The European experience with tax relief for energy efficient equipment in industry all bad or just second best?

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1 The European experience with tax relief for energy efficient equipment in industry all bad or just second best? Lisa Ryan International Energy Agency 9 Rue de la Federation, Paris Cedex 15, France lisa.ryan@iea.org Emilie Jessula 51 rue Raynouard, Paris France emilie@jessula.com Vida Rozite International Energy Agency 9 Rue de la Federation, Paris Cedex 15, France vida.rozite@iea.org Keywords policy recommendations, awareness, financial incentives, market transformation, policy instruments, financing Abstract Improvements in energy efficiency in industry are crucial to achieving not only environmental and energy security objectives, but also to improving productivity and competitiveness at enterprise level. Yet, reluctance to finance energy efficiency improvements is prevalent in many organisations. A range of policy measures are put in place by governments to overcome the market failures preventing increased investment in energy efficiency measures. Although not a first-best policy instrument on a number of levels, tax relief for energy efficient equipment in the industrial and commercial sectors is one mechanism utilised by policymakers in many countries to encourage increased investment in energy efficient equipment by companies. This paper examines the evidence from three such programmes, in the Netherlands, the United Kingdom, and in Ireland, using evaluation criteria grouped under effectiveness and efficiency headings. The case studies suggest that these kinds of programmes appear to be quite effective in encouraging greater market uptake of energy efficient equipment at quite low cost to the public purse. There is however, significant free-ridership and overlap with other policies that reduce the efficiency of this policy instrument. Nevertheless, the experiences of these three countries suggest that these programmes have led to increased awareness of energy efficiency in industry and leverage of private finance and therefore there may be multiplier effects that justify such programmes. The authors would like to thank the reviewers for their careful and detailed comments. Introduction Despite the high potential for energy savings across the economy, there exist several barriers and market failures that limit investments and improvements in energy efficiency. This means that energy efficiency potential is not achieved, reducing economic performance and leading to unnecessary waste and unnecessarily high CO 2 emissions. IEA modeling estimates that in order to reduce CO 2 emissions by half in 2050, energy efficiency would need to account for 40 % of the total emissions reductions in 2050 (IEA, 2009). The presence of market failures justifies government public intervention in order to remove barriers to the optimal allocation of resources, for markets to operate efficiently and for the full potential of energy efficiency to be realized. Some of the barriers to investments in cost-effective energy-efficient technologies in the industrial sector include (IEA, 2009; Sorrell et al, 2004): Low priority of energy issues and a failure to recognize the positive impact that energy efficiency can have on profitability and operations Short investment payback thresholds and limited access to capital Lack of willingness to invest Information and transaction costs Market failures split incentives information failures such as asymmetric information externalities Behavioural failures ECEEE 2012 SUMMER STUDY on Energy efficiency in industry 887

2 Ryan et al 6. THE ROLE OF FINANCING TO IMPROVE INDUSTRIAL EFFICIENCY Governments have a portfolio of policy instruments to address these market failures and to create the conditions necessary to encourage increased investment by the private sector in energy-efficient technologies and processes. Economic instruments can help overcome barriers to energy efficiency by lowering the capital cost of the purchase of energy-efficient products, by providing a price signal which gives an incentive to firms to invest in innovation or to purchase energy-efficient technologies and deliver energy savings at least cost. Many countries are using tax relief programmes to improve energy efficiency; very few evaluations have been carried out to assess their performance. The purpose of this paper is to evaluate the use of tax relief programmes for energy efficient commercial equipment based on analysis of existing programmes in IEA countries. This paper adds value by examining a subject that has not been widely treated in the literature. It represents the first part of a wider project on the use of economic instruments to improve energy efficiency across different sectors. The theory and use of tax relief for energy efficiency Defining tax relief Economic policy instruments in the form of tax incentives, grants, subsidies, financial mechanisms, market-based instruments, and public direct investments are all used by IEA countries as tools to improve energy efficiency in different sectors. Economic policy instruments can address market failures such as externalities where energy end-users do not pay the full cost to society of their energy consumption and other barriers such as the uncertainty and risk associated with recouping the costs of energy efficiency investment in the future, and behavioural failure in the form of inertia and bounded rationality. The terminology used for economic, financial and fiscal policies in the area of energy efficiency policy is not well-defined. For clarity, we provide the following definitions for the relevant terms: Economic instruments: includes all policy instruments that relate to fiscal, financial and other economic incentives and disincentives to deliver energy efficiency improvements across all sectors. Their objective is to employ market forces to secure a more efficient balance between the supply of ( ) services on the one hand, and the demand for and benefits of such services on the other (Andersen 2001). Economic instruments provide market signals in the form of a modification of relative prices (e.g. taxation on certain products) and/or a financial transfer (payment of a charge) (Barde 1994). In the case of energy efficiency, we take the term economic instruments to encompass fiscal policy instruments such as tax relief for energy-efficient activity; user charges on electricity and district heating; financial mechanisms, such as grants and loans; market-based instruments, such as white certificates and carbon emissions trading schemes; and public direct investments in R&D and infrastructure that enable energy efficiency improvements. In this paper, we focus on tax relief for energyefficient commercial equipment which belongs in the category of