oversight

Energy Conservation and Climate Change: Factors to Consider in the Design of the Nonbusiness Energy Property Credit

Published by the Government Accountability Office on 2012-04-02.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

             United States Government Accountability Office

GAO          Report to Congressional Requesters




April 2012
             ENERGY
             CONSERVATION AND
             CLIMATE CHANGE
             Factors to Consider in
             the Design of the
             Nonbusiness Energy
             Property Credit




GAO-12-318
Contents


Letter                                                                                                  1
              Scope and Methodology                                                                     2
              Summary                                                                                   3
              Agency Comments                                                                           4

Appendix I    Briefing Slides                                                                           5



Appendix II   Use of the Credit by Spending Categories and Limits                                       32




              Abbreviations

              AGI               adjusted gross income
              CO2               carbon dioxide
              DOE               Department of Energy
              IRC               Internal Revenue Code
              IRS               Internal Revenue Service
              SOI               Statistics of Income Database


              This is a work of the U.S. government and is not subject to copyright protection in the
              United States. The published product may be reproduced and distributed in its entirety
              without further permission from GAO. However, because this work may contain
              copyrighted images or other material, permission from the copyright holder may be
              necessary if you wish to reproduce this material separately.




              Page i                                 GAO-12-318 Nonbusiness Energy Property Tax Credit
United States Government Accountability Office
Washington, DC 20548




                                   April 2, 2012

                                   The Honorable Max Baucus
                                   Chairman
                                   Committee on Finance
                                   United States Senate

                                   The Honorable Jeff Bingaman
                                   United States Senate

                                   The Honorable Dianne Feinstein
                                   United States Senate

                                   The Honorable John F. Kerry
                                   United States Senate

                                   The Honorable Olympia J. Snowe
                                   United States Senate

                                   The nonbusiness energy property credit 1 is one of a number of federal
                                   initiatives that seek to address concerns about U.S. reliance on foreign
                                   energy sources and the impact of carbon dioxide (CO2) emissions on the
                                   climate. Enacted as part of the Energy Policy Act of 2005, the
                                   nonbusiness energy property credit was intended to increase
                                   homeowners’ investment in energy conserving improvements by reducing
                                   their after-tax costs. The credit is calculated as a percentage of qualified
                                   spending on such improvements as insulation systems, exterior windows
                                   and metal roofs up to a maximum claimable credit. The maximum credit
                                   was set at $500 in 2006 and 2007, raised to $1,500 in 2009 and 2010,
                                   and lowered back to $500 in 2011.

                                   In the enclosed slides, this report compiles and expands upon information
                                   previously presented to you in response to your request, which asked us
                                   to examine factors relating to the nonbusiness energy property credit. To
                                   address the request, we (1) evaluated factors to consider in deciding
                                   whether the credit should be cost-based or performance-based; and (2)
                                   estimated how requiring that only spending above a minimum amount be



                                   1
                                       I.R.C. § 25C.




                                   Page 1                          GAO-12-318 Nonbusiness Energy Property Tax Credit
              eligible for the credit, or introducing a base amount for the 2009 credit
              may have affected measures such as the amount of credit claimed, the
              revenue cost to the federal government, and incentives for taxpayers to
              increase their spending on energy efficiency improvements.


              For our first objective—to evaluate factors to consider in deciding whether
Scope and     the credit should be cost-based or performance-based—we reviewed
Methodology   relevant literature and consulted with experts on criteria for a well-
              designed credit. On the basis of this review, we determined that tax credit
              design, which includes such factors as whether the credit is cost-based or
              performance-based, should be evaluated according to:

              •   how well the logic of the design is related to the credit’s purpose,
              •   how likely the design is to achieve that purpose,
              •   how costly it would be to achieve this purpose using this design, and
              •   how fairly the credit’s costs and benefits are distributed under this
                  design.

              Using these criteria, we analyzed the current credit and changes that
              have been proposed to it.

              For our second objective—estimating how introducing a base spending
              amount for the 2009 credit may have affected measures such as the
              amount of credit claimed, the revenue cost to the federal government,
              and incentives for taxpayers to increase their spending on energy
              efficiency improvements—we used the Internal Revenue Service’s (IRS)
              2009 Statistics of Income (SOI) database, the most current data
              available, to simulate the effects that different bases would have had on
              credit claimed, revenue costs, and incentives faced by taxpayers, using
              actual spending and purchase patterns from the 2009 credit claims.
              These simulations do not include behavioral responses such as changes
              in the number of claimants and amounts of spending due to the credit. To
              conduct these simulations, we examined two alternative bases: a base
              calculated as a percentage of adjusted gross income (AGI) and a base
              derived from average spending on different types of improvements. For
              this objective, we reviewed documentation for the databases we used,
              conducted electronic checks, and determined that the data presented
              were sufficiently reliable for our purposes.

              Throughout this report, the percentage estimates have a margin of error
              of plus or minus 5 percentage points, and the estimates of total amounts
              have a margin of error of plus or minus 5 percent of the estimate.


              Page 2                          GAO-12-318 Nonbusiness Energy Property Tax Credit
          We conducted this performance audit from August 2010 to April 2012 in
          accordance with generally accepted government auditing standards.
          Those standards require that we plan and perform the audit to obtain
          sufficient, appropriate evidence to provide a reasonable basis for our
          findings and conclusions based on our audit objectives. We believe that
          the evidence obtained provides a reasonable basis for our findings based
          on our audit objectives.


