CRS FINDS INCENTIVES MAKE BIOMASS ENERGY COMPETITIVE.

                          Salvatore Lazzari

SUMMARY

Four Federal tax incentives for biomass energy currently exist: a 5.4 cents per-gallon exemption from the motor fuels excise taxes; the $5.35 per barrel section 29 alternative fuels production tax credit; the 54 cents and 60 cents per-gallon tax credits for blended and pure ethanol fuels; and the new 10-per gallon small-ethanol- producer credit. (Two special tax incentives for biomass enacted in 1978 have since been repealed.) The recently enacted `Energy Policy Act of 1992' (P.L. 102-486) liberalizes the rules concerning the gasohol excise tax exemption and the section 29 production tax credit for biomass fuels. In addition, the act introduces two new tax incentives for biomass energy: an income tax deduction for the costs (up to $2,000) of alcohol fuel powered vehicles; and a 1.5- per kilowatt hour income tax credit for electricity produced from "closed-loop" biomass systems.

The four tax incentives for biomass that existed before the 1992 amendments were part of a broader system of tax incentives for alternative energy resources estimated to provide aggregate tax benefits to the alternative energy industry ranging from $850 million to $1,250 million for FY 1993, the precise amount depending upon whether coalbed methane is treated as a conventional or an unconventional natural gas. In terms of the tax subsidy per-unit output of biomass and other alternative fuels the estimate ranges from $3.00 to $4.25 per barrel of oil equivalent. Much of this tax benefit, although not all, will accrue to biomass energy. These estimates suggest that Federal tax incentives lower the cost, and presumably the market price, of biomass energy by an estimated $3.00 to $4.25 per barrel of oil equivalent ($0.50 to $0.75 per MCF of gas) below what the cost would be without the incentives. The estimated net tax benefit to biomass and other energy alternatives contrasts with a small, but positive, net tax burden - the difference between the industry specific subsidies and taxes - on oil and gas ranging from $88 million to $488 million (again depending upon how coalbed methane is treated) for FY 1993. Given the relatively large output of oil and gas in the United States, the estimated net tax on oil and gas ranges from 2.0Q to 7.5 cents per barrel of oil equivalent. Clearly, Federal energy tax policy has shifted from its historical posture in favor of oil and gas to one that favors alternative energy resources, and this shift helps to narrow, but probably not completely eliminate, the competitive disadvantage of biomass and other energy alternatives relative to conventional oil and gas.

The broadening of the existing biomass tax incentives, and the creation of new incentives under P.L. 102-486 will slant Federal energy tax policy even more in favor of biomass energy.

ENERGY TAX SUBSIDIES: BIOMASS VS. OIL AND GAS

Historically, the Federal tax system favored oil and gas, which qualified for two major tax subsidies, over energy from biomass and other alternative energy resources, which received no tax subsidies. ¹ Oil and gas companies could use percentage depletion (instead of cost depletion) for the recovery of the investment in a well, and could expense (deduct currently, rather than capitalize) intangible drilling costs (IDCs). This preferential treatment was curtailed during the 1970s and 1980s. Restrictions were imposed upon the two oil and gas tax subsidies, and several new oil taxes were introduced, all of which raised the industry's effective tax rates and narrowed its preferential treatment relative to investments in other industries. And a variety of tax incentives were introduced targeted specifically for the development of alternative energy resources. While these new tax incentives have been provided to a wide spectrum of renewable and nonconventional forms of energy resources (solar, wind, geothermal, synfuels, shale oil, coalbed methane and many others), biofuels (such as ethanol) and other types of biomass energy became the focus of virtually every energy tax legislation.

As a result, the Federal tax system shifted away from oil and gas toward energy conservation and the development of alternative energy resources such as biomass. Combined with the two expired biomass tax incentives, the general investment tax incentives, and the spending programs and Federal research and development programs in effect at that time, these biomass tax incentives contributed to the enormous growth in the biomass industry over the last 20 years and they help to sustain it today.

This report examines the provisions of the Federal tax code that promote biomass energy and biofuels. The first section describes each incentive in detail, along with its limitations, legislative history and any expansion or liberalization adopted by the recently enacted energy tax act. The second section describes the new biomass tax incentives enacted as part of the energy tax bill of 1992. The third section compares the estimated tax benefits for biomass energy and other energy alternatives in relation to oil and gas, the benchmark energy resource. It will show that current Federal energy tax policy favors biomass and other alternatives to oil and gas.