fiscal policy instruments. Figure 1 provides a schematic diagram for economic policy instruments. Tax relief is an economic instrument that effectively reduces taxes on particular goods to correct market failures and in this case overcome barriers to energy efficiency. It is referred to by the OECD as tax expenditures and defined as provisions of tax law, regulation or practices that reduce or postpone revenue for a comparatively narrow population of taxpayers relative to a benchmark tax (OECD, 2010). For the purpose of this research, we define an energy efficiency tax relief as an instrument that grants special fiscal treatment for the purchase of energy-efficient products and technologies. There are several types of tax relief that reduce tax liability when investments in energy-efficiency are made. These are: Economic policy instruments for energy efficiency Fiscal instruments Financial measures Market- based instruments Direct investment Tax relief Loans Emissions trading schemes Public procurement rules Taxes Grants White certificate schemes Public infrastructure User charges Share participation RD&D investment Figure 1: Classification of economic instruments for energy efficiency policy. 888 ECEEE 2012 SUMMER STUDY on Energy efficiency in industry

3 6. THE ROLE OF FINANCING TO IMPROVE INDUSTRIAL EFFICIENCY Ryan et al Tax credits which allow purchasers or businesses to set a percentage of the investment cost associated with the qualifying equipment as a credit against taxes on business profits or individual income Tax reductions which reduce the sales tax of qualifying equipment immediately at the point of sale Tax rebates, which allow for a refund of purchase or sales taxes of qualifying equipment, similar to tax deductions but must usually be applied for after the purchase Accelerated depreciation allowances which allow purchasers to write-off the cost of depreciation of qualifying equipment more rapidly than standard equipment, thus effectively reducing the total cost of the equipment Tax or custom exemptions which relieve purchasers from paying custom taxes on qualifying imported equipment or excise tax on consumption or purchase of specified products Key issues related to tax reliefs for energy efficiency policy The aim of tax relief is to induce innovation and create incentives to develop new energy-efficient technologies (OECD 2010). However there are several issues that must be dealt with if they are to be efficient and effective. According to the OECD research on tax expenditure, tax expenditures can be unfair, distortionary and costly, as well as prone to rapid growth in number and size (OECD, 2010). Several reasons are given why tax expenditures may be flawed. First of all, they tend to be inequitable by benefitting those in the highest income bracket most. Secondly, tax expenditures are difficult to evaluate and to compare with other government spending programmes, making it difficult to evaluate their effectiveness. Thirdly, tax expenditure programmes can be complex and lack transparency. Finally, tax expenditures can have cost uncertainties because of measurement difficulties. An additional point is whether public funds should be used to support profit-maximising firms to finance energy efficiency investments that will save money over a given period. There are several other issues related to the economic efficiency of tax relief. A workshop of experts and policymakers held in October 2010 at the IEA discussed this subject at length and contributed many of the points below. a) The rebound effect Although tax relief creates incentives to change products purchased for more efficient equipment, there is no incentive to change behaviour and the way the equipment is used. One of the pitfalls of tax relief for improving energy efficiency and other policies is the so-called rebound effect. One manifestation of this would be the more intensive use of energy-efficient equipment than would have been the case with less efficient (more expensive to operate) equipment, leading to higher energy consumption over the life cycle of the equipment. A more likely scenario is when tax relief might induce firms to purchase more or larger capacity equipment than they would otherwise, as a result of the lower prices of equipment, leading to an outcome contrary to the stated environmental objective. However, this rebound effect may also be viewed as a producer surplus where the savings in energy bills are put to increased productivity or are spent on expansion. Complementary measures addressing the efficient use of equipment can mitigate this effect (UKERC 2007). b) Free-ridership and spill-over effects Free-ridership is the phenomenon of purchasers taking advantage of a tax benefit even though they would have bought the energy-efficient equipment in the absence of the incentivet. This means that tax relief is granted to consumers who did not need it and that the programme is not creating any incentives for increased uptake in more efficient equipment. This has a serious effect on the cost-efficiency of these programmes. Up to 60 % of free-ridership has been found for the industrial tax relief programmes described below. The share of free-ridership tends to become smaller as the uptake of the programme increases because as the programme has a wider reach, more people/businesses that would otherwise not have purchased energy-efficient equipment exploit the tax relief. On the other hand, there can be spill-over effects that mitigate free-riding of a tax relief. Particularly in industry, it is possible that even when firms are benefitting from tax relief for a purchase they would have made anyway, they have more cash flow which frees up money to make investments in other projects they could not make before. A tax relief can thus have a spill over and multiplier effect towards other energy efficiency investments. Free-ridership can be reduced by raising the awareness of the benefits of the programme among groups who would not otherwise have purchased energy-efficient equipment. c) Technology lock-in One of the dangers of tax relief is that by providing preferential treatment to specific equipment there is a risk of technology lock-in. In other words, by promoting the adoption of certain technologies, the incentive may prevent the adoption of more efficient technologies that may appear in the future and be more optimal. Particularly in the case of tax relief for industrial equipment, the equipment technology list (ETL) plays a very important role in ensuring the dynamic efficiency of tax relief programmes. An ETL identifying the products eligible for tax relief is associated with most tax relief programmes and is updated quarterly or yearly to ensure the ETL is in line with industry developments and includes the latest technologies for improving energy efficiency. A set of criteria based on the most energy-efficient products and those continuous updates helps avoid technology lock-in. In addition, performance-based criteria for tax relief are likely to reduce the possibility of technology lock-in as they do not specify which technology is eligible, just the energy performance required. d) Policy interaction Tax relief for energy-efficient products are usually implemented alongside other energy and climate-related policies. Tax relief is generally a second-best policy instrument after direct taxes on CO 2 or other pollutants. In this context, it is important to understand and consider how tax relief fits in with these other policies. When evaluating the impacts of tax relief programmes, it is important to take into account the effects of other policies as part of a broader policy package. In industry, national tax reliefs will especially interact with emission ECEEE 2012 SUMMER STUDY on Energy efficiency in industry 889