          Under criteria for evaluating a tax credit design, both the performance-
Summary   based and cost-based credits have advantages and disadvantages with
          neither design being unambiguously the better option based on current
          information. Both a cost-based and a performance-based credit are
          designed to reduce energy use and CO2 emissions by providing
          incentives for energy conservation investment. However, they differ in
          their relative effectiveness and costs. In general, a performance-based
          credit is more likely to effectively reduce energy use and CO2 emissions
          because it rewards energy savings from the investment rather than the
          cost-based credit’s rewarding of spending regardless of whether this
          spending results in energy savings. However, the performance-based
          credit may have significant up-front costs for energy audits, not required
          by the cost-based credit, which could reduce its effectiveness by
          discouraging investment. In addition, for taxpayers who do invest, these
          up-front costs may mean that a performance-based credit may have
          significantly higher taxpayer compliance and IRS administrative costs
          than a cost-based credit. A credit’s fairness depends on subjective
          judgments of how a credit varies with a taxpayer’s income level.

          For those taxpayers claiming the 2009 credit, under both base definitions
          used in our simulations, the total amount of credit claimed fell but
          taxpayers had a greater incentive to spend more on qualifying products.
          The incentive was measured as the average effective rate of credit that
          would apply to additional spending by taxpayers. In 2009, when no base
          was present, a dollar of additional spending would earn, on average, an
          additional 10 cents of credit. When the base derived from average
          spending was introduced in the simulations, a dollar of additional
          spending earned an estimated 14 to 18 cents of credit. However, because
          the simulations do not include behavioral responses, the overall effect on
          revenues and spending of introducing a base is uncertain. For example,
          introducing a base amount, while likely to limit windfall credits for qualified
          spending that would have been done anyway, would also make the credit
          less generous and some taxpayers might no longer use it.



          Page 3                           GAO-12-318 Nonbusiness Energy Property Tax Credit
                  We are not making new recommendations based on this review. This
                  work is intended to assist Congress in considering different ways that the
                  credit can be structured to achieve the stated goals of reducing CO2
                  emissions and minimizing U.S. reliance on foreign energy sources.



Agency Comments   The Internal Revenue Service, the Department of Energy, and the
                  Department of the Treasury provided us with technical comments after
                  viewing a draft of this report, which we incorporated as appropriate.

                  Unless you publicly announce the contents of this report earlier, we plan
                  no further distribution until 30 days from the date of this letter. At that time
                  we will send copies of this report to other Chairmen and Ranking
                  Members of Senate and House committees and subcommittees that have
                  appropriation and oversight responsibilities for IRS. We also will be
                  sending copies to the Commissioner of Internal Revenue, the Secretary
                  of the Treasury, and the Secretary of Energy. Copies are also available at
                  no charge on the GAO Web site at http://www.gao.gov.

                  Should you or your staff have questions concerning this report, please
                  contact me at (202) 512-6806 or mihmj@gao.gov. Key contributors to this
                  report were Michael Brostek, Director; Kevin E. Daly, Assistant Director;
                  Susan F. Baker; Sara Daleski; Lawrence M. Korb; Jeffrey Schmerling;
                  Albert Sim; Ardith A. Spence; and Anne O. Stevens.




                  J. Christopher Mihm
                  Managing Director
                  Strategic Issues




                  Page 4                            GAO-12-318 Nonbusiness Energy Property Tax Credit
Appendix I: Briefing Slides
                Appendix I: Briefing Slides




     Energy Conservation and Climate Change:
        Factors to Consider in the Design of
         the Nonbusiness Energy Property
                     Tax Credit




                                                                                      1




                Page 5                        GAO-12-318 Nonbusiness Energy Property Tax Credit
                                         Appendix I: Briefing Slides




Introduction

•   Various federal initiatives have sought to address concerns about U.S.
    reliance on foreign energy sources and the impact of carbon dioxide (CO2)
    emissions on the climate.

•   One initiative is the nonbusiness energy property credit (I.R.C. §25C),1 a
    tax credit that could encourage taxpayers to invest in residential energy
    efficiency improvements.




    1Energy   Policy Act of 2005, Pub. L. No. 109-58, § 1333, 119 Stat. 594 (Aug. 8, 2005).


                                                                                                                            2




                                         Page 6                                     GAO-12-318 Nonbusiness Energy Property Tax Credit
                        Appendix I: Briefing Slides




Objectives
•   To address questions about whether the nonbusiness energy property
    credit is the best or most effective way to encourage investment in energy
    efficiency improvements, GAO was asked to:
     – evaluate factors to consider in deciding whether the credit should be
         cost-based or performance-based, and

     – estimate how requiring that only spending above a minimum amount
        be eligible for the credit, or introducing a base amount for the 2009
        credit may have affected measures such as the amount of credit
        claimed, the revenue cost to the federal government, and incentives
        for taxpayers to increase their spending on energy efficiency
        improvements.
•   We were also asked for information on use of the credit by spending
    categories and limits. This information is contained in appendix II.

                                                                                              3




                        Page 7                        GAO-12-318 Nonbusiness Energy Property Tax Credit
                              Appendix I: Briefing Slides




                                       Summary
•   Both the performance-based and cost-based credits have advantages and disadvantages with
    neither design being unambiguously the better option given current information.
     – The performance-based credit rewards energy savings from the investment rather than,
         as is the case with the cost-based credit, the spending on investment whether this
         spending results in energy savings or not.
     – However, the performance-based credit may have significant up-front costs for energy
         audits, not required by the cost-based credit, which could reduce its effectiveness by
         discouraging investment and increase its compliance and administrative costs relative to
         the cost-based credit.
•   Under both base definitions used in our simulations, the total amount of credit claimed fell
    and taxpayers who were already investing in qualifying purchases had a greater incentive to
    spend more.
     – For example, in 2009, when no base was present, a dollar of additional spending would
         earn, on average, an additional 10 cents of credit, but when we simulated a base derived
         from average spending, a dollar of additional spending would earn on average an
         estimated 14 to 18 cents of credit.
     – However, because the simulations do not include behavioral responses, including the
         decision to make any initial investment, the overall effect on revenues and spending of
         introducing a base is uncertain.
                                                                                                     4




                              Page 8                         GAO-12-318 Nonbusiness Energy Property Tax Credit
                                           Appendix I: Briefing Slides




Background—2006 and 2007 Credit
•       Enacted as part of the Energy Policy Act of 2005,2 the nonbusiness energy property
        credit was intended to increase homeowners’ investment in energy conserving
        improvements by reducing their after-tax costs.

