax reform, with emphasis on carbon fees and energy tax credits. A study has suggested that extending the Inflation Reduction Act and adding a moderate carbon fee could lead to efficient decarbonization, but doing so would also come with a fiscal cost of around $530 billion between 2026 and 2035. Further, it seems that Congress will continue to make climate policy through tax law, with the IRS largely responsible for implementing these policies.
Future of Energy Tax Credits and Climate Policy
As the Inflation Reduction Act’s energy tax credit implementation guidance is still in progress, focus shifts towards the expiring provisions of the Tax Cuts and Jobs Act (TCJA) at the end of 2025. A carbon fee and the IRA’s tax credits could potentially be key topics during a pivotal tax debate. The tax law is largely used for climate policy due to congressional budget rules, resulting in a complex process of drafting guidance that involves crucial policy decisions.
Extending TCJA and Carbon Fee Consideration
Kimberly Clausing of the University of California Los Angeles School of Law states that fully extending the TCJA would cost approximately $4 trillion over the 10-year budget window. To preserve fiscal resources and accomplish efficient decarbonization, layering on a modest carbon fee could be a beneficial move. This could address concerns from Republicans about the high expense of addressing climate needs by reducing the cost of emissions reductions, and offset potential regressivity of a carbon fee for Democrats by lowering tax burdens.
Climate Tax Policy and the IRS
The role of the IRS in implementing climate policy has expanded due to the intricate and frequently expiring tax benefits Congress provides for both conventional and alternative energy sources. According to a new study by the Brookings Institution, it is probable that Congress will continue making climate policy through the tax code.
Projections and Alternative Emission Reduction Strategies
The Brookings study suggests several possibilities, ranging from repealing the IRA’s energy credits to extending and adding a carbon fee. With current IRA provisions, the United States is projected to achieve a 42% decline from 2005 emissions levels by 2035, assuming no changes to emissions rules or tax laws. Options such as expanding the IRA by doubling the tax credits for the power sector could accelerate the emissions reduction up to 51%. Each alternative comes with a cost per unit of emissions, which varies between $18 and $69.
IRA’s Impact on Reducing Emissions
Evaluating the impact of the IRA’s new or revised provisions is challenging due to the lack of finalized regulations. The cost-effectiveness of credits for clean energy manufacturing as per section 45X is yet to be determined. The Brookings study indicates that the production tax credit and ITC for the electric sector are the most efficient, with estimates between $27 and $87 per ton.
Carbon Fee as a Decarbonization Strategy
The potential reintroduction of a carbon tax could aid speedy decarbonization, according to the Brookings study. This measure could encourage greater deployment of carbon capture and sequestration, end-use electrification, and lower the intensity of electricity generation. Depending on the election results, there could be a compelling case for maintaining the existing IRA and adding a carbon fee on top.
Future Outlook
The upcoming election makes it challenging to predict the details of any future energy tax changes. However, the Brookings study provides some insight into what could transpire in 2025. Even though many IRA regulations should be finalized this year, the resulting legislative debate could disrupt the stability provided by the guidance.
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