commercial business that is planning to install a new cooling system in the year 2000 could receive either a 10-percent tax credit on the purchase price of a residential-type central air conditioner with a cooling efficiency of 13.5 SEER (Seasonal Energy Efficiency Factor) or a 20-percent tax credit for a central air conditioner with a cooling efficiency of 15 SEER. The specific technologies, requirements for eligibility, and applicable credits of the tax incentive program are shown in Table 1.

Table 1. Tax Credit Proposal for Energy-Efficient Building Equipment

"Units for efficiency measures are presented as given in the Department of the Treasury's explanation of the CCTI proposals: HSPF, Heating Seasonal Performance Factor, SEER, Seasonal Energy Efficiency Rating: EF, Energy Factor, COP, Coefficient of Performance.

Uses an electrochemical process to generate electricity and heat.

Source: U.S. Department of the Treasury, "General Explanations of the Administration's Revenue Proposals" (February 1999).

The tax credit is a percentage of the purchase price not exceeding a specified price limit. The purchase prices of the technologies included in the CCTI proposal are such that, in some instances, the tax credit does not exceed the cap. Table 2 illustrates this point by providing the costs and possible tax credits for equipment of the efficiency levels specified in the proposal. Also provided in Table 2, for comparison purposes, is the cost of the equipment that just meets the current energy efficiency standards and thus would receive no tax credit.

In the NEMS residential and commercial modules, the income tax credit is represented as a direct offset to the cost of the equipment. The costs for each of the affected technologies are reduced only for the years specified in the budget language. Once the tax credit expires, it is no longer subtracted from the cost of the technology. Both the reference case and the CCTI analysis case incorporate cost declines for advanced technologies over time as producers gain experience. The size and duration of the credit in the CCTI case are not considered sufficient to alter the rate of the cost declines. The credit is also believed to be too small to affect general consumer behavior toward energy efficiency or to change the barriers to entry that exist in the marketplace. An example of this market phenomenon is the development of heat pump water heaters in the early 1980s. With the help of government and utility supports, sales of heat pump water heaters peaked at about 8,000 units in 1985. Even with continued utility support, however, the decline in real energy prices and uncertainties regarding the technology caused sales to slip to 2,000 units per

year, where they have stabilized. While innovative and aggressive marketing strategies by private firms and government information programs could enhance the effectiveness of the tax credits by increasing the exposure and consumer awareness of a given technology, the short lead time and limited duration of the proposed incentives make changes in consumer behavior unlikely.

"Heating and cooling efficiency, respectively, are given for heating and cooling combination units. Units for efficiency measures are presented as given in the Department of the Treasury's explanation of the CCTI proposals: HSPF, Heating Seasonal Performance Factor, SEER, Seasonal Energy Efficiency Rating: EF, Energy Factor, AFUE, Annual Fuel Utilization Efficiency, GCOP, Gas Coefficient of Performance.

Costs are given in 1998 real dollars.

"Source: Energy Information Administration, Technology Forecast Updates: Residential and Commercial Building Technologies— Advanced Adoption Case, prepared by Arthur D. Little, Inc. (Washington, DC, September 1998). Installed cost is for a phosphoric acid fuel cell ranging in size from 5 to 250 kilowatts of generating capacity.

Sources: Energy Information Administration, Technology Forecast Updates: Residential and Commercial Building TechnologiesReference Case, prepared by Arthur D. Little, Inc. (Washington, DC, September 1998).

It is clear from Table 2 that the tax credits offered would not significantly change the economics of the investment decision from the consumer's point of view. Historically, consumers have been unwilling to invest in energy-efficient equipment with long payback periods. Short tenancy rates, lack of information, the fact that builders (as opposed to consumers) generally purchase the energy-using equipment, and limited availability of investment funds are just some of the factors that tend to affect purchase decisions.

Most of the technologies included in the CCTI proposal currently retain very small market shares in the residential arena. Natural gas heat pump prices have been high and volatile due to low sales, which currently total under 6,000 units per year. A consortium of 120 gas utilities currently subsidizes the development of the York Triathlon gas heat

IU.S. Department of Energy, Office of Building Equipment, Market Disposition of High-Efficiency Water Heating Equipment (Washington. DC. November 1996).

pump in an effort to increase sales to a level at which economies of scale can reduce the installed cost.' 12 The tax credits offered for the purchase of this technology could increase sales somewhat; however, the cost-including the tax credit-is still almost double the cost of a traditional gas furnace/central air conditioner system. With energy prices expected to remain stable in real terms over time, it is unlikely that significant increases in the market penetration of gas heat pumps would occur without substantial subsidies or technological breakthroughs leading to large price reductions.

