Last week, Politico reported that Joe Manchin opposes making clean energy tax credits “direct pay.” If that sounds like another impossibly wonky detail about energy policy, that’s because it is. But it has potentially massive implications.
Clean energy tax credits are currently the biggest climate-related line item still on the table in a potential reconciliation package; essentially, they’re an incentive to build solar and wind installations. And “direct pay” means the companies could collect the incentive through tax refunds. Yet Manchin has questioned the idea in meetings with Senate Majority Leader Chuck Schumer, who’s currently “keeping most Democrats out of the loop to limit public fretting,” Politico’s Burgess Everett reported.
If Manchin gets his way, billions of dollars a year in public money could go to Wall Street rather than to energy transition, or sit unused—a pretty good reason for the public to fret.
Roughly 65 percent of the capital backing for a typical wind project and 35 percent for the typical solar project come from so-called tax-equity investors, mainly housed at big Wall Street Banks. JP Morgan Chase and Bank of America accounted for more than half the tax equity market in 2019 and 2020. The remainder is funded through either debt or equity financing. One of the reasons reformers favor direct pay is that right now, without it, only businesses with a sizable tax liability can take advantage of wind and solar tax credits; even large businesses often need to form special-purpose vehicles with other firms to seek out tax equity investors, and these “SPVs” then pay considerable fees—on the order of 15 to 20 percent of the value of the credit—to sell off their right to collect the cash from their credits. By amending the Internal Revenue Code, direct pay changes in Build Back Better would instead allow entities interested in building clean energy to make payments up front and then recoup the portion eligible for tax credits as a refund.
Because they lack tax liability, nonprofits, and publicly owned utilities—which meet about a third of the country’s retail electricity demand—are excluded from using credits entirely, forcing them to contract out to third parties. Even investor-owned utilities are mostly barred from accessing credits directly. So besides leaving out an enormous chunk of the grid, tax credits currently allow a small group of big banks to skim massive fees off the top of public funds ostensibly meant to drive decarbonization. It also gives them a key role in deciding which projects get built and where. As Lew Daly and Sylvia Chi wrote recently in a report for the Roosevelt Institute, this will likely exacerbate existing race and income inequalities in the clean energy economy.
According to Politico, some banks have resisted direct pay changes proposed in Build Back Better, though they don’t seem to have taken a public stance on the matter. (Neither JP Morgan Chase nor Bank of America responded to a request for comment for this story.) A contingent of Democrats have advocated for direct pay, including Senators Ron Wyden and Tina Smith. Trade associations that represent big renewables developers—including the Solar Energy Industries Association—have argued for it too. Polling from Data for Progress found that, even when presented with negative messaging, 79 percent of Democrats and 67 percent of independents support reforming clean energy tax credits, along with 49 percent of Republicans.
Manchin has articulated his opposition as one based on philosophical principles—that he’s against giving already profitable companies cash. (Notably, Manchin has never opposed giving subsidies to extraordinarily profitable fossil fuel companies.) It’s possible there are other forces at work too. New York is the home of Manchin’s second-biggest tranche of donors after Texas. The Wall Street banks that dominate tax equity financing have been among Schumer’s biggest donors, as well, although a source familiar with the negotiations said that Manchin was the only Democrat opposed to the direct pay provision. Neither senator’s office responded to a request for comment on this story.
Caving on direct pay, though, could neuter the policy that Democrats are hoping will be their best and biggest offering to midterm voters. Banks are tremendously picky about the kinds of projects they agree to finance via tax equity schemes. Tax equity financing has been twice as expensive as debt financing since 2008, and the Congressional Research Service has found that tax equity investors require a rate of return between 7 to 10 percent higher than the return on debt products. The size of the tax equity market last year was $20 billion, having doubled from $10 billion. But these deals don’t grow exponentially. Limited interest in them could be a major bottleneck to distributing the $30 billion a year a reconciliation package could furnish. It was a major reason lawmakers drafted the direct pay provision in the first place. “Build Back Better would tremendously expand the activities and investments eligible for tax credits. There is a limited amount of tax appetite available to make tax equity investments,” says David Burton, a partner at the law firm Norton Rose Fulbright who advises clients on energy project finance and tax policy.
