A new Energy Institute working paper finds that income tax credits for weatherization, solar panels, hybrids, and electric cars go predominantly to higher-income households.
Over the last decade, U.S. households have received more than $18 billion in federal income tax credits for weatherizing their homes, installing solar panels, buying electric vehicles, and other clean energy investments. In a new EI@Haas working paper, available here, Severin Borenstein and I use tax return data from the IRS to examine the socioeconomic characteristics of filers who receive these credits.
We first examine a set of income tax credits aimed at residential investments in energy-efficiency and renewables. Between 2006 and 2012 the largest categories of investments were energy-efficient windows ($4.0 billion), qualified furnaces ($2.4 billion), qualified air conditioners and water heaters ($2.4 billion), ceiling and wall insulation ($2.0 billion), and solar photovoltaic systems ($1.8 billion).
The figure below shows how use of these credits varies across income levels. We divided tax filers into six categories based on their Adjusted Gross Income (AGI). The first five categories are approximately quintiles, and then the last category ($200,000+) includes about 3% of returns.
Income Tax Credits for Clean Energy Residential Investments
Average Credit per Tax Return, By Income Level
The figure shows a strong positive correlation with income. Filers with less than $40,000 in AGI receive less than $10 in credits on average per tax return. The average credit amount more than doubles for filers with $40,000-$75,000 and then doubles again for filers with $75,000-$200,000 in AGI. Finally credits reach $80 per return for filers with AGI above $200,000. The figure above also plots 95 percent confidence intervals, though they are barely visible except for in the highest income category.
Another significant tax credit is the Alternative Motor Vehicle Credit, which provided a credit for hybrid vehicles until 2010 and continues to provide credits for natural gas, hydrogen, and fuel cell vehicles. As the figure below shows, this credit exhibits the same strong positive correlation with income. The bottom three income quintiles receive about 10% of all credits, while the fourth and fifth quintiles receive about 30% and 60%, respectively.
Alternative Motor Vehicle Credit
Average Credit per Tax Return, By Income Level
Finally, we looked at the Qualified Plug-in Electric Drive Motor Vehicle Credit, an income tax credit for electric and plug-in hybrid vehicles. The size of this credit ranges from $2,500 to $7,500 depending on the battery capacity of the vehicle. For example, the Toyota Prius plug-in hybrid qualifies for a $2,500 credit whereas the Chevrolet Volt qualifies for a $7,500 credit.
We find that this credit is considerably more concentrated in the highest income categories. As shown in the figure below, filers with less than $75,000 in AGI rarely claim the electric vehicle credit. The average credit amount jumps considerably in the $75,000-$200,000 category and then soars in the top AGI category ($200,000+).
Electric Vehicle Credit
Average Credit per Tax Return, By Income Level
Thus overall, we find that filers with AGI in excess of $75,000 receive about 60% of the tax credits aimed at energy-efficiency, residential solar, and hybrid vehicles, and about 90% of the tax credit aimed at electric cars.
We find that tax credits are less attractive on distributional grounds than pricing GHGs directly. Previous studies (here and here) have examined how a carbon tax or cap-and-trade program would impact households with different income levels. Whereas tax credits go disproportionately to high-income households, a carbon tax would be paid disproportionately by high-income households. It would seem difficult, therefore, to argue for tax credits on distributional grounds.
Our data come from individual income tax returns, so they miss tax credits received for electric vehicles and solar panels that are leased. Leasing has grown more common in both markets, though especially in the solar market with the well-documented move toward third-party ownership. However, previous research finds that the decision to lease is uncorrelated or even slightly positively correlated with income, so leasing is unlikely to undo the pronounced positive correlation between credits and income.
Why are these tax credits so concentrated among the higher income categories?
Part of the explanation is that all of these credits are non-refundable. You can use these credits to offset your tax bill, but you cannot go negative and receive a net payment from the IRS like you can with the Earned Income Tax Credit and many other tax credits. This is a significant distinction because a large fraction of filers do not have positive tax liability. In 2012, for example, more than one-third of U.S. tax returns had zero tax liability. These filers without tax liability tend to be lower-income, so this helps explain the low take-up in lower income categories. Making these credits non-refundable doesn’t make much sense. After all, what is the real difference between a filer who owes $0 in tax and another who owes $1000? Both reduce carbon emissions when they install an energy-efficient window. Both stimulate innovation when they purchase an electric vehicle. So it seems odd to treat these filers so differently in our tax code.
Another issue is that renters are ineligible for most of these credits. Over 40 million American households are renters, and thus cannot take advantage of any of the credits aimed at weatherization, energy-efficiency, or solar PV. Addressing renters is challenging because of imperfect information and split incentives, but excluding this sector altogether misses a large share of the housing stock. The proportion of households that own a home increases steadily across income quintiles from 0.49 to 0.91 (here), so excluding renters disproportionally impacts lower-income households.
With the electric vehicle credit there are also a couple of additional potential explanations. It may simply be that, for the moment, electric vehicles are only affordable for relatively high-income households. Even after the credit, electric and plug-in electric vehicles are expensive compared to equivalently-sized gasoline-powered vehicles. Finally, another possible explanation is that in California, electric vehicles owners are allowed to drive in high-occupancy vehicle lanes. The value of time is highly correlated with income so this could help explain why this credit is so highly concentrated in the highest income categories.
So what? Should we scrap these tax credits? Should we expand them to include more Americans? Ultimately, in evaluating tax credits or any public policy it makes sense to think about both equity and efficiency. Our new paper is mostly about equity, and the results imply that it probably does not make sense to argue for these tax credits on distributional grounds.
What about efficiency? Although tax credits may initially seem like a good idea, they are actually quite a poor substitute for first-best policies like a carbon tax or cap-and-trade program. Probably the single biggest limitation of a tax credit is that it cannot achieve the efficient level of usage. Take energy-efficient windows as an example. A tax credit can encourage households to install better windows, but it cannot get households to use less heating and air-conditioning. A carbon tax, in contrast, would encourage households both to install better windows and to use less heating and air-conditioning.
Tax credits are also extremely coarse instruments. The social benefits from clean energy investments vary enormously by geography. For example, a new paper by Stephen Holland, Erin Mansur, Nick Muller and Andrew Yates finds that the environmental benefits from electric cars varies from $3000 in California (where most electricity comes from natural gas and renewables) to -$4700 in North Dakota (where most electricity comes from coal). Tax credits ignore this heterogeneity completely, whereas price-based policies would incorporate these differences.
In the end, it is hard not to be somewhat disappointed. The more we have studied these tax credits, the more we realize their limitations. There are large potential social benefits from clean energy investments, but income tax credits are an inefficient instrument for realizing changes in behavior. Moreover, the distributional impacts are a real concern. Through several key features of the tax code, we have set up these credits in a way which excludes millions of Americans from participating, and higher-income households receive the lion’s share of total credit dollars.
For more, see “The Distributional Effects of U.S. Clean Energy Tax Credits” (with Severin Borenstein), NBER Tax Policy and the Economy, 2016, 30(1), 191-234.
Lucas Davis is an Associate Professor of Economic Analysis and Policy at the Haas School of Business at the University of California, Berkeley. His research focuses on energy and environmental markets, and in particular, on electricity and natural gas regulation, pricing in competitive and non-competitive markets, and the economic and business impacts of environmental policy.