This report examines only those tax provisions (incentives) specifically targeted to biomass. Oil and gas tax incentives and penalties will be discussed only to the extent that they are useful in placing the biomass tax incentives in perspective. General tax provisions of the corporate or individual income tax systems (such as accelerated depreciation, or tax rate structure), are not discussed because they are not likely to produce significant differential effects on the two industries. ² This paper also does not discuss two biomass tax incentives -- the 1978 business energy investment tax credit and the 1980 tax-exempt bond provisions for biomass facilities -- that have expired.

CURRENT FEDERAL TAX INCENTIVES FOR BIOMASS ENERGY

The current Federal tax code contains four incentives for biomass energy: the partial exemptions from the various motor fuels excise taxes, particularly the 5.4 cents per-gallon exemption for gasohol; the $5.35 per barrel alternative fuels production tax credit; the tax credits for blended and pure ethanol fuels; and the new 10- per gallon small ethanol-producer credit. Each of these tax incentives is provided for the conversion of biomass, broadly defined, into either a liquid or gaseous fuel or for the use of the biofuel; no incentives are currently provided for the direct combustion of biomass, such as wood. ³ Moreover, in the case of biomass conversion, the tax incentives are for the conversion of biomass into an alcohol fuel, primarily ethanol.

EXCISE TAX EXEMPTIONS FOR ALCOHOL FUELS

CURRENT LAW. The most important tax incentives for biofuels are the exemptions for blends of ethanol and motor fuels, such as gasoline and diesel, from the various Federal motor fuels excise tax. The current Internal Revenue Code (IRC) imposes excise taxes on a variety of motor fuels used in highway transportation; the tax rates depend on the type of fuel and its use. Gasoline and special motor fuels are taxed at 14.1 cents per gallon [IRC section 4041(a)(2), and section 4081] /4/. Diesel fuel is taxed at 20.1 cents per gallon [section 4091, and section 4041(a)]. Fuels used in noncommercial aviation are taxed at either 15.1 cents per gallon [in the case of gasoline, section 4041(c), and section 4081] or 17.6 cents per gallon for jet fuel [section 4041(c), and section 4091]. Fuel used for transportation on inland waterways by commercial cargo vessels is taxed at 15 cents per gallon, rising to 20 cents by 1995 [section 4042].

In the first three of the above four excise taxes, mixtures of ethyl alcohol and the otherwise taxable fuel are partially tax- exempt. For example, ethanol blended either with gasoline ("gasohol") or one of the other qualifying special motor fuels is exempt from 5.4 cents of the 14.1 cents per gallon tax (i.e., the tax rate is 8.7 cents). Ethanol blended with diesel -- sometimes called "dieselhol" -- is exempt from 5.4 cents of the 20.1 cents tax (the tax rate is 14.7 cents). Ethanol blended with either aviation gasoline or jet fuel qualifies for a 5.4 cent exemption (making the taxes on the ethanol mixtures 9.7 cents and 12.2 cents, respectively). These tax exemptions apply to mixtures that are at least 10 percent ethanol. If the fuel contains at least 85 percent pure alcohol the exemption is 6.05 cents. ⁵

The excise tax exemptions for alcohol fuels mixtures, particularly the 5.4 cents gasohol exemption, has been the single most important tax incentive for biofuels, causing (along with high oil prices and State tax exemptions) fuel ethanol production (produced mostly from corn) to increase from about 40 million gallons in 1978 to over 1 billion gallons in 1991. ⁶

LIMITATIONS. It should be noted that, in the case of alcohol blends the alcohol must be at least 190 proof (95 percent pure alcohol), the mixture must be at least 10 percent alcohol, and the alcohol cannot be derived from petroleum, natural gas, or coal (including peat). The latter limitation means that exempt alcohol is, generally, derived from biomass. The only exception to the latter rule is for special motor fuels that are 85 percent alcohol (ethanol or methanol) derived from natural gas, which is exempt for 7.0 cents of the 14.1 cents tax [the tax rate is 7.1 cents per gallon (section 4041(m))]. ⁷ It should also be noted that the motor fuels excise taxes apply to liquid fuels only; gaseous fuels, such as compressed natural gas, are tax-exempt. The excise tax exemptions for alcohol fuels expire on September 30, 2000.

LEGISLATIVE HISTORY. The excise tax exemptions for alcohol fuels originated with the Senate's version of the Energy Tax Act of 1978 (P.L. 95-618), which introduced the special tax provisions for biomass and other alternative energy resources, and signaled the new shift in Federal energy tax policy. ⁸ The tax act was part President Carter's National Energy Plan. However, tax provisions for conversion to alternative transportation fuels (gasohol) were not part of the original House bill (H.R. 8444, 95th Congress), which embodied the tax provisions of the National Energy Plan. The version of H.R 8444 reported out of the Senate Finance Committee included the excise tax exemptions for gasohol fuels. The exemption was intended to induce a substitution of ethanol and methanol for gasoline used in transportation. The underlying rationale for the ETA was the perceived failures in the energy markets in allocating resources efficiently and fairly, in coping with the 1973 oil embargo, and in adjusting to the sharp increases in energy prices, the shortages, and the associated adverse economic and social problems. The belief was that the Federal Government had to influence resource allocations through tax incentives and other financial incentives. Each of these tax instruments was intended to contribute to the general goal of conserving conventional energy resources (primarily oil and gas), stimulate production of alternatives to oil and gas, reduce oil imports, and achieve energy security.