4 Ryan et al 6. THE ROLE OF FINANCING TO IMPROVE INDUSTRIAL EFFICIENCY Source: WEC survey (WEC 2008) Figure 2: Countries with fiscal incentives for energy efficiency. trading schemes (ETS) as operated across Europe. Tax relief should be aligned with a broader environmental tax reform 1 and should address a market failure that an existing policy such as carbon-pricing does not already address. Policies should be complementary or reinforcing. Given the potential policy interaction, one of the difficulties in evaluating the impact of tax reliefs on energy savings, is determining how much savings are actually applicable to the tax relief alone and not a result of a combination of policies. e) Challenges with data records for evaluation Very few evaluations of tax relief programmes have been carried out to date and data, particularly in industry, are very limited which makes analysis more difficult. Tax relief for energy efficiency investments in some countries is too recent for adequate data and proper evaluation. Difficulty in collecting data is also related to the fact that it is easier to collect data on taxes actually paid than on taxes that are not since tax relief is often awarded directly by suppliers to products included on ETL, and so ex-post evaluations are scarce. Finally, the success or failure of tax relief programmes depends on many specific conditions and so analysing cost-effectiveness needs to be done on a caseby-case basis (Worrell et al, 2009). These issues should be considered in any evaluation of the use of tax relief to improve energy efficiency. According to the World Energy Council 2008 survey, fiscal incentives (mostly subsidies) are used in more than 80 % of OECD countries (Moisan, 2010) of which tax credits are used in 40 % of OECD countries, accelerated depreciation in 12 % and tax relief in 28 % (Figure 2). 1. Environmental tax reform is defined as reform of the national tax system where there is a shift of the burden of taxes, for example from labour to environmentally damaging activities, such as unsustainable resource use or pollution. Trends in energy efficiency in industry Industrial energy use represents one third of global energy consumption and 40 % of worldwide CO 2 emissions (IEA, 2009). Total final energy use by industry reached 3,015 Mtoe in 2007, which represents almost a doubling of energy use since China is responsible for approximately 75 % of the industrial production growth since Energy intensity has decreased over this period as a result of improvements in energy efficiency and material flow management (IEA, 2010a). For a group of 21 IEA member countries, energy intensity in manufacturing fell 32 % between 1990 and 2006 (IEA, 2009), however this improvement has been more than offset by growing industrial production worldwide. Yet, opportunities to further improve energy efficiency in the industrial sector are still possible (IEA, 2009). Governments should, therefore, use policies to further encourage energy efficiency improvements. Globally, the IEA estimates that through the implementation of the best available technologies, total potential energy savings for the five most energy-intensive sectors in industry (iron and steel, cement, chemicals and petrochemicals, pulp and paper, and aluminium) are equivalent to 14 EJ per year (IEA, 2009). This equals to 12 % of energy use in industry in 2006, and 4 % of global energy consumption in that same year. The industrial sector is very diverse and heterogeneous and includes a wide range of economic activities. Energy efficiency in the industrial sector is related to the type of processes used to produce the commodity, the age and efficiency of the equipment used, and the efficiency of production, including operating conditions. Because production volumes, schedules and type of product manufactured change frequently, installation and continued optimisation of an energy-efficient process is made more difficult (McKane et al, 2007). Finally, in the industrial sector, the organizational culture is very important and the decision-making process for investments in energy efficient technologies is shaped by company rules, corporate culture, overall operational cycle, the company s perception of its level of energy efficiency and split incentives (IEA-IIP 2011). There are other institutional and behavioural barriers that inhibit energy efficiency improvements in the industrial sector (McKane et al, 2007; Worrell and Price, 2001), such as the following: Achieving the support of management for energy efficiency investments is difficult. This is because management focuses on production and lacks understanding of operational costs and equipment life cycle costs. Also there exists a budgetary disconnect between capital projects (predominantly equipment purchase and installation) and operating expenses. An industry is a business and the primary concern is production, not energy efficiency. Industrial systems are thus not designed with operational efficiency in mind and frequently staff lack capacity and expertise in the design and operation of energy-efficient systems. Optimized industrial systems usually lose their initial efficiency gains over time because of changes in personnel and production. 890 ECEEE 2012 SUMMER STUDY on Energy efficiency in industry

