Action at the local level is critical to meeting national and global climate goals, and many public organizations across the United States — including cities, town, counties, public utilities and school districts — are already rising to this challenge. Since 2018, local governments have purchased or installed more than 16 gigawatts (GW) of renewable energy.
While local governments are critical to climate action, in the U.S., they historically haven’t been able to access the same federal incentives for clean energy investment that the private sector has. But the Inflation Reduction Act of 2022 (IRA) changed the game.
The IRA contained unprecedented support for climate action, including expanding valuable tax credits for renewable energy investments. It also created an entirely new pathway — called “elective pay” or “direct pay” — through which local governments and other tax-exempt entities can access these credits for the first time. This presents a momentous opportunity for local governments to invest in clean energy while bringing new green jobs, energy security, enhanced climate resilience and other benefits to their communities.
Here, we break down recent WRI research showing how local governments and public organizations can best leverage the IRA’s direct pay provision to maximize the benefits of their clean energy investments.
How Public and Nonprofit Organizations Benefit from IRA Tax Credit Reforms
The IRA expanded both the scope of and timeline for clean energy tax credits. It modified the Investment Tax Credit (ITC) and Production Tax Credit (PTC), which have been key drivers of renewable energy investment in the U.S. for decades, and expanded which technologies are eligible for each credit. It also offers bonuses on top of the ITC and PTC’s base values for projects which meet criteria related to domestic content, labor standards and equity siting, with the goal to bring tangible benefits to low-income and historically disadvantaged communities.
Critically, the IRA opened the door for local governments and other tax-exempt entities to access these and other tax credits. Through a mechanism known as elective pay (direct pay), the IRA allows nonprofit and public organizations — which would otherwise be unable to claim federal tax credits because of their tax-exempt status — to directly tap into a dozen distinct IRA tax credits.
However, the structure of IRA incentives and the process to access them can be complex. Taking full advantage of these tax credits and maximizing the benefits they can bring to communities will require careful planning, coordination and staff capacity.
WRI — with support from Bloomberg Philanthropies and in partnership with the Local Infrastructure Hub — has published a new guidebook, Catalyzing Local Clean Energy: A Roadmap for Maximizing Inflation Reduction Act Opportunities and Community Benefits, to help local governments understand and take advantage of the IRA’s clean energy tax credits.
Building on insights from the guidebook, here are five key takeaways for local governments to consider as they look to capitalize on the IRA’s clean energy incentives.
1) Elective Pay Gives Tax-exempt Entities Greater Leverage in Energy Procurement and Paves the Way for More Public Ownership of Clean Energy Assets.
For local governments, nonprofits and other tax-exempt entities, elective pay makes direct ownership of clean energy infrastructure easier and more affordable than before.
Previously, if any government or tax-exempt organization wanted to take advantage of clean energy tax credits, they were required to purchase power from private entities. Such arrangements often required special project financing vehicles which reduced the overall value of the project for these entities. In addition, larger projects primarily took the form of power purchase agreements (PPAs). These involve buying power from projects that may not be directly sited in a community, thus reducing the local economic and social benefits of investing in clean energy. Even on-site solar and other projects constructed on local government facilities and land were generally owned and operated by third parties using smaller-scale PPAs and lease models.
If public and nonprofit organizations wanted to avoid these financing arrangements and build their own clean energy infrastructure, it meant forgoing energy tax credits. This increased the price of direct ownership projects, limiting local governments’ clean energy investments in scale and ambition.
Now, thanks to the IRA’s elective pay provision, local governments and other tax-exempt entities can receive the full value of federal tax credits without entering into third-party arrangements. This makes direct ownership of clean energy assets a more viable pathway, opening up new opportunities to drive local project development, job creation and other benefits associated with clean energy deployment within local communities.
2) The IRA’s Bonus Credits Can Advance Equity and Enhance Savings but They Require Advance Planning.
In addition to the base values of the ITC and PTC, the IRA offers bonuses for projects that meet certain criteria related to domestic content, labor standards, and developing projects within low-income and designated “energy communities” (those historically reliant on income from fossil-based generation or with brownfield sites). These credits are intended to incentivize economic growth driven by the clean energy transition across underserved communities and geographies.
With the right knowledge and planning, local governments can capitalize on IRA bonus credits by prioritizing development in eligible locations, such as low-income communities, brownfields, covered housing programs and publicly owned land on or near retired coal plants. This can not only generate additional savings, but also encourage clean energy development in ways that align with local public policy goals.
However, there are important guidelines and limitations that local governments should be aware of. For example, some of the criteria used to determine bonus credit eligibility, such as the definition of “energy communities,” can shift over time. Local governments should be sure to identify which areas in their community qualify and plan their projects on timelines that allow these bonuses to be claimed as expected.