          – In 2006 and 2007, the maximum claimable credit was $500.
              • Of this $500, a maximum of $200 could be claimed on exterior windows
              • In all years, any credit amounts exceeding tax liability could not be carried forward.

          – The credit was calculated as 10 percent of qualified spending on insulation systems,
            exterior windows, exterior doors, and metal roofs.

          – Spending on other types of residential energy property received a 100 percent credit
            but had credit limits by spending category, specifically:
              • up to $50 for advanced main air circulating fans used in a furnace;
              • up to $150 for furnaces or hot water boilers; and
              • up to $300 for heat pumps, central air conditioning systems, or water heaters.



2   Pub. L. No. 109-58, § 1333, 119 Stat. 594 (Aug. 8, 2005).                                                    5




                                           Page 9                        GAO-12-318 Nonbusiness Energy Property Tax Credit
                           Appendix I: Briefing Slides




Background (Cont.)—2009 Credit
•   After expiring in 2008, the credit was reauthorized for 2009 and 2010 as part of
    the American Recovery and Reinvestment Tax Act of 2009

     – the overall credit limit was raised from $500 to $1,500;

     – the rate of credit, which in 2006 and 2007 varied based on the type of
       spending, was set at 30 percent for all types of qualified spending; and

     – credit limits by spending category were eliminated.

•   For 2011, the credit was reauthorized at pre-Recovery Act limits and standards.




                                                                                                 6




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                                              Appendix I: Briefing Slides




    Background (Cont.)—Taxpayer Characteristics:
    Number of claimants, total credit claimed, and total spending in 2006, 2007,
    and 2009
•     In 2006 and 2007, over 4 million taxpayers claimed the credit, and in 2009, the number of
      claimants increased to almost 7 million.

•     From 2006 to 2007, both spending and credit claimed declined, but in 2009, compared to
      2007 levels, the total spending more than tripled and the credit claimed increased five-fold.

•     The increase in total spending in 2009 may be explained in part by a change in the relevant tax
      form’s instructions, which did not limit the amount the claimant could enter on the form for
      categories that were previously subject to limits.
    Table 1: Total Returns Filed, Claimants, Spending, and Credit Claimed for the
    Nonbusiness Energy Property Credit, 2006, 2007, and 20093
                                                                                                      Total credit claimed
                       Total tax returns filed                                   Total spending       (millions of dollars)
                              (millions)               Total claimants         (millions of dollars)a
          Year                                            (millions)
          2006                   138.4                        4.3                       $7,947                       $956
          2007                   153.6b                        4.3                      $7,484                        $938
          2009                   140.5                         6.8                     $25,567                     $5,288

      Source: GAO analysis of IRS data.
      aSpending reported to IRS in 2006 and 2007 could not exceed certain category limits; for 2009, no category limits were included in

      the reporting instructions.
      bFor 2007, the aggregate number of returns include those returns that were filed solely to receive an economic stimulus payment.

      Excluding these returns, 143.0 million returns were filed in 2007.
      3GAO estimates were computed using the SOI advance 2009 Individual Complete Report. In our computations, the nonbusiness             7
      energy property credit is applied against tax liability remaining after all other credits are taken into account.




                                              Page 11                                        GAO-12-318 Nonbusiness Energy Property Tax Credit
                           Appendix I: Briefing Slides




Current Design:
Elements of Both a Cost- and Performance-Based
Credit
•   Cost-based credits provide incentives that are usually a fixed percentage of
    qualified spending, or sometimes, qualified spending above a base amount.

•   Performance-based credits provide incentives that are tied to specific measures of
    energy savings.

•   The nonbusiness energy property credit combines features of both cost-based and
    performance-based credits.
     – It is cost-based in that the amount of credit claimed is directly proportional to
        the taxpayer's qualified spending.
     – It is performance-based in that only certain qualifying purchases are eligible.




                                                                                                 8




                           Page 12                       GAO-12-318 Nonbusiness Energy Property Tax Credit
                                      Appendix I: Briefing Slides




    Design Evaluation:
    Both performance- and cost-based credits are designed to
    conserve energy and reduce CO2 emissions by subsidizing energy
    conservation investment
•   The credit's purpose is to reduce inefficient energy consumption and CO2
    emissions.
     •       The rationale for providing the tax credit is the view that individuals invest too little from
             society’s point of view when they consider only their own energy cost savings.
     •       In addition, there is evidence that taxpayers make too little energy conservation
             investment based on their own energy costs. They do this, for example, when they
             underestimate the savings from future operating cost reductions due to their more
             efficient equipment.
•   Both the cost- and performance-based credits address this purpose by providing
    incentives for energy conservation investment.4
      – Who actually benefits from the credit depends on its incidence, i.e., the share of the
        credit going to producers and consumers of the improvements. If supply is relatively
        unresponsive to price, a greater share of the benefit would go to producers in the form
        of higher prices. This result may still be consistent with the purpose of the credit if it
        promotes the growth of markets for more energy efficient products.
•   Ideally, the credit should be designed to reduce individuals’ costs sufficiently so
    that, in the aggregate, their return on investment equals society’s return in terms
    of energy use and CO2 emission reductions.
    4While
         both credit designs address the purpose of the credit, they do so indirectly by promoting conservation investment.
    Another, more direct method of reducing energy use and CO2 emissions that has been suggested is a carbon tax on energy
    consumption.