The original exemption was, as discussed above, for the full amount of the gasoline tax: 4 cents per gallon. The Crude Oil Windfall Profits Tax (P.L. 96-223) extended the 4 cent exemption from October 1, 1984 to December 31, 1992. The Surface Transportation Assistance Act of 1982 (P.L. 97-424) raised the gasoline tax from 4 cents to 9 cents per gallon and also changed the exemption for gasohol from the complete 4 cent exemption to a partial 5 cent exemption (gasohol would be taxed at 4 cents per gallon instead of 9 cents per gallon). The Tax Reform Act of 1984 (P.L. 98-369) raised the diesel fuel tax from 9 to 15 cents per gallon as part of a compromise that also lowered the highway use taxes on trucks. The 1984 tax law also raised the gasohol exemption from 5 to 6 cents (i.e., it reduced the tax rate for gasohol from 4 to 3 cents), and retained the 9 cent exemption for "neat" alcohol fuels, and provided that alcohol produced from natural gas would also qualify for the exemption. The Tax Reform Act of 1986 (P.L. 99-514) reduced the excise tax exemption for 85 percent alcohol from 9 cents to 6 cents per gallon (for sales made beginning on 1987). The Technical and Miscellaneous Revenue Act of 1988 (P.L. 100-647) made minor liberalizations to the excise tax rules. Finally, the OBRA of 1990 reduced the exemption to 5.4 cents per gallon.

AMENDMENTS IN THE ENERGY POLICY ACT OF 1992. P.L. 102-486 extends the gasohol excise tax exemption to gasohol that contains less than 10 percent alcohol. Two categories of gasohol mixtures are prescribed: mixtures containing 7.7 percent alcohol; and mixtures containing 5.7 percent alcohol. The exemption for 7.7 percent mixtures is 4.16 cents per gallon (the tax rate is 9.94 cents); the exemption for 5.5 percent mixtures is 3.08 cents per gallon (the tax rate is 11.02 cents).

THE ALTERNATIVE FUELS PRODUCTION TAX CREDIT

The second major tax break for biomass fuels is the alternative fuels production tax credit, also known as the "section 29 tax credit," named after the section of the IRC in which it resides.

CURRENT LAW. The alternative fuels production tax credit is a credit against the producer's income tax for the PRODUCTION AND SALE of fuels derived from a wide variety of alternative energy resources. Qualifying fuels are grouped into three categories: oil from shale or tar sands; liquid or gaseous synthetic fuels from coal, gas from coal seams (coalbed methane), tight sands, Devonian shale and geopressurized brine; and liquid or gaseous fuels from wood, agricultural byproducts, and other biomass. Certain types of alcohol fuels qualify for this credit including both ethanol and methanol, and alcohol produced from coal and lignite. Moreover, alcohol fuels produced from coal or lignite may be used as feedstocks, unlike other fuels, without invalidating the tax credit. ⁹

The production tax credit is $3.00 per barrel, in real terms, in barrels of oil or oil equivalent. ¹⁰ The $3.00 amount is adjusted for inflation (using 1979 as the base year and the GNP deflator as the price index), which makes the current credit about $5.35 per barrel of oil equivalent (for qualifying gases the credit is about $1.00 per thousand cubic feet). The availability of the credit is linked to the average wellhead price of domestic crude oil (called the reference price). When the reference price of oil is below $23.50 (in real terms), the tax credit becomes available; when the price of oil is between $23.50 and $29.50, the credit is phased out proportionately; when the price of oil is above $29.50, no credit is available. These trigger or threshold prices are also adjusted for inflation so that a comparison may be made with the reference price in nominal terms. At this writing, the phase-out range in current dollars is between $40 and $50 per barrel. With the market price of West Texas Intermediate crude oil (the reference price in nominal terms) at about $22 per barrel, well below the $40 ($23.50 times the inflation adjustment factor of 1.70), the credit is available. ¹¹ Most of the current credit goes for coalbed methane gas and very little for biomass. ¹²

LIMITATIONS. The production tax credit is available for fuels produced through December 31, 2002. However, the facilities must be placed-in-service (or from wells drilled) after 1979 and before 1993. To prevent "double dipping" the credit is reduced by any subsidized financing (grants, loans, tax-exempt financing) energy tax credits, including the enhanced oil recovery tax credit enacted as part of the OBRA 90. The credit is nonrefundable and is limited to the excess of a taxpayer's regular tax over several tax credits and the tentative minimum tax.