5 6. THE ROLE OF FINANCING TO IMPROVE INDUSTRIAL EFFICIENCY Ryan et al Finally, there is a technical risk in changing production processes and systems, and firms are not willing to incur additional costs for energy efficiency investments to modify their processes outside of the normal operational cycle. Policy instruments can help overcome some of these barriers and improve energy efficiency in industry. Tax relief for energy-efficient commercial equipment In industry, tax relief programmes aim to encourage investments in energy-efficient equipment by granting special treatment for the purchase of particular energy-efficient technologies. By reducing the upfront purchase costs of energy-efficient equipment, tax relief programmes try to accelerate the adoption of these technologies in the industrial sector. In 2005 tax relief schemes for the purchase of energy-efficient technologies in industry were found in 22 countries globally (Price et al. 2005)., To the best of our knowledge, tax relief programmes for energy efficiency improvements in the industrial sector currently exist in 10 IEA countries: Belgium, Canada, France, Ireland, Italy, Japan, the Republic of Korea, the Netherlands, the United Kingdom and the United States (IEA, 2010b). The sectoral definition is quite broad for most of these programmes, and they tend to be defined by the types of equipment covered by the tax relief rather than the sector they will be used in. Therefore we use the term commercial equipment to denote equipment in both industrial and commercial 2 sectors and include a range of activities from heavy manufacturing industry to light services sectors. There are different mechanisms for operating tax relief programmes for energy-efficient commercial equipment. In most programmes, eligible products must be part of a list of energy-efficient equipment as an Energy Technology List (ETL). The lists are often grouped into technology or product categories and, in the better-designed programmes, are updated regularly, in order to phase out technologies that have become common in the market and no longer need a tax relief to encourage their purchase. Examples of energy-saving commercial equipment eligible for tax relief include: electric motors and drivers, boiler equipment, refrigeration equipment and heat pumps. Tax reliefs allow investors to deduct a percentage of their investments costs from their total profits, thus reducing their tax liability and encouraging investments they otherwise would not have carried out. For several tax relief programmes, there is a minimum and maximum expenditure threshold that can be claimed on eligible equipment. With the accelerated depreciation allowance schemes, investors can depreciate their investments in qualifying products at a much faster rate, allowing for reduced tax payments, increased cash-flow and reduced energy costs. Other policy measures exist to encourage energy efficiency improvements in industry. These include energy management programmes, voluntary agreements, ETS, audits, performance standards and labelling. These will not be treated here. Evaluation of case studies This paper describes the evaluation of the case studies of tax relief programmes for energy-efficient commercial equipment. The objective of this evaluation is to assess the performance of existing tax relief programmes in industry in terms of their ability to achieve energy efficiency improvements and their value as a policy instrument. Very few evaluations of tax relief programmes have been carried out to date and data, particularly in industry, is very limited which makes analysis more difficult. The methodology for this analysis consisted of four main steps: a. A literature review on the use of tax relief for energy efficiency in industry was carried out. The objective was to investigate the general theoretical understanding and perception of tax relief compared with other policy instruments in the literature. This allowed for a better understanding of tax relief and provided a solid background to carry out a more comprehensive analysis and to help identify key issues related to tax relief for improving energy efficiency. b. A search for countries with these tax relief programmes for energy efficient industrial equipment was conducted. Data was collected with a survey questionnaire sent out to programme managers in ministries and government agencies in selected countries. c. A workshop entitled Tax Incentives for Improving Energy Efficiency in Industry and Transport was held in October 2010 at the IEA in Paris with approximately 50 attendees drawn from government programme managers, programme evaluators and industry experts. This workshop helped answered key questions and issues related to tax relief, enabled a discussion between programme managers and recognized experts in the field and identified evaluation criteria for tax relief programmes. d. Evaluation criteria were used to analyse the retrieved country data, and case studies were drawn up for evaluation of the selected tax relief programmes. Evaluation criteria The two main criteria chosen to evaluate the performance of tax relief programmes are environmental effectiveness and economic efficiency. For each criterion a series of general evaluation questions have been established to guide the evaluation process. To answer these questions, a selection of indicators was agreed upon during the IEA Tax Incentives Workshop to help identify the data needed to measure the performance of tax relief programmes. However, as previously mentioned, for many of the tax relief programmes, data is limited and information is sometimes difficult to collect. Therefore, the evaluation is more qualitative, supported by quantitative data when possible; for some of the indicators for which no quantitative data is available, observable changes and comments from programme managers serve as material for evaluation. 2. The term commercial sector here is used synonomously with tertiary or services sector. Environmental effectiveness The effectiveness of a policy is defined here as the extent to which a policy meets its intended objectives and realises positive environmental outcomes. In the case of tax relief for im- ECEEE 2012 SUMMER STUDY on Energy efficiency in industry 891

6 Ryan et al 6. THE ROLE OF FINANCING TO IMPROVE INDUSTRIAL EFFICIENCY proving energy efficiency, the goal is to increase the uptake of more efficient technologies in order to achieve energy savings. Evaluating their performance thus implies (i) estimating the energy savings attributable to the programme and (ii) determining if the programme was successful in encouraging the adoption of more efficient technologies. Answering the following questions helped determine the environmental effectiveness of tax relief programmes industry: 1. Impact: How has the tax relief affected consumer purchasing decisions and producer supplies? Has the incentive caused changes in consumer purchasing trends and suppliers production patterns? Indicators: Number of applications and qualifying investments awarded Level of awareness of the programme (%) Level of influence of the programme = effect of the tax credit on purchasing decisions (%) Number of qualifying products available on the market Sales of qualifying products 2. Energy savings: Since the implementation of the tax relief programme, what are the observed energy savings and CO 2 emission reductions in the sector? To