                                                                                                                              9




                                      Page 13                                  GAO-12-318 Nonbusiness Energy Property Tax Credit
                              Appendix I: Briefing Slides




    Design Evaluation:
    The performance-based credit better targets conservation
    investment but its higher initial costs may discourage some
    investment
•   For a better chance of producing the intended benefit, the credit should target activities that
    most directly promote the credit’s purpose and provide sufficient incentives for taxpayers to
    increase these activities.
•   The performance-based credit is likely to better target conservation investment spending.
      – The performance-based credit provides fixed amounts of credit for achieving different
         levels of energy savings. It therefore provides an incentive for taxpayers to minimize the
         spending required to achieve a given amount of energy savings. The credit is designed to
         reward additional energy savings and CO2 reductions but not additional spending.
      – The cost-based credit is designed to reward spending on conservation investment that
         may, or may not, lead ultimately to additional energy savings.
•   However, the relative effectiveness of the incentives provided by performance-based and
    cost-based credits is less certain.
      – Performance based credits are likely to have larger up-front costs than cost-based
         credits and may discourage taxpayers from buying qualifying energy savings products.
           • These costs include energy audits to establish a baseline of energy use against
              which to measure improvements and possibly post-improvement audits to confirm
              that energy savings have been realized. These added costs could reduce the
              incentive to undertake any investments.
           • On the other hand, such audits might also increase participation if they reassure
              taxpayers that they will actually save energy.


                                                                                                    10




                              Page 14                         GAO-12-318 Nonbusiness Energy Property Tax Credit
                             Appendix I: Briefing Slides




    Design Evaluation:
    Performance-based credits may have significantly higher
    compliance and administrative costs than cost-based credits
•   To assess the credit design, the benefits likely to be produced by the credit should
    be compared to its costs, which include the lost tax revenue and IRS administrative
    costs as well as more indirect costs, such as taxpayer compliance burden and
    economic efficiency costs.
•   Performance-based credits may have significantly higher compliance and
    administrative costs than cost-based credits.
     – Taxpayer compliance costs are higher due to up-front costs, such as energy audits not
       required by cost-based credits.
     – According to IRS officials, administration costs are likely to be higher for performance-
       based credits that reward measurable (not estimated) increases in energy efficiency
       because examinations would have to verify that improvements were made, not just that
       money was spent.
•   The relative economic efficiency costs of the alternative credit designs are
    uncertain because their effects depend on the degree to which the credits alter
    decisions to spend across different improvement types and how much they reduce
    energy use and CO2 emissions. The effects are difficult to infer from design alone.
•   The relative effect of a cost-based credit and performance-based credit on
    revenue costs is uncertain because it depends chiefly on whether the credit has
    base amounts and limits and which credit rates are chosen.


                                                                                                    11




                             Page 15                         GAO-12-318 Nonbusiness Energy Property Tax Credit
                           Appendix I: Briefing Slides




    Design Evaluation:
    The fairness of how the credit’s costs and benefits are
    distributed depends on subjective value judgments

•   The fairness of the credit’s design depends on the judgment of whoever is
    evaluating the design.
     – Views on what is a fair distribution of the credit’s costs and benefits can differ
         dramatically across individuals.
•   However, whatever one’s views of fairness, an analysis of the distribution of costs
    and benefits by such factors as income level can be useful.
•   Under an ability to pay principle of fairness, fairness requires that those who are
    more capable of bearing the burden of a tax should pay more. Equivalently, for a
    tax credit, they should receive less of the benefit.
     – Those who adopt an ability-to-pay principle of fairness may view as unfair a
         distribution where lower income taxpayers receive lower benefits from the
         credit than higher income taxpayers.
•   However, under the same principle, fairness requires that taxpayers who have the
    same ability to pay should bear the same tax burden, or in this case, receive the
    same benefit.
     – Those who adopt this principle may view as unfair that taxpayers who invest in
         energy conservation have lower tax liabilities than taxpayers with the same
         income who do not invest.


                                                                                               12




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                       Appendix I: Briefing Slides




Introducing a Base:
Credit Design Features

 •   As currently designed, all qualified spending up to the various limits is
     eligible for the nonbusiness energy property credit. This design increases
     the likelihood of windfall credits being earned for spending on qualifying
     energy efficient investments that would have occurred without the credit.

 •   A base that would eliminate windfall benefits would reward only the
     additional spending that taxpayers make due to the availability of the
     credit.
      – The credit amount would be calculated as the credit rate multiplied by
         the amount of qualified spending in excess of the base amount.
      – A base that eliminates windfalls is difficult to determine because it
         requires estimating how much consumers would spend on the types of
         products qualifying for the credit if the credit did not exist.
      – Because such a base amount is difficult to determine, other tax credits,
         such as the research tax credit, use proxies for these unknown
         amounts.
                                                                                           13




                       Page 17                       GAO-12-318 Nonbusiness Energy Property Tax Credit
                              Appendix I: Briefing Slides




