December 3, 2012
Blogs, U.S.

Let wind power tax credit expire

By Benjamin Zycher, American Enterprise Institute - 12/03/12 12:30 PM ET | The Hill's Congress Blog | thehill.com

Ronald Reagan once observed that a federal program is the closest thing to eternal life to be found in this world. The latest example of this reality is the production tax credit for wind power, a program scheduled to expire at the end of this year, but which already has been extended six times. Despite the Beltway cacophony on the fiscal cliff, sequestration, and entitlement reform, seemingly small policy issues often carry huge implications, with economic effects far greater than the narrow budget impacts might suggest.

And that decidedly is the case with the PTC: It has introduced and preserved a very substantial distortion in the operations and structure of the electric power sector. Because producers of wind power receive a federal tax credit of $22 per megawatt-hour (mWh), they have powerful incentives to underprice their electricity, often finding it profitable to charge negative prices by paying system operators to take their power, particularly when demand is relatively low at night and in the winter. In the short run, this means that conventional generating facilities – coal, gas, and nuclear – cannot be operated efficiently, and also must underprice their outputs when engineering constraints make it difficult or dangerous to cycle up and down.

“Underpricing” may sound great for consumers, but, sadly, there are no free lunches. Operating costs for the conventional generators must rise with less efficient operation. Wind power simply is less reliable than conventional generation – that is why it cannot be scheduled – so that large costs for backup electricity must be borne in order to prevent brownouts and blackouts. Transmission costs are higher for wind power, and consumers must pay them whether directly or indirectly. These extra costs are real but hidden by the PTC.

In the longer run, the PTC and the underpricing phenomenon distort investment in the electric power sector, as expected returns are reduced for conventional power and increased for wind farms. This investment outcome yields a mix of generating capacity more costly and less reliable than otherwise would be the case, and affects technological advance adversely. In addition, the PTC allows individual states to shift part of their bills for wind power onto federal taxpayers, thus increasing the adoption of state policies subsidizing wind investment. Renewable portfolio standards – guaranteed market shares – are a prominent example of this effect. Over time, regional economies and the U.S. economy in the aggregate will be burdened increasingly with a power generation mix substantially less efficient than otherwise would be the case.

The arguments usually offered in defense of the PTC are surprisingly weak. The data show that wind power has achieved all available scale economies and learning efficiencies; accordingly, another extension of the PTC will not yield lower costs. Wind power receives federal financial support per mWh between twenty and one hundred times that given conventional power; the PTC does not “level the playing field.” The backup costs for wind power are far greater than the costs of the adverse environmental effects of conventional electricity, even if we assume that current environmental regulation does nothing to reduce the latter.

The usual “sustainability” argument in favor of renewables is incorrect simply as a matter of basic economics: Because the market rate of interest makes it profitable to conserve resources for future periods when prices might be higher, the fact that coal and gas are depletable is irrelevant. The “green jobs” argument ignores the adverse employment effects of the taxes that must be imposed to finance the PTC, and of the higher economic costs of an inefficient electric power system.

Perhaps 2013 will differ from the past if recognition of the magnitude of federal fiscal problems has reached a critical mass. One way to achieve greater fiscal discipline is to subject programs both broad and narrow to serious scrutiny. The PTC would not survive that kind of critical attention, and the time has come to end it.