Is it possible that something as mundane as the treatment of depreciation by the federal tax code could be negatively impacting investments in energy efficiency? That is the question ACEEE attempts to answer in the new white paper, Depreciation: Impacts of Tax Policy. The paper is the third in a series of four working papers that examine how tax reform might encourage or discourage investments in energy efficiency.
When considering tax reform, it is important to examine how the current code, and potential changes to the code, provides incentives or disincentives for desirable actions. Ideally the code should encourage rather than discourage actions useful to society. For example, the tax code includes incentives for home ownership (e.g., home interest costs are deductible) and there have been various reforms and proposed reforms to eliminate disincentives to marriage (e.g., removing the “marriage penalty”). Among the actions we would like to encourage, and not discourage, are cost-effective energy efficiency investments (about half of the primary energy in the United States is consumed by commercial and industrial entities, not including energy used for transportation). There is enormous potential for businesses to reduce energy consumption through currently available energy efficiency measures, as well as innovative technologies in the future. For example, a January 2012 ACEEE study on long-term efficiency opportunities estimated available energy savings average about 45-62 percent in the commercial sector and 36-51 percent in the industrial sector. Realization of these energy savings will help make American businesses more productive; improve their competitive position relative to foreign firms; and improve the security, cost, and environmental impacts of high energy use.
The current treatment of depreciation has become a jumble of schedules and exemptions that does more to confuse taxpayers than guide them. Some depreciation periods are overly long—for example, lighting fixtures and heating, ventilating, and air conditioning systems are depreciated over 39 years even though most of this equipment typically needs to be replaced around 20 years of age. If an antiquated system is repaired, that expense can be charged against revenue in the year incurred, thereby decreasing tax liability, but if the asset is replaced, the company must first write off the residual value of the asset, then start a depreciation schedule for the new asset. Even though there are likely to be operational cost benefits to the new equipment, the tax treatment complicates the transaction with a likely negative impact on shareholder value. Recognizing that newer lighting and heating and air-conditioning systems are more energy efficient than ten- or twenty-year old systems, this type of treatment by the tax code discourages both new capital investment (something that arguably the economy is in great need of) as well as investments that have societal benefits related to energy conservation and pollution mitigation.
In other cases, such as combined heat and power systems, depreciation periods vary for the same type of equipment depending on who owns the equipment. This can discourage use of such equipment in some sectors. In addition, assets that intuitively might seem to be personal property (i.e., things that have a consumable or impermanent nature to them) are treated by the tax code as real property, or structural assets that will be around for decades. Real property often has long depreciation periods, discouraging investments.
Our goal is to identify rational policy options for the depreciation of business assets—policies that are fair and that match depreciation periods to the typical economic lives of such assets. If depreciation periods are too long, it discourages commercial and industrial investments that would otherwise be cost-effective. Correcting the alignment of depreciation with actual service life would remove what may be a substantial impediment to investment in energy efficiency technologies.
ACEEE plans to produce a report on tax reform later in 2012, building on our working papers and comments we receive on them. The first working paper, Should the U.S. Consider a Modest Emissions Fee as Part of a Strategy to Lower Marginal Tax Rates?, was published in January. The second paper, Modifying How Energy Costs Are Treated for Business Tax Purposes in Order to Decrease Subsidies and Increase Energy Efficiency, was published in March. Comments on all of the papers can be e-mailed to firstname.lastname@example.org.