Introducing a Base:
Effects on the Use of the Credit
•   Introducing a base can affect use of the credit in two opposite ways:
      – The base can reduce the take-up rate of the credit, i.e., the number of taxpayers making
         qualifying purchases.
           • Because the amount of credit on spending only over a base amount generally
              would be less than a credit on the full amount of spending on a qualifying purchase,
              some taxpayers may choose to make no investment at all.
           • Several factors could affect the taxpayers’ decision to invest, such as the amount of
              spending that is "reactive," reflecting investment that cannot be postponed
              because of, for example, equipment failure.
      – The base can increase the amount of spending on qualifying purchases by those who
         choose to invest.
           • For those who have made the decision to invest, i.e., who are “in the market,” the
              base can increase the incentive for additional spending.
                 – In particular, claimants constrained by credit limits (about 25 percent of
                    claimants in 2009) may find that more of any additional spending will be
                    eligible for the credit.
•   The simulations in this report focus on this second effect and do not include the effects on
    spending due to any change in the number of taxpayers choosing to make an investment.
                                                                                                    14




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                                     Appendix I: Briefing Slides




Introducing a Base:
Determining the Base
 •    Bases or floors that are currently part of the Internal Revenue Code include amounts
      calculated as a percentage of income (such as the floor on deductions for medical expenses)
      or spending (such as the research tax credit).
 •    Following this precedent in the code, the base for the nonbusiness energy property credit
      could be calculated as a percentage of each taxpayer’s qualified spending or adjusted gross
      income (AGI).
        – This option could reduce the administrative costs of the base because it uses only the
           information reported on tax returns.5
 •    The base could also be calculated using price information on nonqualifying improvements.
        – The rationale is that such prices may be used to better approximate the spending that the
           taxpayer would have done without the credit.
        – Department of Energy (DOE) currently collects information on the costs of many types of
           energy efficient home improvements.
        – However, DOE indicates that because prices vary so widely across locations, it would be
           very difficult to construct a base from these prices that would apply nationally.
        – Setting bases that vary by location and product type would increase the administrative
           costs of the credit.



 5the actual spending on qualifying investments would need to be calculated by IRS from information on prior tax year returns.
                                                                                                                           15




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                                 Appendix I: Briefing Slides




Introducing a Base:
The Base Used in the Simulations
•   To illustrate the effects of introducing a base amount, we recalculated the amount
    of credit taxpayers would have claimed and estimated how incentives to use the
    credit would have changed under alternative base definitions, for the pattern of
    spending observed in 2009.
     – Percentage of AGI base: We calculated the AGI base as a percentage of the taxpayers’
       adjusted gross income where, for each category, this percentage was the average
       amount spent by claimants in 2009 as a share of their AGI.
     – Average spending base: We calculated the average spending base as the average of
       actual 2009 spending in each improvement category.
•   It is not known how the credit take-up rate or spending would change if a base
    were introduced. We adjusted the base amount by a range of values--which we
    call the base rates--to show how sensitive our estimates of incentives and credit
    claimed are to the size of the base. The simulations used 25 percent, 50 percent,
    and 75 percent of these category bases as base rates.
     –   When implementing a base, policymakers may wish to consider trade-offs between take-up rates
         and incentives for induced spending. All else equal, a lower base may have a less discouraging effect
         on the decision to invest but is more likely to reward spending that would have been done anyway.
•   The simulations were run using the 2009 IRS Statistics of Income (SOI) database of
    individual tax returns and show what credit would have been claimed and other
    results if the different bases had been in effect. The comparison of the results of
    the simulations to the actual 2009 data shows the effects of introducing the bases.
                                                                                                            16




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                          Appendix I: Briefing Slides




Introducing a Base:
Illustration of How to Calculate Credits Using the
Average Spending Base
•   The graph on the next slide illustrates the calculation of the base amount
    for the average spending base.
     – The spending type in this example is windows and the amount of qualified
       spending is $4,000.
     – Average qualified spending for windows by all taxpayers in 2009 was $3,665.
     – The base amount was calculated using the lowest base rate as 25 percent of
       average spending which is equal to $916.
         • If this base were implemented, IRS would, based on the most recent tax
           return data available, provide taxpayers the base amount--taxpayers
           would not be expected to calculate this amount.
•   The credit is calculated as the difference between the qualified spending
    of $4,000 and the base amount of $916, which is equal to $3,084,
    multiplied by the credit rate of 30 percent, or about $925 of credit.



                                                                                              17




                          Page 21                       GAO-12-318 Nonbusiness Energy Property Tax Credit
                          Appendix I: Briefing Slides




Introducing a Base: Illustrative Example of a Taxpayer
Spending $4,000 on Windows (Average Spending Base)
   $4,000                         $3,084                                        $925
                              = $4,000 - $916                              = $3,084 x 30%
                                                                                                Credit
                                                                                                earned


                                                                               $3,075
                                                                           = $4,000 - $925
                                                        Spending
                                                        that
                                                        qualifies
                                                        for credit
               Spending
               on
               windows
                                                                                                Net cost to
                                                                                                taxpayer



                                    $916
                               = $3,665 x 25%
                                                        Base
                                                        amount



Average spending base (average spending = $3,665; base rate = 25%)
                                                                                                           18




                          Page 22                                    GAO-12-318 Nonbusiness Energy Property Tax Credit
                           Appendix I: Briefing Slides




Introducing a Base:
Illustration of How to Calculate Credits Using the
Percentage of AGI Base
•   The graph on the next slide illustrates the calculation of the base amount
    for the percentage of AGI base.
     – As in the previous example, the spending type is windows and the amount of
       qualified spending is $4,000.
     – AGI for this taxpayer is $25,000 and qualified spending on windows as an
       average share of income was about 5.1 percent in 2009.
     – The base amount for this taxpayer, using the lowest base rate of 25 percent, is
       equal to 1.275 percent of $25,000 of AGI (25 percent of the 5.1 percent share
       of income) which is equal to about $319.
         • If this base were implemented, taxpayers would be given the percentages
            corresponding to their level of AGI with their tax returns.
•   The credit is the difference between the qualified spending of $4,000 and
    the base amount of $319, which is equal to $3,681, multiplied by the
    credit rate of 30 percent, or about $1,104 of credit.

