Why are financial incentives important in the context of solar?

The realization of climate change and depletion of fossil fuels has emphasized the adoption of renewable energy sources like solar energy. But the fact remains that solar energy has not yet reached grid parity in most places. In order to help businesses and home owners economically produce electricity from solar farms, governments around the world have introduced various financial incentives.

How can they be classified?

Financial incentives available for solar farms are classified into:

  1. Capital subsidies
  2. Tax incentives
  3. Generation-based incentives

Capital Subsidies

Capital subsides are incentives available on the total project cost of solar farms. Depending on the country, type of solar plant and the project size, a certain percentage of the capital investment is written off. Therefore it simply reduces the upfront cost of installing a solar farm.

Example :  Indian government provides a capital subsidy of 30% on off-grid solar power plants.

Since it is a one-time cost incentive, it does not encourage customers to generate and consume electricity efficiently.

Tax Incentives

Tax incentives or tax credits aid in deducting the income tax payable to the government. So, a certain portion of the tax owed to the government is subtracted from the total tax payable.
Tax incentives are provided by the federal as well as state governments. Two common types of tax incentives are discussed as follows:

  • Accelerated Depreciation

Accelerated Depreciation (AD) is a form of tax incentive where the value of a solar plant reduces at a faster rate in the early years. It accelerates profit-making by reducing the taxable income in the early years.

Example: An AD of 80% is provided by Government of India to investors setting up solar power plants for captive use.

  • Federal Tax Credits

Federal tax credits allows homeowners to subtract part of the cost of the solar system from the tax owed to the government. Note that unlike a tax deduction incentive like AD where the taxable income is reduced, FTC is a dollar-for-dollar reduction in income taxes. In the US, a federal tax credit of 30% of the solar system is available for residential and commercial solar systems.

For example, let us assume you purchase a solar panel system for $10000. With a 30% federal tax credit, you subtract $3000 from the money you owe in taxes. So, if your income tax is $5000, after the tax credit it reduces to $2000.

  • Tax Exemptions

There are tax exemptions in place  in some countries in order to facilitate the adoption of solar. There are sales, customs and/or excise duty exemption on solar system components especially panels. In India, there are no taxes imposed on solar panels whether it is imported or manufactured locally. Depending on the country-specific policies, other solar components may also be applicable for tax exemptions.

Tax Holidays

In some countries, governments provide incentives in the form of tax holidays to promote growth in the sector. For example, in India,  the solar PV plants receive a 100 percent tax holiday on the earnings for a period of 10 years.

Generation-based incentives

In this case, the customers are rewarded for the electricity that is generated from solar. The main feature of generation-based incentives is that it benefits the most efficient customer.

Feed-in-tariffs and Renewable Energy Certificates (RECs) are two common types of generation based incentives.

  • Feed-in-Tariffs (FiT)– This is an incentive provided by the utility to the customer wherein the customer is paid for every unit of electricity that is fed into the grid. The $/KWh paid for the electricity generated reduces over time thereby benefitting early adopters more. FiT schemes have been successfully implemented in many European countries like UK and Germany.
  • Renewable Energy Certificates (RECs)– Green Certificates (Renewable Energy Credits/ Renewable Energy certificates) are awarded as a proof that a certain amount of electricity is produced by a renewable energy source like solar. Typically, the solar energy provider is credited with 1 green certificate for every MWh of electricity that is produced. Rather than the physical electricity that is produced, green certificates are about taking credit for the environmental benefit brought in by use of solar energy.

Additional incentives

  • Subsidized loans

Subsidized loans are available in the form of zero or low interest rates from banks, utilities, governments or other organizations. These are very uncommon and are usually available only for a limited period of time.

It is important to understand  that until solar energy reaches grid parity, it is going to be widely supported by these financial incentive mechanisms. The effective implementation of these incentives enhances the financial viability of solar projects.

  • Green Bonds/ Clean Renewable Energy Bonds (CREBs)

 

A green bond is a special kind of  special type of tax credit bond providing project developers or electricity utilities the equivalent of an interest-free loan for financing qualified energy projects. The bondholder receives tax credits in lieu of a portion of the traditional bond interest, resulting in a lower effective interest rate for the borrower. Warren Buffett’s MidAmerican Energy company offered $1 billion in bonds, at 5.375 percent interest, to finance about half of the cost of its huge 550-megawatt Topaz Solar Farm in San Luis Obispo County in central California.

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