While the fees that tax equity deals bring to banks are certainly welcome, tax equity deals are also a means of maintaining or expanding more lucrative business. “Banks view tax equity either as a way of keeping existing customers happy or getting new investment for their banking business,” Burton told me, noting that banks often agree to tax equity deals with the understanding that they can also underwrite bigger-ticket IPOs and bond deals.
Allowing developers the option to get payments back on their tax bill instead would both expand the kinds of actors that can take advantage of credits and keep them from needing to go to a small collection of big Wall Street banks to do so. Burton cautions that direct pay is not a panacea and argues there would still likely be considerable room for tax equity investors, who could also play a role monetizing depreciation benefits not covered by the direct pay change.
Continuing to rely on tax equity markets tilts the scales against smaller businesses that don’t have much more to offer banks. “It’s going to become a tale of two cities. In some ways it already is, but it’ll just be more extreme because there will be so much demand,” Burton said of the increased competition BBB could create for limited pools of tax equity.
In that sense, Manchin’s opposition to direct pay could strike a blow at his favorite industries and technologies. The fossil fuel industry–backed Carbon Capture Coalition has advocated making the 45Q tax credit for carbon capture and storage project direct pay. Since such projects are expensive and risky—often facing massive cost overruns—banks have so far been wary of stepping in with tax equity financing, though some investors are angling to get involved. “Generally banks and insurance companies are tax equity investors and are relatively conservative institutions that are not on the cutting edge of technology, and they want to invest in and be exposed to very well-understood, proven technology,” Burton told me. “That’s wind and solar.” If all credits remain as is, then solar, wind, and carbon capture could find themselves vying for the same funds and potentially go up against nuclear, transmission lines, and green hydrogen as well. Manchin’s office did not respond to a comment as to whether he also opposed making 45Q direct pay.
Continuing to privilege bigger firms and more established technology could hit extra hard as the Federal Reserve continues to raise interest rates in the name of combating inflation. The rapid decline in the cost of renewables over the last decade has been in large part the result of rock-bottom interest rates, coupled with favorable tax credits at home and industrial policy abroad.
The theory the Biden administration seems to have been working from in constructing its Build Back Better climate provisions—and making tax credits their star player—was that there would continue to be an abundance of private capital sloshing around the economy. The cheap debt financing that created the so-called “everything boom” was good for renewables too. Wind and larger-scale solar installations require big up-front injections of cash. Because operating costs are relatively low (they don’t need to keep buying fuel, like a gas or coal-fired power plant) they could use revenues to pay down debt. Government policy and incentives would shepherd all that cheap money in the direction of the energy transition, helping accelerate trends that were already underway. That momentum could help deploy renewables and electric vehicles, as well as seed technologies to decarbonize sectors like steel and concrete.
But the economy looks a bit different from when those plans were written. The Fed is raising interest rates, and the administration is trying to bring down gas prices at all costs, potentially heaping even more subsidies on fossil fuel companies and fueling demand for oil with a gas tax holiday. As scholars Asker Voldsgaard, Florian Egli, and Hector Pollitt explained recently, the success of new green technologies like green hydrogen depends on cheap, clean, and abundant electricity. Higher interest rates and a limited appetite for tax equity deals could hold up all kinds of investment in cleaner energy and electrical grids as investors get more cautious across the board.
All this doesn’t bode well for decarbonization. Manchin’s apparently resolute opposition to direct pay could keep the flawed tax credit system relatively ineffective. Alternatively, the West Virginia coal baron could simply be biding his time in the hopes that nothing passes at all.
A previous version of this article incorrectly stated David Burton’s name.