LEGISLATIVE HISTORY. The production tax credit was introduced by the 1980 windfall profit tax (WPT) and has been amended several times. Most of the amendments concern the placed-in-service deadlines. The original 1980 WPT established a placed-in-service deadline of December 31, 1989. This was extended to December 31, 1990 by the Technical and Miscellaneous Revenue Act of 1988, and to December 31, 1991 by OBRA of 1990, which also liberalized the treatment of tight-sands gas.

AMENDMENTS IN THE ENERGY POLICY ACT OF 1992. H.R. 776 provides for a three-year extension of the placed-in-service rule, and an extension of the credit, for biomass and synthetic fuels. Under these new rules, producers of gas from biomass or liquid, gaseous or solid synthetic fuels from coal or lignite, pursuant to a binding contract signed before January 1, 1996, would have until December 31, 1996 to build a facility and begin production. If these conditions are met, then production tax credits for these fuels would be available for another five years through December 31, 2007 (instead of December 31, 2002). These amendments mean that production of alternative fuels from new facilities or new wells will no longer qualify for the section 29 credit if the new facilities are placed in service after 1997.

THE TWO ALCOHOL FUELS TAX CREDITS

In place of an exemption, the Federal tax code provides an alcohol fuels mixtures tax credit (the blender's credit), and a tax credit for straight alcohol fuel. Both credits are part of IRC section 40.

CURRENT LAW. The blender's tax credit is 54 cents per gallon for alcohol that is at least 190 proof, and 40 cents per gallon for alcohol that is at least 150 proof but less than 190 proof. No credit is available for alcohol that is less than 150 proof. This credit is available to the blender only for use as a motor fuel in a trade or business whether produced and used by him or produced and sold by him. The straight alcohol fuels credit is 60 cents per gallon for alcohol that is at least 190 proof, and 40 cents per gallon for alcohol between 150 and 190 proof. This credit is typically available to the retail seller that dispenses it in the fuel tank of the buyer's vehicle. These credits have been available since October 1, 1980, and will, under current law, continue to be available through December 31, 2000.

The alcohol fuels tax credits apply to most types of ethanol (i.e., alcohol derived from renewable energy resources such as vegetative matter, crops, and other biomass) and to methanol derived from wood. The alcohol cannot be derived from petroleum, natural gas, or coal (including peat). This rule effectively limits the tax credits to ethanol since most economically feasible methanol is derived primarily from natural gas and does not qualify for the credits. Currently, about 95 percent of current ethanol production is derived from corn.

A 1990 IRS ruling allowed mixtures of gasoline and ETBE -- Ethyl Tertiary Butyl Ether -- to qualify for the 54 cents blender's credit. ETBE is a compound that results from a chemical reaction between ethanol (which may be produced from renewable energy) and isobutylene. ETBE, which is no longer an alcohol after its chemical reaction, is being considered for use as a substitute for MTBE -- Methyl Tertiary Butyl Ether -- as the oxygenate in reformulated gasoline mentioned under the Clean Air Act of 1990 for use in designated ozone nonattainment areas. Allowing ETBE to qualify for the blender's tax credit is designed to stimulate the production of ethanol for use in reformulated gasoline and to reduce the production of MTBE, an alternate oxygenate made from natural gas. This would increase the share of the U.S. corn crop allocated to ethanol production above the current 4-5 percent. It would also significantly increase Federal revenue losses from the alcohol fuels credits, which heretofore have been negligible due to blender's use of the exemption over the credit.

LIMITATIONS. There are several limitations to the two alcohol fuels tax credits: First, the alcohol cannot be derived from petroleum, coal, or natural gas. Thus, the alcohol must be derived from renewable energy resources such as vegetative matter, crops, wood, and other biomass to qualify for the credits. This limitation means that the credits are currently available only to ethanol, since most economically feasible methanol is made from natural gas, which does not qualify for the credits. Second, the alcohol fuels tax credits are a component of the general business credit under IRC section 38, which includes the jobs tax credit, research and development tax credit, low-income housing tax credit, and other credits. The general business tax credit is limited to the taxpayer's net income tax over the larger of either 25 percent of net regular tax liability above $25,000 or the tentative minimum tax. ¹³ Third, any taxpayer who claims the credit must also report it as gross income for the tax year in which the credit is earned (IRC section 87). Fourth, the credits are not refundable; they may be used only against a positive tax liability; they are of no value if the producer has no tax liability. Finally, and more importantly, the credits are offset by the excise tax exemptions claimed on the same fuel. Typically, blenders prefer the excise tax exemption over the credit because the exemption is an immediate "up-front" tax benefit, which increases cash-flow, while the benefits from the tax credit must await the preparation of the tax returns. The limitations under IRC section 38 also could reduce the value of the alcohol fuels tax credits.

