Tax Credits are not a Substitute for Debt Capital, Rather, They Provide Equity Capital

Published by Michael Novogradac on Friday, July 11, 2014 - 12:00am

A recent paper, “An Analysis of the Costs, Benefits, and Implications of Different Approaches to Capturing the Value of Renewable Energy Tax Incentives,” by Mark Bolinger of Lawrence Berkeley National Laboratory argues that “tax equity is currently twice as expensive (on a comparable after-tax basis) as the project-level term debt that it likely supplants.” The paper then notes that “under a variety of plausible future scenarios examined in this report and relevant to utility-scale wind and solar projects, the benefit of monetization is found to no longer outweigh the incremental cost, and it makes more sense for sponsors – even those without tax appetite – to use the benefits internally rather than seek out third-party tax equity.”

Unfortunately, this analysis incorrectly presumes that tax equity “likely supplants” long-term low cost debt. In practice, tax equity is principally supplanting third party equity. Which means the right comparison should be the cost of tax equity versus the cost of other forms of equity.

Cost of Tax Equity vs. Long-Term Debt

The paper states “tax equity is currently more than twice as expensive as 15-year term debt on an after-tax basis.” (The paper assumes tax equity needs an eight percent after tax rate of return and 15 year term debt comes at a four percent cost, after tax.)

As such, the paper notes that for companies unable to use the tax benefits, tax syndication provides net equity, but for companies that can use the benefits, tax syndication is less efficient and for companies that expect profits in the future, they may be better off not syndicating and using the tax benefits in the future to offset future taxes.

It is no surprise that if a company is not equity capital constrained and has adequate access to 15 year low cost debt, then such an option may be more financially beneficial. Unfortunately, most companies don’t find themselves in such a situation.

Cost of Tax Equity vs. Other Equity

As companies grow, they generally will max out on low cost long-term financing, and need to raise equity to provide the risk capital needed to increase their ability to borrow at long-term 15 year rates.

As such, the proper comparison is the ability for companies to raise equity and what the after tax cost of that equity is.

Research from the National Renewable Energy Laboratory suggests that equity returns for non-tax credit equity “exceeded tax equity returns by roughly 1-2 [percent].” The authors even state that this evidence contradicts the “claims that tax equity partner yields are excessive.”

This means that to the extent that tax equity capital is supplanting this non-tax credit market equity, it is supplanting a higher yield equity with lower yield equity. Switching to market equity would increase costs.

In short, the benefit of monetization continues, as it provides a cheaper source of equity capital, and generally can’t simply be swapped out for cheaper long-term debt.