what extent can these savings be attributed to the programme? Indicators: Gross energy saved in addition to autonomous energy efficiency improvements 3 (KWh or toe as a function of product output if possible) Gross carbon emissions and other pollutants saved (tons CO 2 equivalent or tons of other emissions) 3. Rebound effect: Since the introduction of the tax relief, have qualifying technologies been used more often or more intensively? Indicators: Percentage increase in use of energy-efficient technologies (%) 4. Free-ridership: To what extent do consumers who are already aware of energy saving options and who already purchase more efficient equipment, take advantage of the tax relief and profit from tax benefits when they would have made the purchase anyway? Indicators: Purchases that would have occurred without tax relief (%) Spill over/multiplier effect to other energy-efficient projects (%) 3. Autonomous energy efficiency improvement is the improvement in energy efficiency due to ongoing technological advancement that occurs year-on-year even in the absence of policies and is estimated to be 1 2 % annually (IEA 2005). Economic efficiency Evaluating the economic efficiency of a policy instrument involves examining static and dynamic efficiencies. The static efficiency of an instrument establishes whether the objectives are achieved at least cost compared to other policy instruments and requires a benefit-cost analysis. The dynamic efficiency determines the extent to which the policy promotes innovation and continuous improvements in energy efficiency. Answering the following questions helped determined the economic efficiency of tax relief programmes in industry: 5. Costs: How much does the programme cost? What is the cost-effectiveness of the programme? Do the benefits in terms of energy savings and CO 2 emissions reductions outweigh the costs of the programme? Are the costs continually decreasing? Indicators: Value of awarded tax credits = government revenue foregone (Euros) Administrative costs (Euros) Annual and lifetime total (Euros) Cost-effectiveness = total costs/energy saved (Euros/GJ) 6. Policy interaction: How do tax relief programmes interact with other policies in the sector? How do they complement each other? How much improvement can be attributed to tax relief alone? Indicators: Other policies impacting the sector Industrial competitiveness Other criteria Process: Is the tax relief simple to administer? Administrative and transaction costs Case Studies In total, 10 IEA countries use some type of tax relief programme for encouraging the adoption of energy-efficient equipment in industry: Belgium, Canada, France, Ireland, Italy, Japan, the Republic of Korea, the Netherlands, the United Kingdom and the United States. Of these ten countries, it was possible to retrieve information for six (Table 1). Two countries have tax relief programmes and four countries have accelerated depreciation schemes. All the programmes are ongoing. This analysis will focus only on the Netherlands, Ireland and the United Kingdom due to availability of data and similarity between schemes. The Netherlands Final energy intensity in the Dutch economy has improved by 22 % and energy efficiency in industry (using ODYSSEY energy efficiency indices) has improved by 24 % since 1990 (ECN, 2009). In 2007, industry accounted for 32 % of final energy 892 ECEEE 2012 SUMMER STUDY on Energy efficiency in industry

7 6. THE ROLE OF FINANCING TO IMPROVE INDUSTRIAL EFFICIENCY Ryan et al Table 1: General overview of tax relief programmes for energy efficiency in the industrial sector. Country Name of Programme Incentive details Dates of programme BELGIUM Tax deduction for energy saving investments Tax relief 15.5 % of investment cost deductible 1983 ongoing CANADA Accelerated Capital Cost Allowance for Efficient and Renewable Energy Generation Accelerated Depreciation Between 30 % 50 % write off per year 1996 ongoing FRANCE Amortisation Law for Energy Saving Equipment Accelerated Depreciation 100 % write off in the first year of purchase 1991 ongoing IRELAND Accelerated Capital Cost Allowance Scheme (ACA) Accelerated Depreciation 100 % write-off in the first year of purchase Oct 2008 Dec 2012 Tax relief NETHERLANDS Energy investment Allowance (EIA) 44 % of investment cost deductible from profits 1997 ongoing UNITED KINGDOM Enhanced Capital Cost Allowance Scheme (ECA) Accelerated Depreciation 100 % write-off in the first year of purchase 2001 ongoing consumption although CO 2 emissions from the industrial sector decreased by 4 MtCO 2 between 1990 and 2007 (ECN, 2009). Within the framework of the Netherlands Energy Efficiency Action Plan, the total expected annual energy savings by the end of 2016 are between 54 and 84 GWh. The industrial sector is expected to achieve total annual energy savings between and GWh (Netherlands Energy Efficiency Action Plan, 2007). There are three tax relief programmes in the Netherlands for improving energy efficiency in industry. These are the EIA, VAMIL and MIA programmes. The VAMIL and MIA programmes are tax credits for investments in energy-efficient equipment, especially targeted towards SMEs. Our study will focus on the EIA programme as it applies to all businesses and is the largest tax relief programme of the three. Besides these schemes, the Netherlands has implemented other energy efficiency policies and measures in the industrial sector including an Energy Tax imposed on the consumption of energy, the voluntary Long-Term Agreements and Benchmarking Agreements, an Environmental Protection Act that sets minimum obligations for companies, the Environmental Quality Electricity Production for CHP law and an Energy Centre for SMEs to encourage energy savings and deliver energy advice. The Energy Investment Deduction Scheme (EIA) The Energy Investment Deduction Scheme (EIA) is a fiscal policy that grants a tax deduction to companies when they invest in energy efficient equipment and renewable energy. The scheme was introduced by the Ministry of Economic Affairs in January 1997 and is jointly administered by SenterNovem and the Dutch Tax Authority. SenterNovem is an agency of the Dutch Ministry of Economic Affairs focusing on sustainable development and innovation. The EIA applies to all Dutch tax-paying businesses across all economic sectors and allows them to deduct 44 % of the investment costs of eligible equipment from their profits in the calendar year the purchase was made. There is an investment threshold of 450 and a cap of 115 million. In order to claim tax relief under the EIA, eligible equipment, also known as capital assets under the programme, must meet required energy-performance criteria and/or be specified on the Energy Technology List (ETL). There are five application areas, all with their own energy-performance requirement. The five categories are: Corporate buildings Processes (industry, warehouses, farmers, etc.) Combined generation of heat and power Transport resources (ships, rail and road vehicles) Energy advice (but the firm must have implemented the recommendations). The List is updated every year and companies may contribute to the elaboration of the list and suggest technologies to be included. On average, there are 50 new proposals of technologies to be included on the list every year. In 2010, there were 139 assets on the ETL. When a product is judged to become commonplace in the market it is no longer eligible for a tax deduction under the EIA Individual product sales are monitored over time and compared with a theoretical technology diffusion S-curve. Where it is observed that after a rapid rise in sales, the rate of increase of sales of a product has plateaued, then it is assumed that the product is now widespread. ECEEE 2012 SUMMER STUDY on Energy efficiency in industry 893