                                                                                               19




                           Page 23                       GAO-12-318 Nonbusiness Energy Property Tax Credit
                           Appendix I: Briefing Slides




Introducing a Base: Illustrative Example of a Taxpayer
Spending $4,000 on Windows (AGI Base)
    $4,000                          $3,681                                      $1,104
                                = $4,000 - $319                             = $3,681 x 30%

                                                                                                 Credit
                                                                                                 earned


                                                                                $2,896
                                                                           = $4,000 - $1,104

                                                         Spending
                                                         that
                Spending                                 qualifies
                on                                       for credit
                windows
                                                                                                 Net cost to
                                                                                                 taxpayer




                                        $319             Base
                               = 5.11% x $25,000 x 25%
                                                         amount

AGI base (average share of AGI spent = 5.11%; AGI = $25,000; base rate = 25%)
                                                                                                               20




                           Page 24                                    GAO-12-318 Nonbusiness Energy Property Tax Credit
                                 Appendix I: Briefing Slides




Introducing a Base:
Illustration of Base Amounts, Qualified Spending, and Credit
Amounts under Different Base Definitions and Base Rates
•   The table on the next slide shows base spending and credit amounts for the
    average spending base under different assumptions about the base rates.

•   The table also shows base, spending and credit amounts for the percentage of AGI
    base under different assumptions about the base rates and AGI.

•   The total credit amount declines for both base types as the base rate increases.

•   The credit amount for the percentage of income base decreases as income
    increases.
     –   With the AGI base, a lower-income taxpayer will earn more credit than a higher income taxpayer
         spending the same amount. In the examples, the AGI base equals 5.11% of income multiplied by a
         base rate. For any base rate, the base amount increases as income rises so lower income taxpayers
         have a lower base. In the examples, taxpayers are assumed to spend $4,000 on windows, regardless
         of income, and the amount of spending that qualifies for credit is larger for lower-income taxpayers
         with a lower base.


                                                                                                            21




                                 Page 25                             GAO-12-318 Nonbusiness Energy Property Tax Credit
                                      Appendix I: Briefing Slides




  Introducing a Base: Illustrative Example of a
  Taxpayer Spending $4,000 on Windows
                 Average spending base (average spending on windows in 2009 = $3,665)

                          Base amount                  Spending qualifying for the                Credit earned
                          (by base rate)                        credit                            (by base rate)
                                                            (by base rate)
                   25%          50%        75%          25%          50%        75%        25%         50%          75%

                $916         $1,833     $2,749       $3,084         $2,168    $1,251     $925        $650          $375

          Adjusted gross income base (average share of AGI spent on windows = 5.11 percent)

AGI                       Base amount                  Spending qualifying for the                Credit earned
                          (by base rate)                        credit                            (by base rate)
                                                            (by base rate)

                   25%          50%        75%          25%          50%        75%        25%         50%          75%

$25,000         $319         $639       $958         $3,681         $3,361    $3,042     $1,104      $1,008        $913

$75,000         $958         $1,916     $2,874       $3,042         $2,084    $1,126     $913        $625          $338

$150,000        $1,916       $3,833     $5,749       $2,084         $167      $0         $625        $50           $0

Source: GAO analysis of IRS data.
                                                                                                                    22




                                      Page 26                                GAO-12-318 Nonbusiness Energy Property Tax Credit
                              Appendix I: Briefing Slides




Introducing a Base:
Simulated Effects on Credit Claimed and Marginal
Incentives in 2009 of Alternative Base Definitions
•   In 2009, about $5.3 billion was claimed in nonbusiness energy property credit, and
    across all claimants the average marginal incentive was about 10 percent.
     – The average marginal incentive is the percentage change in the amount of credit
       associated with an increase or decrease in spending, divided by the percentage change
       in spending, averaged across all claimants.
     – In this case, on average, a dollar of additional spending would earn an additional 10
       cents of credit, or equivalently, would reduce the cost of a dollar of additional spending
       by 10 cents.

•   In simulations introducing a base spending amount, the amount of credit claimed
    fell, and the average marginal incentive to use the credit rose.
     – Introducing a base amount reduced the revenue cost of the credit to the government
       and simultaneously gave taxpayers a stronger incentive to invest in qualifying energy
       efficiency improvements.
     – Because the simulations do not include behavioral responses, the actual effect of
       introducing a base on revenues and spending is uncertain. Taxpayers facing a stronger
       incentive to use the credit may spend more than they otherwise would, increasing both
       the revenue cost of the credit and the amount spent on energy efficiency
       improvements. However, a base would also make the credit less generous overall,
       which could reduce the number of claimants, decreasing both the revenue cost of the
       credit and the amount spent on energy efficiency improvements.