LEGISLATIVE HISTORY. The alcohol fuels tax credits were enacted as part of the 1980 WPT at the initial amounts of 40 cents and 30 cents per gallon for proofs greater than 190 and between 150 and 190 respectively, and raised by the Surface Transportation Assistance Act of 1982 to 50 cents and 37.5 cents, respectively. The Tax Reform Act of 1984 raised the credits to 60 cents and 45 cents. This law also introduced the provision that alcohol produced from peat, like coal, would not qualify for the credits.

ETHANOL TAX CREDIT FOR SMALL PRODUCERS

An additional tax incentive for biofuels production is the small ethanol-producer credit introduced as part of OBRA 90.

CURRENT LAW. IRC section 40 provides for an income tax credit of 10 cents per gallon ($4.20 per barrel) for up to 15 million gallons of annual ethanol production by a small ethanol producer. A "small producer" is defined as one with ethanol production capacity of less than 30 million gallons per year (about 2,000 barrels per day). This credit is available for alcohol produced by a small producer and sold to another person for blending into a qualified mixture in the buyer's trade or business, for use as a fuel in the buyer's trade or business or for sale at retail where such fuel is placed in the fuel tank of the retail customer. Casual off-farm production of ethanol does not qualify for this credit.

LIMITATIONS. The new ethanol tax credit is limited to small producers, and aggregation rules are provided to prevent the credit from benefiting producers with a capacity in excess of the 30 million gallons per year limit, or from going to production in excess of the 15 million gallon limit.

LEGISLATIVE HISTORY. The small-producers credit was added by the Omnibus Budget Reconciliation Act of 1990 (P.L. 101-508); it has not been amended.

NEW BIOMASS TAX INCENTIVES IN THE ENERGY POLICY ACT OF 1992

The end of 1992 witnessed the enactment of broadly-based energy legislation -- The Energy Policy Act of 1992 -- designed to resuscitate a Federal energy policy that many argued was missing. The law, P.L. 102-486, which some call the crowning achievement of the 102nd Congress, includes numerous provisions intended to reduce dependence on petroleum imports: a restructuring of the electric utility industry to enhance competition, promotion of alternative transportation fuels, provisions that mandate new and more stringent energy efficiency standards, and numerous other provisions. Title XIX of the law contains a variety of energy taxes and tax incentives. In addition to the liberalization of existing biomass tax incentives, as discussed above, H.R. 776 creates two new tax incentives for biomass: an income tax deduction for the costs of a vehicle that burns alcohol or some other clean-burning fuel; and an income tax credit for electricity generated from "closed-loop" biomass facilities.

INCOME TAX DEDUCTION FOR ALCOHOL FUEL VEHICLES AND ALCOHOL STORAGE FACILITIES

Beginning on July 1, 1993, the purchaser of a new vehicle that burns either ethanol, methanol, ether, any combination of these, or some other clean-burning fuel, will qualify for a limited income tax deduction for the costs of the vehicle allocable to the engine and any collateral equipment used to store or deliver the fuel. The maximum deduction is $2,000 for cars, $5,000 for light trucks, and $50,000 for heavy trucks or buses. This deduction is also provided for the costs of retrofitting used non-qualifying vehicles to clean- fuel burning vehicles, and for the costs of equipment used to store or dispense the alcohol fuels and other clean-burning fuels into the tank of the clean-burning vehicle. Qualifying storage and dispensing equipment includes equipment used to compress natural gas into a usable fuel, provided that the equipment is located on the site that dispenses the fuel into the vehicle. The storage equipment deduction is limited to $100,000 per year. Alcohol fuels must contain 85 percent alcohol. Other clean burning fuels that qualify for the deduction are compressed natural gas, liquefied petroleum gas, and hydrogen.