Local governments should also be aware that the Low-Income Communities Bonus Credit Program operates differently from the other bonus credits. Projects wanting to receive the Low-Income Communities Bonus Credit must file a separate application to demonstrate that they meet the requirements of any of the four qualifying categories. Furthermore, the program is capped at a total of 1.8 GW of nameplate capacity (the total installed generating capacity) per year, and each individual project must be less than 5 MW in size. The first application period for the Low-Income Communities Bonus Credit Program opened on October 19, 2023, and applications will be accepted until all capacity for the 2023 calendar year is allocated.
3) Local Governments Need to Be Aware of Increasing Domestic Content Requirements Over Time.
The IRA’s domestic content provision is arguably the most important bonus credit for local governments to be aware of. Over the next few years, for entities aiming to use elective pay, the domestic content element of the IRA tax credits will move from being a bonus, additional credit on top of the ITC and PTC base credits to being a de facto requirement that reduces their base value if not met.
Failing to meet domestic content requirements will result in:
- A 10% reduction in base value for projects that begin construction in 2024
- A 15% reduction in base value for projects that begin construction in 2025.
- A 100% reduction in base value for projects that begin construction after 2025.
In other words, beginning in 2026, projects claiming elective pay will get no value from the ITC or PTC if they do not meet domestic content provisions. Projects which do meet these requirements will still receive the bonus as an added value on top of the credit’s full base value.
There are exceptions to these rules. Notably, these requirements do not apply to projects with less than 1 megawatt (MW) of nameplate capacity. Furthermore, the IRA allows waivers in certain cases where meeting domestic content requirements would increase project costs by 25% or more, or where the materials needed to meet these requirements are not available in “sufficient quantity or quality” from domestic manufacturers.
Local governments can employ several strategies to make it easier to fulfill domestic content requirements. These include keeping individual clean energy installations under 1 MW in capacity; seeking an exception if the project qualifies for one; and contracting early on with private developers or domestic manufacturers to ensure compliance.
4) Local Governments Can “Stack” Federal Grants with Elective Pay to Save Money and Cover Upfront Project Costs.
According to proposed IRS guidance, using tax-exempt grants or forgivable loans to fund a project does not affect the value of IRA tax credits, unless the total amount of the grant plus the elective pay refund is greater than the tax basis of the project. In other words, public entities can partially fund clean energy projects using grant money and still receive the full value of the tax credits.
This means that local governments and other tax-exempt entities can “stack” grants with elective pay to achieve significant cost reductions and create larger, more ambitious clean energy projects. Potential federal funding sources from the IRA that can be stacked with elective pay tax credits include:
Other grant programs may have their own restrictions on stacking, however, so local governments should consult the program rules of each funding source that they plan to use to ensure that stacking with tax credits is allowed.
It is important to keep in mind that clean energy projects eligible for elective pay must be placed into service before receiving the tax credit. This means local governments must fund or finance projects on the front end. While local governments can pursue grant funds for this, timing and individual grant limitations may hinder their ability to provide “bridge” capital.
Fortunately, the EPA’s Greenhouse Gas Reduction Fund (GGRF), established under the IRA, will capitalize national nonprofit lenders and local community development finance institutions (CDFIs) to offer local governments and eligible entities financing options that carry a lower, more accessible cost of capital. As local governments seek to spin up new elective pay projects, the GGRF may soon provide attractive lending solutions to cover steep upfront costs.
5) Local Governments Can Act as Educators and Conveners to Spur Community-wide Clean Energy Adoption.
Finally, local governments should look beyond their own projects and programming, leveraging the IRA’s clean energy provisions to spur uptake throughout their communities and help their residents gain maximum benefits from clean energy projects.
As a first step, local governments can educate residents about the incentives available to individuals and businesses, such as residential home energy tax credits and energy-efficient appliance rebates. Local governments can also make it easier for community members to adopt clean energy by removing certain procedural barriers in their permitting and zoning codes. For example, a local government with zoning authority can affirm that rooftop solar installations are a by-right accessory use in all major zones, eliminating the need for special use permits.
Local governments can also develop larger programs with community-wide footprints and provide real estate for the development of innovative and equitable clean energy projects, such as micro grids and community solar. And they can explore new approaches to purchasing clean energy for the community — like, for example, developing a low-income solar program in which the local government owns solar panels on single-family residential rooftops and sells the electricity generated by the panels to participating households.
Furthermore, as they gain more experience, local governments can help other community-serving elective-pay entities (like school districts and nonprofits) understand the opportunities available to them and navigate the process.
Taking Advantage of the New Clean Energy Landscape in the U.S.
The IRA presents a massive opportunity for all U.S. communities to benefit from the clean energy transition. Through grants, loans, tax credits and more, local governments can reduce greenhouse emissions and air pollution, support economic revitalization and the creation of a green workforce, and help low-income residents build wealth and save on energy costs.
Exciting first steps are already being taken, with cities like San Antonio and Baltimore factoring elective pay into new clean energy projects. With the new opportunities made possible by the IRA, local governments are well poised to seize the moment and make the clean energy future a reality.
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