8 Ryan et al 6. THE ROLE OF FINANCING TO IMPROVE INDUSTRIAL EFFICIENCY To apply for EIA, the company must report the investment within three months of purchase and submit a form to the Bureau responsible for Investment Rule, IRWA. After confirmation of receipt from IRWA, the Ministry of Economic Affairs issues statement confirming the corporate asset is eligible for EIA support. The company then submits this form in their tax return and the tax authority calculates the final tax deduction after approving the EIA application or not. The United Kingdom In November 2008, the UK adopted the Climate Change Act with a target to reduce the UK s carbon emissions 34 % by 2020 and 80 % below 1990 levels by % of the UK s emissions come from the power and heavy industry sector and the objective is to cut these emissions by 22 % from 2008 levels by 2020 (NEEAP UK, 2007). Final energy consumption in the industrial sector amounted to 26.7 Mtoe in 2009 (DECC, 2010). The largest falls in energy intensity in the last 30 years have been in the industrial sector, mainly due to structural changes. Key legislation in the United Kingdom to help meet national emissions reductions targets and improve energy efficiency is the Climate Change Levy and Climate Change Agreements. Introduced in April 2001, the Climate Change Levy (CCL) is a tax on the use of energy in industry, commerce and the public sector to encourage businesses to reduce their GHG emissions and become more energy efficient. The Climate Change Agreements (CCA) grant an 80 % reduction from the CCL to businesses that have met energy efficiency or carbon-saving targets. In 2010, the Carbon Reduction Commitment was introduced to complement the CCL and CCA and encourage emissions reductions in sectors not covered by the existing legislation. It is a mandatory carbon emissions trading scheme to cover all organisations using more than 6,000 MWh per year of electricity (Carbon Trust website). Enhanced Capital Allowance Scheme (ECA) The Enhanced Capital Allowance scheme for Energy Saving Technologies (ECA) is an accelerated depreciation scheme introduced in the UK in This measure was implemented as part of the Climate Change Levy Programme to encourage investments in low-carbon, energy-saving equipment and to help the UK reach its Kyoto target. The ECA scheme allows businesses to write off the whole cost of qualifying equipment against taxable profits in the year of purchase (rather than the normal practice of writing off the depreciation of the equipment over 8 years). The ECA is managed by the Carbon Trust on behalf of the Government. ECA grants 100 % first-year capital allowance to all businesses that pay corporate taxes and who invest in eligible energyefficient equipment. This means companies can deduct 100 % of the investment cost of eligible energy-efficient equipment from their profits in the first year of purchase. There is no investment cap or threshold. ECA is claimed through the business s tax return. To qualify for ECA, products must meet the requirements on the Energy Technology Criteria List (ETCL) and be registered on the Energy Technology Product List (ETPL). The combination of these two lists makes up the Energy Technology List of qualifying products for the ECA scheme. The list includes over 15,000 energy-saving products classified into 15 groups and 54 sub-categories. The ETCL is reviewed annually and the ETPL is updated at the beginning of each month. There are also four technologies that qualify for an ECA but do not appear on the ETPL and are referred to as non-listed products: component based automatic monitoring and targeting equipment (AMT), combined heat and power (CHP), lighting and pipework insulation (ECA website). Ireland In 2009, the industrial sector accounted for 18 % of Ireland s final energy consumption and was responsible for 14.8 % of CO 2 emissions after a dramatic drop of 20 % in industrial CO 2 emissions between 2008 and 2009 as a result of the economic recession (SEAI, 2010). Between 1995 and 2007, final energy usage in industry grew 36 % while energy intensity decreased 47 %. This is in part due to structural changes in the Irish industrial sector. Using energy intensity at constant structure, Sustainable Energy Authority of Ireland (SEAI) estimates that Figure 3: Estimated annual CO 2 savings from ECA. 894 ECEEE 2012 SUMMER STUDY on Energy efficiency in industry

9 6. THE ROLE OF FINANCING TO IMPROVE INDUSTRIAL EFFICIENCY Ryan et al Discussion of industry case studies Table 2 summarises and compares the findings for tax relief programmes for energy-efficient commercial equipment in the three countries selected for evaluation. The results of the analysis show that tax relief programmes for encouraging energy efficiency in industry are likely to have achieved significant energy and CO 2 emissions savings. The difficulty is in attributing these savings to the tax relief schemes, since there is considerable scope for overlap and interaction with other policies and economic factors affecting the industrial sector. Over the period , three factors occurred in these three countries which may have reinforced the impact of the energy-efficient equipment tax relief scheme: GDP per capita decreased by between 2 and 11 %; the EU emissions trading scheme covered the industrial sector; and all three countries had either voluntary energy saving agreements or networks in place to encourage industry to reduce energy consumption. The evaluation results show that tax relief programmes for encouraging energy efficiency in industry have achieved some energy and CO 2 emissions savings. The UK ECA scheme appears to have achieved the most in terms of energy savings for least cost (although administration costs are not available for this analysis). The mid-term review of the Irish ACA does predict that the scheme will deliver cumulated energy savings between 700 