How Taxes Pervert our Energy Choices

"The power to tax is the power to destroy."
 -  Chief Justice John Marshall

The US tax code is a marvelous and impressive intellectual structure.   As an engineer I took a business class in taxation for corporations while getting my MBA.  Engineering is the art of extracting utility from first principles of science and combining it with hard-won practical experience.  I found, to my frustration, that taxation is not like that.  Taxes are whatever Congress and the IRS say they are, logic or principle be damned.

Tax codes are often written to support national goals, above and beyond mere revenue generation.  This is often called "social engineering" although an engineer might not recognize it as such.  Case in point - energy policy, specifically the different tax treatments of our electrical generation options.

We should remember that there is a time value to money.  To win the lottery and get a check today for $1 million is far, far better than to get a million dollars in $50,000 installments over 20 years.  That's the main reason we pay interest on loans and receive interest on our bank deposits.  For a business, their income taxes are based on their profits.  Profits are what's left from revenues when the costs of doing business are subtracted.  When a business makes an investment in a fixed asset like a wind farm or a nuclear power plant, they are allowed to deduct the capital costs from revenues.   However, they can't do that all in a single year but have to stretch it out over what is, in principle, the useful life of that asset.

That's a good principle, but like much of the tax code, it is subject to Congressional tweaking.  To help businesses a bit and encourage investment in capital goods, the current code allows what's called accelerated depreciation so that they can recover the capital costs earlier in the asset's life rather than later.  Like cash and lottery payouts, a tax deduction today is worth more than one 20 years from now so we can see how Congress views competing electrical generation sources by how quickly they allow the write-offs to occur.

For wind farms, the current code allows the write-offs over 3.5 years, a real boon for investors in wind mill projects. In fact, many such projects depend on this tax advantage to secure financing, especially since the right to take these deductions can be allocated with some freedom amongst the project's investors and the developers.

Alas, for nuclear power plants, the tax picture is not so rosy.  They have to take their write-offs over 20.5 years, a significant disadvantage over a comparable investment in a wind project.  Taking a hypothetical $5 billion in generation investment in each technology, here's a chart showing when those deductions could be taken and for how much:

From this chart, it is easy to see that the investors in a wind project get to write-off a LOT more money a LOT sooner than the investors in a nuclear plant.  This is greatly to the advantage of the wind developers.  At a 35% corporate tax rate, the difference in Year 2 alone is over $650 million in bottom line after-tax profits to the wind investors - that's cash money that can cut dividend checks.  Maybe now you can see why T. Boone Pickens is pushing wind farms.

Let's take the figures from Department of Energy's Energy Information Agency for capital costs and productive experience ("capacity factor") to see exactly what this means in terms of electrical production.  Let's assume an equal "overnight" investment of $5 billion in wind mills and $5 billion in nuclear power plants.  That will buy you about 1.5 gigawatts of nuclear capacity and 2.6 gigawatts of wind farm capacity.  However, that's only the equipment's theoretical ability to make electricity and not how much electricity it likely will supply per year once in service.  For that we need to multiply our capacity by something called "capacity factor" which is what it really delivers.  Again, using EIA's numbers on what really happens out in the real world in terms of expected production:

So that $5 billion will produce over TWICE the annual electrical output for American consumers if invested in nuclear power plants than if in wind farms.  One has to ask, do these provisions in the tax code really serve Americans' interests or are they written with someone else in mind?  Yet, Congress wants 20% of our electricity to come from "renewables" like wind.  The California legislature, to prove its green bona fides, recently passed a law to make California electric consumers buy 33% of their electricity from renewables.  All I can say is, "Thanks guys!"

Not only are the rules on depreciation written to the disadvantage of nuclear power but there is an excise tax on its output, buried within your electric bill.  Once the capital costs are covered, the production costs of nuclear electricity run about $25 per megawatt-hour at wholesale.  But the Federal government imposes a $1 a megawatt-hour tax that goes into the Nuclear Waste Trust Fund to eventually cover the costs of safely disposing of the spent nuclear fuel.  Cash that are not spent currently on waste disposal goes into the US Treasury who then issues promissory notes to the trust fund towards the day when actual construction begins.  The plan was to bury it deep under Yucca Mountain in Nevada, a plan not without its critics, but now put on indefinite hold by the Obama Adminstration.  With no action on dealing with the problem, perhaps Congress could consider putting the nuclear 4% tax (at wholesale) on hold too.

So, in comparing the tax treatment of wind against that of nuclear power, one could get the idea that Congress is rewarding the inefficient while hobbling the productive.  I'd call that perversion and poor public policy.

Joseph Somsel is a nuclear engineer who reads the fine print on his monthly electric bill.