The only generating technology included in the CCTI tax incentive proposal for energy-efficient building equipment is the fuel cell. Currently, units sized for residential applications are in the prototype stage, with a projected commercialization date of 2001-2002. There is only one manufacturer of fuel cells for commercial-sized units. The current cost for a commercial-sized fuel cell is about $3,000 per kilowatt of capacity; the CCTI tax credit would reduce the cost to $2,500 per kilowatt.13 As an example, assume that a commercial business purchases a fuel cell system, the tax credit is taken, and the cost of the fuel cell is financed at 9-percent interest for 7 years. Including the fuel savings that would result from using the heat produced by the fuel cell to satisfy the company's hot water needs in place of a natural-gas-fired water heater, the fuel cell could provide electricity for around 20 to 21 cents per kilowatthour, depending on regional natural gas prices. That cost is about three times the average U.S. commercial electricity price. Thus, a much larger incentive or a dramatic drop in fuel cell costs in the next few years would be required to spur adoption of this technology.14

Results

The analysis results indicate that the CCTI tax incentive proposal for energy-efficient building equipment could reduce projected carbon emissions by 1.5 million metric tons (0.3 percent) and buildings energy use by 26.8 trillion British thermal units (Btu)-0.1 percent of delivered energy-in 2005. Table 3 shows the savings in the CCTI analysis case relative to the reference case. The CCTI case includes the tax credits for all the technologies listed in Table 2.

Table 3. Projected Energy Savings and Carbon Emissions Reductions from the CCTI Tax Incentive for Energy-Efficient Building Equipment, 2005, 2010, and 2020

Source: Energy Information Administration, Office of Integrated Analysis and Forecasting.

12Energy Information Administration, Technology Forecast Updates: Residential and Commercial Building Technologies-Reference Case, prepared by Arthur D. Little, Inc. (Washington, DC, September 1998).

13Fuel cell costs from Energy Information Administration. Technology Forecast Updates: Residential and Commercial Building Technologies-Advanced Adoption Case, prepared by Arthur D. Little, Inc. (Washington, DC, September 1998).

14 Assumed financing terms also include a 20-percent down payment. Natural gas and electricity prices for this example are 1998 prices from Energy Information Administration, Annual Energy Outlook 1999, DOE/EIA-0383(99) (Washington, DC, December 1998).

Given the small increase in the projected market share for the technologies targeted by this tax credit proposal, it follows that a significant portion of the decreased tax revenues could result from tax credits received by consumers who would have purchased the equipment with no additional incentive. For example, sales of all natural gas heat pumps would be eligible for the tax credit, and with sales currently totaling 5,500 units per year, $5.5 million could be claimed by consumers who would have purchased the equipment absent any tax credit. In the years covered by the tax credit (2000-2003), the analysis indicates that a total of 36,444 natural gas heat pumps would be purchased in the reference case, 15 and that an additional 25,119 units would be purchased because of the tax credit in the CCTI case. In the CCTI case, the Treasury would incur a total reduction of $61.6 million in projected tax revenues related to purchases of natural gas heat pumps. Of the $61.6 million, 60 percent of the tax credits paid would go to unintended beneficiaries.

Tax Credits for Energy-Efficient New Homes

Background

The following CCTI tax credits for energy-efficient new homes are proposed:

• In calendar years 2000 and 2001, a credit of $1,000 for new homes that are at least 30 percent more efficient than the International Energy Conservation Code (IECC) (same as Energy Star Home)

• In calendar years 2000 through 2002, a tax credit of $1,500 for new homes that are at least 40 percent more efficient than the IECC

• In calendar years 2000 through 2004, a tax credit of $2,000 for new homes that are at least 50 percent more efficient than the IECC.

The IECC eligibility standard is an update to the more commonly referenced Model Energy Code (MEC), most recently issued in 1995. Given the similarities between the two codes and the data and software availability already established for MEC95, MEC95 was used as the basis for qualifying for the tax credits. Because there is some overlap between the equipment eligible for tax credits under the CCTI energy-efficient building equipment proposal and the eligibility requirements for the credit for energy-efficient homes, only one of the credits can be claimed for a given structure.16 It is not clear how the energy savings would be certified to assure that the requirements of the tax

credit were met.

