The guidance implementing the energy tax credits in the Inflation Reduction Act is not yet complete, but it’s already time to look ahead to the Tax Cuts and Jobs Act provisions expiring at the end of 2025 — and the wide-ranging tax debate that is bound to ensue. A tax bill might not cross the finish line next year, but there will be a push for one. Much will be up for negotiation, and chances are good that a carbon fee and the IRA’s tax credits will be among the prime topics under consideration.
A reminder, since it bears repeating once in a while: We make climate policy today through the tax code because of congressional budget rules. Using the tax law instead of alternatives makes it hard for Congress to know exactly how much its proposed policies are likely to cost, because the cost of credits or taxes generally depends on choices made by taxpayers, whereas direct expenditures like grants and loans can be capped. Congress sometimes dabbles in caps on credits and did so in the IRA, but it’s not typical. The result is a high-stakes process of drafting guidance in which critical policy decisions are made.
Fully extending everything in the TCJA is expensive — $4 trillion over the 10-year budget window, said Kimberly Clausing of the University of California Los Angeles School of Law. But Congress is unlikely to want to let many of the TCJA’s provisions expire, which opens up the opportunity to build fiscal resources and achieve efficient decarbonization through layering on a modest carbon fee, she said. “This is a great moment to consider this approach, because within politics, there are grand bargains to be had,” Clausing said. For Republicans who worry that addressing climate needs is too expensive, a carbon fee is a way to reduce the cost of emissions reduction. And for Democrats who worry about the potential regressivity of a carbon fee, there are options like the child tax credit to lower tax burdens and raise benefits that would offset the fee’s impact.
Treasury and the IRS have long had to deal with the patchwork of arcane and frequently expiring tax benefits Congress doles out for conventional energy sources and alternative energy, but the IRA turbocharged that and turned the IRS into the agency primarily responsible for implementing climate policy. The agency’s greatly increased purview over climate policy is unlikely to change soon. A new Brookings Institution study on possible climate tax policy choices for 2025 suggests that Congress will continue making climate policy through the tax code.
The Brookings study examined a menu of possibilities, from repealing the IRA’s energy credits to extending them and adding a carbon fee. The United States is projected to hit a roughly 42 percent decline from 2005 emissions levels in 2035 under the existing IRA provisions, assuming there are no new emissions rules or tax law changes. Repealing the IRA completely would result in a 36 percent decline, according to the Brookings study. Expanding the IRA by doubling the tax credits for the power sector — the production tax credit, investment tax credit, and the credit for nuclear — would accelerate the decline in emissions up to 51 percent. Each alternative has an average abatement cost per unit of emissions, ranging from $18 for a carbon fee and partial repeal of the IRA to $69 for current law with no new emissions rules.
Unsurprisingly, there is a fiscal cost to expanding the IRA’s credits: an estimated $530 billion between 2026 and 2035. The Brookings study authors noted that their estimates of most options are likely lower than those of official scorers, except for the carbon fee, which is estimated to raise $590 billion over the 10-year window. With a partial repeal of the IRA’s credits, that number rises to $1.39 trillion. Partial repeal here means retaining the production tax credit and ITC for electricity generation and the nuclear credits with their current expiration date. “The lower revenues from the carbon fee in this analysis are due in part to the lower economy-wide emissions in these scenarios in addition to potential countervailing changes in IRA tax credits due to greater deployment of subsidized resources with a carbon fee in place,” the study explained.
IRA Efficiency at Reducing Emissions
It’s challenging to evaluate the effect of each of the IRA’s new or dramatically revised provisions, in part because Treasury and the IRS haven’t finalized many of the proposed regulations yet. The decisions on some of those rules will be consequential in determining how much they cost the fisc and how efficient they are at reducing emissions. The new study explains that estimates of the cost-effectiveness of credits for clean energy manufacturing under section 45X or medium- and heavy-duty vehicles aren’t available yet.