INCOME TAX CREDIT FOR CLOSED-LOOP BIOMASS FACILITIES

The second new tax incentive in P.L. 102-486 that would benefit biomass energy is the income tax credit for production of electricity from "closed-loop" biomass systems defined as systems that use renewable plant matter exclusively as an energy source to generate electricity. The credit, which also applies to electricity generated from wind energy systems, equals 1.5 cents per kilowatt hour of electricity and is phased out, proportionately, as the national average price of electricity produced from renewables rises from 8.0 cents to 11 cents per kilowatt hour. Both the credit and the phase- out limit are adjusted for inflation. It is important to note that biomass is narrowly defined for purposes of this new credit. It does not apply to municipal or agricultural waste or to scrap wood and other wastes. This credit will be part of the general business credit, and its limitations, which were discussed above. It will also be offset by any type of grant or subsidized financing, including tax-exempt bond financing.

THE MAGNITUDE OF BIOMASS ENERGY TAX BENEFITS IN RELATION TO OIL AND GAS

This section of the report estimates the tax benefits to biomass and other energy alternatives that result from the various tax incentives peculiar to that industry. These are compared to any tax benefits that might accrue to oil and gas, the benchmark energy resource, as a result of Federal tax incentives and taxes peculiar to that industry. For each industry, first we estimate aggregate tax benefits, then we estimate tax benefits per unit of output.

Aggregate tax benefits to each industry are measured as the sum of the losses in Federal tax revenues -- also referred to as "tax expenditures" -- that result from each of the various tax incentives peculiar to that industry. The source for these estimates is the annual tax expenditure study published by Congress's Joint Committee on Taxation, which shows these losses for each of the industry- specific tax incentives. It is assumed that these losses in Federal tax revenues are equivalent to the reduction in industry tax liabilities. Tax benefits per unit of output are measured as the total industry tax benefits divided by estimated output. The latter is a better indicator of the effect of the tax benefits on relative prices among the fuels, which forms the basis of economic decisions. This particular framework of analysis abstracts from the general provisions of the income tax laws; it considers only those provisions peculiar or special to each industry. The comparison will show that biomass energy receives a fairly sizeable net tax subsidy compared with oil and gas, which is subject to a small, but positive, net tax.

AGGREGATE TAX BENEFITS

Table 1 shows the four tax incentives for biomass and other alternative energy resources and the corresponding annual revenue loss -- reductions in industry tax liabilities -- resulting solely from those incentives as calculated by the Joint Committee on Taxation. The table includes only the incentives prior to the enactment of P.L. 102-486. ¹⁴ According to these estimates, the biomass and alternative energy industry tax liabilities will be $1,250 million lower in FY 93 as a result of the four tax incentives peculiar to that industry. In other words, biomass and other alternative energy resources will receive a net tax subsidy, i.e., above and beyond the general provisions of the income tax laws. Note that, unlike oil and gas, there are no industry-specific Federal taxes targeted for this industry. It is difficult to determine the share of this $1,250 million that accrues specifically to biomass energy because the sum revenue loss corresponding to the alternative fuels tax credit is not disaggregated. Much of this benefit undoubtedly accrues to biomass, but a portion of it also accrues to such fuels as coalbed methane, which some consider not to be an alternative fuel. If half of this tax benefit accrues to coalbed methane production, then the total tax benefit to alternative energy resources is reduced to $850 million for FY 1993.

In order to put these estimates in perspective, table 2 shows Joint Committee of Taxation calculations of the various industry- specific Federal tax incentives and penalties imposed on oil and gas. Oil and gas benefits from four tax subsidies (including the two discussed in the introduction) and is penalized by three special taxes. The tax subsidies are: percentage depletion allowance, which is available only to independent producers, and only for limited quantities of output; expensing of domestic IDCs, which is available to all who drill for oil and gas, subject to limitations for corporate producers; exemption from the material participation requirements of the passive loss limitation rules; and a new 15 percent tax credit for enhanced oil recovery techniques. The tax penalties are: the alternative minimum tax imposed on oil and gas producers; a 9.7 cents tax per barrel on domestic and imported crude oil to finance Superfund; and a 5 cents tax per barrel on domestic and imported crude oil to finance the Oil Spill Liability Trust Fund. ¹⁵

  TABLE 1. SPECIAL TAX INCENTIVES FOR BIOMASS AND ALTERNATIVE ENERGY

TAX BENEFITS PER UNIT OF OUTPUT

Estimates of aggregate tax benefits do not take into account the fact that economic decisions are based on relative prices per unit of output. To estimate the effect of the various tax incentives and taxes (in the case of oil and gas) on the relative prices of the two fuels we merely have to correct for the size difference between the two industries, which is significant. The U.S. oil and gas industry is ostensibly very large in comparison with the alternative energy industry, which was basically nonexistent until the 1970s. In 1990, for example, oil and gas output accounted for 53 percent of total domestic energy production, as compared with 9 percent for total renewable energy and 4.5 percent for biomass, broadly defined. ¹⁷