GWh and 1000 GWh by The cost efficiency of each programme is estimated from the total costs of the programme, i.e. the administrative costs and the cost of revenue foregone due to the tax relief, divided by the net energy savings. The net energy savings are the gross energy net of the estimated free-rider. The energy savings achieved in all cases are estimated to have been mitigated by free-ridership. Quite different assumptions are made in each country regarding the level of free-ridership. This ranges from 25 % in the UK to 70 % in Ireland. The different factor used will affect the estimate of cost effectiveness significantly and to some extent enhances the UK results. If the same free-ridership level of 50 % were used in estimates for all three countries, the costeffectiveness would be 0.02, , and per kwh for the Netherlands, UK, and Ireland respectively. In all cases, the cost is well below the average national industry price of electricity and would indicate that the programmes are relatively cost-effective. These cost-effectiveness estimations do not take into account the cost of the investment for industry. The data for the marginal investment cost to firms buying more efficient technology is not available and therefore the true marginal cost of energy saving to society with these policies has not been estimated here. However, if it is assumed that (a) the policy maker has already carried out an assessment on whether it makes sense economicly to promote these technologies and has decided it does so that the question is simply which policy should be used to achieve this goal; and (b) that firms act rationally and will only be willing to pay additional upfront costs of more efficient technologies if they recoup the cost of the incremental investment through the tax relief; (and these are significant assumptions) then we consider it reasonable to examine these policy measures from a public budget perspective alone. The role of the technology lists, or ETL, in each country in promoting energy-efficient technologies appears to be quite important on a number of levels. For one, the ETL helps overenergy efficiency in industry improved 16 % between 1995 and 2007, amounting to energy savings of 524 Ktoe (SEAI, 2009). As energy demand in Ireland grew almost 84 % between 1990 and 2007 and was expected to grow 24 % between 2007 and 2020, the government put in place a package of policy measures to improve energy efficiency across all sectors of the economy (Ireland Department of Communications, Energy and Natural Resources, 2009). According to the NEEAP, these measures have the potential of delivering energy savings of 23,730 GWh in 2020 and reducing CO 2 emissions by approximately 5.7 million tonnes (Ireland Department of Communications, Energy and Natural Resources, 2009). Specifically in the industrial sector, actions that have been put in place to achieve energy savings include the Accelerated Capital Allowance Scheme, the Large Industry Energy Network (LIEN), the Irish Standard for Energy Management, IS393, the Sustainable Energy Incubator Programme and other initiatives for SMEs including the Energy MAP Initiative and the Sustainable Energy Awards. Accelerated Capital Allowance Scheme The Irish Accelerated Capital Allowance (ACA) scheme is a tax relief that grants accelerated depreciation to all tax-paying Irish companies, regardless of the sector, for their investments in energy-efficient products. The ACA was introduced in 2008 and is administered by the SEAI. The purpose of the scheme is to increase the use of energy efficiency equipment in the industrial sector and to help Ireland improve its industrial energy efficiency to meet its EU emissions reduction targets. Similar to the UK ECA scheme, the ACA allows companies to write-off 100 % of the purchase value of qualifying energy efficient equipment against their profit in the year of purchase, instead of the normal eight-year write-off period. There is a minimum amount of expenditure defined for each equipment category (see ACA categories and criteria on ACA website of the SEAI). Eligible products for ACA are detailed on the ACA Specified List of qualifying products. Each product is based on specific technology criteria developed with the aim to capture only the top % of the most energy-efficient products on the market. The List is updated four times a year in order to keep in line with industrial developments and include the latest technologies. New products are continually added to the list; in 2008, there were five technologies on the list, 29 in 2009 and 49 in Including new technologies on the list is submitted to a rigorous selection process with an external panel of experts approving the submissions of equipment suppliers. Successful products require Ministerial approval before being published on the website. The ACA is an entirely online process. All necessary information for suppliers and end users and the list of eligible products is available on the SEAI ACA website 5. The administration process for claiming ACA is all online. The ACA costs are relatively low because all equipment is tax deductible as a depreciation over 8 years. Therefore the cost of the tax credit is only the difference between accelerating the depreciation over one year compared with over 8 years ECEEE 2012 SUMMER STUDY on Energy efficiency in industry 895

10 Ryan et al 6. THE ROLE OF FINANCING TO IMPROVE INDUSTRIAL EFFICIENCY Table 2: Summary of tax relief programme for energy-efficient industrial equipment. NETHERLANDS UNITED KINGDOM IRELAND Programme description Tax relief: 44 % of investment cost deductible against taxable profits Accelerated depreciation: 100 % write-off in first year Accelerated depreciation: 100 % write-off in first year Value of subsidy Tax liable reduced by 8.8 % investment (44 %*20 %) Effectiveness 1. Impact Tax liable reduced by 12.5 % cost of investment (100 %*12.5 %) Tax liable reduced by 100 % cost of investment (100 %*12.5 %) Number of applicants 11,502 (in 2009) 2,985 (in 2005) N/A Amount of investments awarded 870 million Around 240 million Around 3.2 million Level of uptake (aware, unaware companies) N/A 37 %, 25 % %, 30 % Level of influence N/A 19 % increase 30 % increase Number of products/categories on ETL Sales of qualifying products (units) 139 categories 15,000 products 49 categories N/A 28,800,513 ( 1,220 million) N/A 2. Energy savings Gross energy saved 8,458 GWh 11,500 GWh 74 GWh Gross CO 2e saved 1,200 kt CO 2 6,277 kt CO kt CO 2 3. Free-ridership 50 % 25 % 70 % Economic efficiency 5. Costs Administrative costs 4.3 million 0.4 million Value of tax credits 62.5 million 0.4 million Total costs 66.8 million 30 million 0.8 million Net cost-effectiveness (total costs/net energy saved) 0.02/kWh /kWh 0.036/kWh 6. Policy interaction Voluntary Agreements, EU ETS Voluntary energy saving programmes, EU ETS Large Industry Energy Networks, EU ETS 7.Process Programme administrator(s) SenterNovem and Tax Authority Carbon Trust Sustainable Energy Authority of Ireland 896 ECEEE 2012 SUMMER STUDY on Energy efficiency in industry

