Congress is likely to tackle federal tax reform in 2017 and may consider new ideas. One proposal it should seriously consider is clean tax cuts—the application of supply-side tax rate cuts to investments that reduce the emissions of harmful pollutants. Cutting tax rates on income gained from clean investments such as energy efficiency improvements could incentivize investors to tap large amounts of private capital.
The Grace Richardson Fund (GRF), an organization with conservative roots and an interest in addressing climate change and other environmental issues, is pioneering the clean tax cut concept. Their view is that conservatives tend to see traditional tax incentives as wasteful, but are interested in tax cuts. They believe that reducing taxes on income from clean investments could increase these investments substantially and help clean the environment.
GRF worked with the Sabin Center at Columbia University and the Rocky Mountain Institute on a charrette to explore and refine the clean tax cut concept. The resulting report spells out the concept in more detail. GRF then decided to sponsor a series of charrette workshops on specific areas where the federal government could offer clean tax cuts and asked ACEEE to host a workshop on clean tax cuts for commercial real estate. In March 2017 we held a charrette workshop with commercial real estate experts, and today we are releasing a white paper on what we found.
Clean tax cuts can potentially work in a wide variety of applications but might be particularly influential in markets where investment returns are passed on to individuals and included on individual tax returns. Such investors are often in above-average tax rate brackets, making tax cuts enticing. Commercial real estate (including multifamily housing) is one such market, where individuals often invest in real estate investment trusts (REITs), limited liability corporations (LLCs), and limited liability partnerships (LLPs). In all of these structures, the returns (or losses) are passed on to the investors to include in their income taxes, making commercial real estate an excellent place to launch the clean tax cut concept.
In our working paper, we provide background information on commercial buildings, commercial real estate structures, and opportunities for additional energy improvements. We then outline two proposals for clean tax cuts for commercial real estate that participants discussed during the charrette. The first proposal aims to provide a lower tax rate (the long-term capital gains rate) on income from buildings that are ENERGY STAR® certified. The second proposal suggests expensing energy efficiency investments that achieve energy savings of at least 10% for all commercial buildings, including those that passed income on to individual tax returns and those were covered by business tax returns.
As we developed the post-workshop paper, we further analyzed these two proposals. Our analysis finds that the lower tax rate would provide a strong incentive for energy efficiency upgrades in the approximately 30% of the commercial real estate market owned by REITs, LLCs, and LLPs. The immediate expensing would provide a more modest incentive, but applies to about 75% of the commercial real estate market (the proportion of the total market that is taxable). The expensing could also apply to untaxed government and nonprofit buildings if they are allowed to pass the tax value of expensing to the architects, engineers, and contractors who work on efficiency upgrade projects.
As tax reform discussions take shape, ACEEE will suggest a variety of strategies that promote energy efficiency and keep costs to the US Treasury at modest levels. We discussed some options in a 2013 ACEEE report, such ending overly long depreciation periods and focusing tax incentives on transforming markets for more-efficient new and existing homes and commercial buildings. With the release of today’s working paper, we are adding clean tax cuts to the list of ideas that could promote investment and energy as well as energy bill savings and, by extension, economic growth.