If Congress is inclined to consider cost-effectiveness in deciding what to prioritize, the Brookings study provides a provisional roadmap. Last year some of the study authors estimated that the overall cost-effectiveness of the IRA’s climate and energy provisions is between $42 and $102 per ton of carbon dioxide reduced. Goldman Sachs came up with a cost of $52 per ton last year.
More detailed estimates — many of which were provided by the Brookings study authors — so far indicate that the production tax credit and ITC for the electric sector are the most efficient, at between $27 and $60 per ton, according to one study, and $36 to $87 per ton, according to another. In contrast, the section 45Q credit for carbon capture has estimates of $129 per ton and between $148 and $418 per ton of carbon dioxide. Passenger vehicle credits clock in at between $63 and $113 per ton. And the section 45V hydrogen credits cost $750 per ton. Section 45V’s much higher abatement costs are due in large part to the credit’s purpose of encouraging technological change. But being an outlier could complicate future tax legislation discussions, as the credit has already been the focus of congressional grumbling about its implementation.
It’s important to note that the Brookings study didn’t endorse its scenarios, as the goal was simply to see what could happen. Accordingly, the study chose a scenario to expand the IRA by increasing the technology-neutral production and investment tax credits for clean electricity and the credits for nuclear by 50 percent. This choice was predicated on the cost-effectiveness of those credits and the fact that most of the emissions reductions in the IRA come from those incentives.
Carbon Fee
The resurrection of a possible carbon tax shouldn’t be surprising. Carbon taxes raise revenue, at least in the short run, and, as the Brookings study outlined, they have the distinct advantage of speeding decarbonization. “Adding a carbon fee . . . increases [carbon capture and sequestration] and hydrogen deployment, spurs greater end-use electrification, and lowers the carbon intensity of electricity generation in the modeling,” the paper explained. As a practical matter, much depends on the outcome of the election in November. If Democrats hold both chambers of Congress and the presidency, there is a strong argument for keeping the IRA the way it is and layering a carbon fee on top, because that would strengthen the effects of the law, Clausing said.
Senate Budget Committee Chair Sheldon Whitehouse, D-R.I., has carbon fee proposals waiting in the wings, both with a border adjustment: the Save Our Future Act of 2021 (S. 2085) and the Clean Competition Act (S. 3422). The Clean Competition Act would start out by imposing a carbon intensity charge on energy-intensive industries, and then expand to include imported finished products that meet specified requirements. The Save Our Future Act would assess a fee on fossil fuels and other sources of greenhouse gases starting at $54 per ton of emissions. The fees in both proposals would be excise taxes housed in chapter 38, right after the subchapter on taxes on ozone-depleting chemicals. The proposed statutory text of the Clean Competition Act doesn’t use the word “tax.”
Ensuring that any carbon fee proposal is nondiscriminatory is key, Clausing said. “We don’t want to unravel the good efforts that our partners abroad are making,” she said. A tariff on foreign products with no domestic parallel, as the Foreign Pollution Fee Act (S. 3198) proposes, is undesirable because it undermines the decarbonization efforts of other countries, she said. U.S. manufacturing has an edge because it is already fairly clean, so “if our manufacturers have the same costs, but are only polluting one-third as much, they’ll still pay less than dirtier competitors abroad,” Clausing added.
A carbon fee on retail gasoline is politically unappealing, which led the Brookings study authors to exempt it from their tax base. They analyzed the effect of a fee starting at $15 per ton of carbon dioxide in 2027 that increases to $65 by 2035 and thereafter increases with inflation. That is a more modest carbon price than most of the recent carbon pricing bills have suggested. There are, of course, myriad possible options for a carbon tax, including a huge range of possible rates, as well as more extensive potential carveouts.
The contours of any future bill including energy tax changes are difficult to predict because of the upcoming election, but for taxpayers looking ahead to 2025, the combination of options in the Brookings study offers a glimpse of the possibilities. While many of the regulations implementing the IRA should be finalized this year, the results of the legislative debate may unsettle the stability the guidance provides.
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