                                                                                                    23




                              Page 27                         GAO-12-318 Nonbusiness Energy Property Tax Credit
                                    Appendix I: Briefing Slides




  Introducing a Base:
  Simulated Effects on Credit Claimed and Marginal
  Incentives of Alternative Base Definitions in 2009

                         2009       Simulated credit with                  Simulated credit with AGI
Base definition          credit     average spending base                  base

                                    Low–25 Medium High–75 Low–25                          Medium        High–75
                                    percent –50     percent percent                       –50           percent
                                            percent                                       percent

Total credit             5.3        4.2           3.3             2.6      3.9            2.9           2.1
earned (billions
of dollars)

Average                  10%        14%           16%             18%      15%            18%           21%
marginal
incentive

Source: GAO analysis of IRS data.
                                                                                                              24




                                    Page 28                             GAO-12-318 Nonbusiness Energy Property Tax Credit
                                 Appendix I: Briefing Slides




Introducing a Base:
Distributional Effects of the Alternative Bases
•   Simulating a minimum spending requirement as a share of AGI indicates that taxpayers with
    between $0 and $80,000 in AGI would claim a larger share of the credit than they actually
    claimed in 2009. For example, in 2009, taxpayers with between $20,000 and $40,000 in AGI
    claimed about 10.2 percent of total credit. In simulations with an AGI base, they claimed
    from about 12.0 percent to about 16.3 percent of total credit, depending on the base rate.
     –   Taxpayers with more than $100,000 in AGI generally accounted for a smaller share of credit claimed
         in simulations with an AGI base. For example, taxpayers with AGI between $250,000 and $500,000
         claimed about 4.1 percent of credit in 2009 and between 1.5 and 2.9 percent of total credit in these
         simulations.
     –   Under the AGI base, taxpayers with AGI between $80,000 and $100,000 accounted for about the
         same share of credit claimed as the share of credit they actually claimed in 2009.
•   Simulating a base amount derived from average spending on qualifying purchases produced
    an opposite but less pronounced effect on the share of credit claimed by these income
    groups.
     –   Taxpayers with AGI between $0 and $80,000 claimed a smaller share of credit than they actually
         claimed in 2009. For example, in simulations with an average spending base, taxpayers with
         between $20,000 and $40,000 in AGI claimed anywhere from about 8.1 percent to 9.4 percent of
         total credit, depending on the base rate, always less than the 10.2 percent of credit they claimed in
         2009.
     –   Taxpayers with AGI over $100,000 claimed a larger share of credit in simulations with an average
         spending base than they actually claimed in 2009. For example, taxpayers with AGI between
         $250,000 and $500,000 claimed between 4.6 and 5.6 of total credit in these simulations, as
         compared to 4.1 percent of total credit in 2009.


                                                                                                             25




                                 Page 29                              GAO-12-318 Nonbusiness Energy Property Tax Credit
                                            Appendix I: Briefing Slides




  Introducing a Base:
  Distributional Effects of the Alternative Bases
Adjusted gross    Percentage
income            of all                                                  Share of credit claimed
  • Income Distribution Table
(dollars in
thousands)
                  taxpayers
                  with AGI >
                  0 in 2009
                                 2009           Simulated credit with an AGI base      Simulated credit with an average spending base


                                                 High         Medium       Low         High              Medium           Low

$0-$20            33.7%              0.8%          1.5%         1.2%          1.0%            0.6%            0.6%           0.7%

$20-$40           24.0               10.2             16.3       14.0         12.0            8.1              8.7            9.4

$40-$60           14.1               16.8             22.0       20.2         18.5            14.0            15.0           15.9
$60-$80           9.3                18.4             20.5       20.2         19.5            17.1            17.7           18.1

                  6.3
$80-$100                             15.4             14.8       15.3         15.5            15.2            15.3           15.4

$100-$125         4.7                12.8             10.8       11.6         12.3            13.6            13.3           13.0

$125-$150         2.6                7.9              5.5        6.5           7.2            8.7              8.4            8.1

$150-$250         3.6                12.2             7.2        8.7          10.6            15.0            13.9           13.1
$250-$500         1.3                4.1              1.5        1.9           2.9            5.6              5.0            4.6
Greater than
                  0.5
$500                                 1.5              0.2        0.3           0.5            2.2              1.9            1.7


 Source: GAO analysis of IRS data.
                                                                                                                                26




                                            Page 30                                  GAO-12-318 Nonbusiness Energy Property Tax Credit
                              Appendix I: Briefing Slides




Conclusion
•   The nonbusiness energy property credit has been claimed by millions of taxpayers since it
    was first introduced in 2006.
•   While making the credit performance based likely would result in greater reductions in
    energy use than does the current credit, the performance based design is not clearly superior
    given current information because the performance-based credit likely would have greater
    taxpayer and government compliance and administration costs.
•   If the cost-based credit is retained and a base spending amount was required, taxpayers who
    make qualifying purchases would have a greater incentive to spend more on such purchases
    and windfall benefits to those who would have made purchases without the credit would be
    reduced. However, a base spending requirement would reduce the absolute amount of credit
    taxpayers receive for qualifying purchases and might therefore result in fewer taxpayers
    making such purchases.
•   Further, a base that excludes only windfall spending is difficult to construct. Proxy bases may
    over- or under correct for windfall benefits. A comprehensive evaluation of proxies for
    windfall spending would assess their effect on windfalls and their net effect on additional
    spending on qualified energy saving purchases.