11 6. THE ROLE OF FINANCING TO IMPROVE INDUSTRIAL EFFICIENCY Ryan et al come information barriers and provides technical energy performance information on technologies included on the list. Indeed, the ETL provides a good benchmark of the efficient technologies available on the market and provides firms with a clear source of information on the energy performance of the products they are deciding to invest in. The ETL also serves as an accreditation list for qualifying products and as a procurement benchmark, particularly in the UK and Ireland. This has encouraged suppliers to participate in the scheme and also has helped increase awareness of potential energy savings and encouraged firms to invest in listed products. There are several design features that must be considered to ensure the good operation of the list. In order to avoid freeriding, the products included on the ETL should fulfil several criteria: They should be energy efficient and have higher than average energy performance; They should be those with a higher payback period and therefore incur greater initial cost than more average products; They should be at an early stage of diffusion and deployment in the market; The list should be updated frequently to ensure that the products on the list continue to meet three previous criteria. The risk is that the ETL can become less dynamic and can cause technology lock-in. Therefore the ETL must be updated frequently in order to keep in line with market developments and cease allocating tax credits for products that are common in the market. This was a priority for all programmes and was highlighted at the IEA workshop on the topic in Aalbers et al. (2010) found that including products with a higher payback period helped reduce the number of free-riders. The importance of the ETL shows a need for a register of energy performance of commercial equipment and accreditation schemes. The level of uptake of tax incentive programmes in industry has been increasing. The Irish and UK evaluation of accelerated depreciation schemes attempted to determine the level of awareness and influence of the programme among end-users and companies. In both countries, the level of awareness was higher among respondents who were already involved in other energy-saving programmes. Although the programme and ETL has helped increase investments in energy-saving products, other factors may have had a more significant impact. Awareness and influence of the schemes seems more likely when companies are already involved in other programmes, suggesting that tax incentive programmes alone are not sufficient to influence investment decisions. The Irish review does conclude nonetheless that as more and more technologies are being added to the ETL, the level of influence will increase allowing for more companies to benefit from the scheme. On the positive side, the costs associated with these tax incentive programmes do not appear to be high. The Netherlands has the highest administrative costs to run their programme and this may be due to the shared administration between two agencies, SenterNovem and the Tax Authority, for the scheme. The cost-effectiveness of the three schemes ranges between Euro cent per kwh energy saved. This shows a net ben- efit of the scheme, even with conservatively high estimates of free-ridership. Despite a rather low incentive amount, the number of companies applying for tax relief is increasing, while the costs of the programmes are relatively low. There are steps that can be taken to reduce the number of free-riders and increase the efficiency of the tax incentive. However, the potential for policy interaction is high and the fact that most of these programmes operate in tandem with other policies suggests that tax incentives may only have a marginal role but serve as a useful complementary measure. Conclusions Tax relief schemes for energy efficient commercial equipment have not been greatly analysed to date in the literature. They have potential to bring energy efficiency invesmtments to the attention of the boardroom and increase finance of energy-efficient technologies and processes. This short analysis indicates that there are most likely higher benefits than costs related to the scheme in that energy is saved at significantly less cost than the value of the electricity price. The main drawbacks of such schemes are the potential for free-ridership, the duplication with other related policies in the industrial sector, and possible market distortion as a result of technology lock-in. A first-best solution involving energy prices and carbon taxes would not suffer the same issues. However, there are advantages associated with tax relief programmes that are unlikely to be matched by other marketbased instruments. In many cases the barriers to energy efficiency include market failures that cannot be addressed by energy and carbon price signals alone. Tax relief can induce multiplier effects like raising awareness of energy efficiency more broadly, can be tied to technical information on energy technology lists, and draw the attention of agents responsible for financial investment within company who normally are not concerned with the efficiency of production equipment. This can help overcome information failures and split incentives. Overall, the analysis of the three tax relief programmes in the Netherlands, the United Kingdom and Ireland allows us to draw some general conclusions about the performance of tax relief for energy-efficient commercial equipment. The level of uptake has been increasing in all programmes as more companies are becoming aware of available tax credits and more and more qualifying products are being purchased. The importance of the ETL shows a need for a register of energy performance of commercial equipment and accreditation schemes. Despite a rather low incentive amount, more and more companies are applying for tax credits. The potential for policy interaction is high and the fact that most of these programmes operate in tandem with other policies suggests that tax relief may only have a marginal role but have served as useful complementary measures. Tax relief will not address all the barriers to energy efficiency in industry but should be complementary to other policies and included as part of a policy package where appropriate. It should be targeted at increasing the adoption of energy efficient technology by industry and complement policies such as carbon and energy pricing to encourage the better operation and design of equipment in industry. ECEEE 2012 SUMMER STUDY on Energy efficiency in industry 897