   TABLE 2. SPECIAL OIL AND GAS TAX INCENTIVES AND TAXES FOR AND THE

If coalbed methane is treated as an alternative fuel, the estimated Federal subsidy for alternative energy resources as a whole is about 72 cents per million BTUs or about $4.25 per barrel of oil equivalent. In contrast, oil and gas experiences a net tax burden estimated to be about 1.3 cents per million BTUs, which is equivalent to about 7.5 cents per barrel of oil. When coalbed methane is treated as a conventional fuel, the tax subsidy for alternative energy sources declines to about $3.00 per barrel and the net tax burden on oil and gas increases to about 2 cents per barrel. Thus, the net special tax burden on the oil and gas industry is small per unit of output, while the net tax subsidy for alternative energy resources is large per unit of output.

These estimates suggest that Federal tax incentives lower the market price of biomass energy by an estimated $3.00 to $4.25 per barrel of oil equivalent ($0.50 to $0.75 per MCF of gas) below what the market price would be without the incentives. Clearly, the Federal tax incentives help to narrow, but probably not completely eliminate the competitive disadvantage of biomass and other energy alternatives relative to conventional oil and gas. The estimates also indicate that Federal energy tax policy is, at this writing, slanted in favor of alternative energy resources, a policy posture that constitutes a reversal of the historical posture in favor of oil and gas.

² Under certain restrictive conditions, some types of biomass equipment may qualify for a slightly accelerated depreciation. See: Middleton, G.L., Jr. Impact of Future Tax Incentive Legislation on the Development of Biomass Energy. Biolog, v. 7, (1990) February/March. p. 7-11.

³ However, the Energy Policy Act of 1992 contains a tax incentives for biomass used directly to generate electricity. See p. 9.

⁴ Special motor fuels are gasoline substitutes and additives such as liquefied petroleum gas, naphtha, and benzene. The 14.1 cents tax also applies to gasoline and special motor fuels used in noncommercial motorboats.

⁵ This would make the tax rates for mixtures with 85 percent alcohol as follows: 8.05 cents for gasoline and alcohol; 14.05 cents for diesel and alcohol; 9.05 cents for gasoline and alcohol used in noncommercial aviation; and 11.55 cents for jet fuel and alcohol.

⁶ The 5.4 cents per gallon exemption for gasohol represents 38 percent of the 14.1 cents gasoline tax. When the gasoline tax was 9.1 cents per gallon the gasohol tax exemption was raised to 6 cents per gallon (66 percent of the tax). Under the original 1978 statute, the exemption was 4 cents per gallon (100 percent of the tax). Thus in absolute terms, the gasohol tax exemption first increased from 4 cents to 6 cents, then decreased to 5.4 cents. In relative terms, however, the gasohol tax exemption has steadily decreased. The dieselhol tax exemption has decreased from 100 percent to 40 percent, and to 26 percent of the excise tax.

⁷ In the case of the blended fuels, methanol produced from coal or natural gas does not qualify for the tax exemptions because in 1977, when the ethanol exemption was first introduced, the Congress believed that the cost of producing methanol from coal and natural gas was low at that time and did not warrant a Federal tax subsidy; whereas, the cost of producing methanol from wood and ethanol from grain was costly and did warrant a subsidy. According to a committee report:

The technology for the production of ethanol from agricultural products and for the production of methanol from forestry products seems to require greater subsidies than for the production of methanol from coal or from urban waste.

See: U.S. Congress. Senate. Finance Committee. Energy Production and Conservation Tax Incentive Act. Senate Report No. 95-529 on H.R. 5263, 95th Cong., 1st Sess. Washington, U.S. Govt. Print. Off, 1977. p. 45.

⁸ The other four components of Carter's National Energy Plan were: the Public Utilities and Regulatory Policies Act (P.L. 95-617); the National Energy Conservation Policy Act (P.L. 95-619); the Powerplant and Industrial Fuel Use Act (P.L. 95-520); and the Natural Gas Policy Act (P.L. 95-621). For biomass energy, Energy Tax Act introduced the excise tax exemptions for alcohol fuels, the business energy investment tax credits, and the tax-exempt bond provisions to provide financing incentives. Each of these provisions is discussed in this paper. The Energy Tax Act also provided for the gas-guzzler tax, incentives for van pooling, and miscellaneous energy tax provisions.

⁹ Two other types of biomass qualified for the production tax credit under the provisions of the original 1980 law: processed wood fuel treated to increase the BTU content of the wood by at least 40 percent, and steam from agricultural products. These two types of biomass no longer qualify for the tax credit under original expiration dates. The credit for processed wood fuel expired on October 1, 1983, and the credit for steam from solid agricultural products expired on December 31, 1985. Solid agricultural products included only solid byproducts of farming or agriculture and excluded timber products or other forms of biomass. Thus waste wood used directly as a fuel did not qualify for the credit.