                                                                                                    27




                              Page 31                         GAO-12-318 Nonbusiness Energy Property Tax Credit
Appendix II: Use of the Credit by Spending
              Appendix II: Use of the Credit by Spending
              Categories and Limits



Categories and Limits




    Appendix II: Use of the Credit by
     Spending Categories and Limits




                                                                                           28




              Page 32                                GAO-12-318 Nonbusiness Energy Property Tax Credit
                               Appendix II: Use of the Credit by Spending
                               Categories and Limits




Appendix II: Use of the Nonbusiness Energy Property Credit by
Spending Categories and Limits

•   About 5 million out of 6.8 million total claimants, or about 73 percent of all claimants,
    reported spending on only one type of energy improvement in 2009. Their qualified
    spending of about $16.7 billion accounts for about 65 percent of spending by all claimants.
•   About 1.1 million of these claimants, or about 23 percent, were subject to the overall credit
    limit of $1,500, with close to 400,000 of these returns reporting spending on windows. About
    6% of claimants reporting spending on only one type of improvement had limited tax liability
    that constrained the amount of credit claimed.
•   A similar analysis of how spending was affected by limits for claimants reporting spending on
    more than one kind of improvement would be difficult. For instance, it is not possible to
    attribute their limited use of the credit to a particular category of spending, since constraints
    related to the overall credit limit or tax liability depend on total spending in all categories.
•   The next three slides show the number of claimants and amount of spending by spending
    categories according to whether taxpayers were:
      – unconstrained by any of the credit’s limits
      – constrained by the overall limit
      – constrained by the tax liability limit


                                                                                                            29




                               Page 33                                GAO-12-318 Nonbusiness Energy Property Tax Credit
                                                  Appendix II: Use of the Credit by Spending
                                                  Categories and Limits




      Appendix II: Use of the Nonbusiness Energy Property Credit

Table 1: Use of the Nonbusiness Energy Property Credit by Unconstrained Claimants in 2009

Retrofit type                 Claimants reporting spending                                Claimants reporting spending
                              on only one type of retrofit                                on more than one type of retrofit
                              Number                        Spending                      Number                         Spending
                                                            (in millions)                                                (in millions)
Insulation
                                       848,490                       $947.0                        644,100                         $453.9

Windows
                                       765,600                      $1,605.2                       619,284                         $726.4

Doors
                                       754,523                       $811.3                        681,297                         $522.3

Roofs
                                       107,659                       $291.5                         95,388                         $136.2

Energy efficient building
property                               387,210                       $875.1                        132,373                         $166.8

Furnaces and hot water
boilers                                608,467                       $1251.0                       214,217                         $256.1

Furnace fans
                                       52,218                        $115.3                         59,543                          $57.2

All retrofit types
                                     3,524,166                      $5,896.3                      1,060,682                       $2,318.9

 Source: GAO analysis of IRS data.

 These tax returns account for about 68 percent of all claimants and about 32 percent of total spending in 2009. Because their use of the
 nonbusiness energy property credit is unconstrained, their credit claimed equals 30 percent of their spending, which is about 47 percent of all credit
 claimed.                                                                                                                                           30




                                                  Page 34                                        GAO-12-318 Nonbusiness Energy Property Tax Credit
                                                  Appendix II: Use of the Credit by Spending
                                                  Categories and Limits




         Appendix II: Use of the Nonbusiness Energy Property Credit
 Table 2: Use of the Nonbusiness Energy Property Credit by Claimants Subject to the Overall
 Credit Limit of $1,500 in 2009
 Retrofit type                 Claimants reporting spending                                 Claimants reporting spending
                               on only one type of retrofit                                 on more than one type of retrofit
                               Number                        Spending                       Number                        Spending
                                                             (in millions)                                                (in millions)
Insulation
                                        107,303                        $850.8                        281,604                        $794.5

Windows
                                        393,447                       $3,635.8                       425,030                       $2,060.9

Doors
                                         21,546                        $160.2                        319,995                        $630.0

Roofs
                                         86,786                        $792.1                        114,725                        $676.5

Energy efficient building
property                                245,143                       $1,944.9                       139,584                        $688.7

Furnaces and hot water
boilers                                 237,430                       $1,810.5                       161,846                        $735.7

Furnace fans
                                         33,193                        $252.0                        54,008                         $178.4

All retrofit types
                                       1,124,848                      $9,446.3                       594,234                       $5,764.8

  Source: GAO analysis of IRS data.
These tax returns account for about 25 percent of all claimants and about 59 percent of total spending in 2009. Because of the overall credit
limit, their credit claimed is less than 30 percent of their spending and is around 49 percent of all credit claimed.
                                                                                                                                                31




                                                  Page 35                                        GAO-12-318 Nonbusiness Energy Property Tax Credit
                                                      Appendix II: Use of the Credit by Spending
                                                      Categories and Limits




             Appendix II: Use of the Nonbusiness Energy Property Credit
     Table 3: Use of the Nonbusiness Energy Property Credit by Claimants with Limited Tax Liability
     in 2009

     Retrofit type                 Claimants reporting spending                                 Claimants reporting spending
                                   on only one type of retrofit                                 on more than one type of retrofit
                                   Number                        Spending                       Number                         Spending
                                                                 (in millions)                                                 (in millions)
    Insulation
                                            37,837                         $118.5                         70,361                         $118.1

    Windows
                                            77,150                         $405.5                         90,071                         $254.5

    Doors
                                            29,645                          $52.7                         82,309                          $94.9

    Roofs
                                            28,871                         $166.9                         34,955                         $120.0

    Energy efficient building
    property                                52,861                         $276.0                         34,693                          $95.4

    Furnaces and hot water
    boilers                                 66,366                         $296.8                         30,112                          $54.6

    Furnace fans
                                            11,592                          $56.9                         14,434                          $30.0

    All retrofit types
                                            304,322                       $1,373.3                       142,698                         $767.7

     Source: GAO analysis of IRS data.
   These tax returns account for about 7 percent of all claimants and about 8 percent of total spending in 2009. Because of limited tax liability,
   their credit claimed is less than 30 percent of their spending and equals about 5 percent of all credit claimed.
                                                                                                                                                     32




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                                                      Page 36                                         GAO-12-318 Nonbusiness Energy Property Tax Credit
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