Given the intricate interactions between building shell measures, equipment measures, building orientation and shading, and equipment sizing, it is difficult for any estimate to incorporate all the potential effects included in designing and building a home. The NEMS residential model is not a building simulation model and therefore cannot handle all the different aspects and interactions of building systems. In order to give some perspective on the magnitude and potential impacts that the CCTI tax incentive might have, an offline analysis was completed using a building simulation model (PEAR),17 the MECcheck software, 18 and a cash flow/payback model. When the three models are used in concert, energy savings, code compliance, and investment information can be determined. Although the models estimate energy savings and code compliance, they do not address all issues associated with

15 Reference case results based on assumptions used for the Annual Energy Outlook 1999 (AEO99). AEO99 and the assumptions for AEO99 are available on the EIA web site at www.ela.doe.gov.

Personal communication from John McClelland, Office of Tax Analysis, Department of the Treasury, March 8, 1999.

"U.S. Department of Energy, Program for Energy Analysis of Residences (PEAR), DOE/SF/00098-H3 (Washington, DC, June 1989). IBU.S. Department of Energy, Office of Codes and Standards, MECcheck, Version 2.05 (Washington, DC, February 1998).

the energy efficiency aspects of new home construction. The software used for this analysis, although possibly not the state of the art, was readily available, and analysts were familiar with its use.

19

Even with the use of very detailed building simulation models, there are several limitations of note regarding this analysis. The MECcheck and PEAR programs do not include a number of options that may affect the costs of meeting the qualifications for the tax incentives. The software does not allow for orientation properties, which allow builders to minimize sun exposure in the summer and maximize it in the winter. There is no credit for downsizing the heating and cooling equipment, which allows builders to install smaller, less costly units when a tighter building envelope is in place. There is no accounting for more efficient ventilation systems (e.g., tighter duct work), and only conventional building materials are considered. In addition, there is no unique solution for achieving an energy savings target. To the extent that some of these options can be and are used to meet the CCTI efficiency level requirements, their omission in this analysis may cause higher estimated costs of meeting the program's requirements than if the options were included.

As of the end of 1998, 16 States had adopted MEC95 or better building codes,20 and 36 States had adopted some form of the MEC or its equivalent.21 Implementation and enforcement of the code are difficult, and construction often is not compliant. Building codes in States without mandatory codes may be set on a county-specific basis, making estimates of an "average new home" building shell difficult. A somewhat different approach to increasing the building of energy-efficient homes is to offer the tax credit to the homebuilder, as opposed to the homeowner. If the credit were offered to the builder, more energy-efficient homes would be made available to prospective buyers, because the builders would receive an incentive to construct more energy-efficient homes. Currently, builders can recoup only the incremental cost of improving energy efficiency in the sales price of the home, because they do not receive the benefits of lower energy bills. To address this issue, Rep. William Thomas (R-CA) is preparing to introduce the Energy Efficient Affordable Home Act of 1999, which would enable the builders of energy-efficient homes to receive the $2,000 tax credit.22 The CCTI tax credit would be available to homeowners only; however, given the restrictions on allowable tax credits, it is not clear whether all parties interested in receiving the tax credits could claim them.

For this analysis, two prototype houses were used as typical for two climate regions: north and south. Tables 4 and 5 detail the characteristics and costs of efficiency measures for each prototype and the expected tax credit. It is assumed that each percentage level specified in the tax credit proposal relates to energy savings relative to the MEC95 code for heating and cooling only. It is further assumed that the most efficient equipment is installed as a means to meet the credit, because it is generally the cheapest option per Btu saved.

Methodology and Results

MECcheck was used to establish the characteristics of a MEC95-compliant home, which were then input into PEAR, a building simulation model developed by DOE, to establish MEC95-compliant energy consumption for heating and cooling. The characteristics were then changed to achieve the levels of energy consumption specified in the tax credit proposal. The characteristics shown in Tables 4 and 5 are the results of this process. The costs associated with the efficiency improvements were then mapped to each particular characteristic. As noted above, the solutions given in

DOE-2 and REM-RATE are two examples of building simulation models that are better equipped to handle some of these issues. Building Standards and Guidelines Program (BSGP). Setting the Standard, Vol. 7, No. 2 (1998).

21Other MEC codes include 1992 and 1993 versions. See Building Codes Assistance Project, web site www.solstice.crest.org/ efficiency/bcap.

22 Alliance to Save Energy, "e-FFICIENCY NEWS" (March 1999).