¹⁰ Technically, the amount of the credit is linked with the BTU (British Thermal Unit) content of oil. Each 5.8 million BTUs of fuel, the energy content of one barrel of oil, qualifies for the $3.00 credit.

¹¹ The Congress believed that when oil prices are high, market incentives should suffice to stimulate production of alternative fuels.

¹² Coalbed methane is eligible for the production tax credit, and it has generated much of the revenue losses from the credit. Coalbed methane is a colorless and odorless natural gas that permeates coal seams, and is virtually identical to conventional natural gas. Under IRC section 29, coalbed methane is treated as an unconventional gas because it resides in an unconventional location -- coal beds -- as opposed to conventional gas reservoirs. The combined effect of the $1.00 per MCF tax credit (which was at times 100 percent of natural gas prices) and declining production costs (due to technological advances in coalbed methane drilling and production techniques) was sufficient to offset the decline in oil and natural gas prices, and the resulting decline in domestic conventional natural gas production. Data show that production of coalbed methane has increased from 0.1 billion cubic feet in 1980 to over 300 billion cubic feet in 1991, a large part of it in response to the production tax credits, and virtually all of it at the expense of conventional gas production. The credit for coalbed methane benefits largely oil and gas producers, both independent producers and major integrated oil companies, and complicates calculation of the special tax benefits to biomass and other alternative energy resources in relationship to the net tax burdens on oil and gas.

¹³ Any unused general business credits may generally be carried forward 15 years or carried back three years.

¹⁴ H.R. 776 contains tax relief for both the oil and gas industry as well as the biomass industry. In absolute dollar terms, the tax relief for the two industries over five years is about the same, reducing taxes by about $200 million annually. But, the tax relief for biomass and alternative energy resources is larger, in relation to industry size, than for oil and gas. Moreover, oil and gas would still be a net special taxpayer, while the net tax subsidy to alternative energy resources would increase. Thus after H.R. 776 the posture of energy tax policy is even more slanted in favor of biomass and other energy alternatives. These tax incentives resulting from H.R. 776 are excluded from our analysis because they are negligible for FY93, the period of analysis, and because we were unable to separate the tax decreases for biomass from the tax decreases for other qualifying fuels. U.S. Congress. House. Committee on Ways and Means. Comprehensive National Energy Policy Act. House Report No. 102-74, Part 6. Washington, U.S. Govt. Print. Off, May 5, 1992. 94 p.

¹⁵ The Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (P.L. 96-510) -- commonly known as Superfund -- originally imposed a 0.79 cents excise tax on oil received by a domestic refinery. Under the Superfund Amendments and Reauthorization Act of 1986 (P.L. 99-499), this tax was increased to 8.2 cents per barrel of domestic oil and 11.7 cents per barrel of imported oil. This tax differential was ruled to be in violation of GATT -- the General Agreement on Tariffs and Trade -- to which the United States is a signatory and a 9.7 cents tax was imposed equally on domestic and imported oil as part of the Steel Trade Liberalization Program Implementation Act (P.L. 101-221). The 5 cents per barrel tax on crude oil for the oil spill liability trust fund was enacted under Omnibus Budget Reconciliation Act of 1989 (P.L. 101-239). This tax, also part of the 1980 Superfund law, was originally 1.3 cents per barrel, but no revenues were ever collected because the enabling legislation required to activate the tax under the 1980 law was not enacted. Legislation in 1989 activated the tax at the higher rate of 5 cents per barrel. Another excise tax on domestic crude oil was introduced in the 1980 windfall profit tax but this tax was repealed in 1988 by the Omnibus Trade and Competitiveness Act (P.L. 100-418).

¹⁶ The revenue loss from the expensing of IDCs as shown in the table has two important shortcomings: First, it excludes expensing of losses from abandoned properties because the Joint Tax Committee, which determines tax expenditure items and estimates the corresponding revenue losses, does not consider it a tax expenditure. Second, a revenue loss estimate for one year shows only a cash-flow effect, which is not a good indicator of the value of IDCs that are based on timing. Calculations that take these two shortcomings into account lower the net tax burden on the oil industry somewhat, but it is still a positive tax burden. These calculations do not affect the net tax subsidy to biomass and other energy alternatives, therefore do not effect the major conclusions of the report.

¹⁷ Renewable energy includes hydroelectric power, biofuels, geothermal energy, wind energy, and solar energy. See: U.S. Department of Energy. Annual Energy Review. DOE/EIA-0384(91). Washington, June 1992. p. 241-257.