Accelerated depreciation for smart grid technologies becomes law
After a series of failed attempts, Congress finally passed enhanced tax incentives for smart grid technology as part of the $700 billion Emergency Economic Stabilization Act, signed into law on Oct. 3, 2008. These new provisions provide for accelerated depreciation for smart meters and other smart grid equipment, a change that supporters believe will stimulate greater utility investment in smart grid technology. The move was hailed by the demand response industry and other smart grid advocates as an important step in addressing structural obstacles to broad development of smart grid systems.
Summary of the legislation
The new smart grid tax provisions reduce the depreciation rate for smart grid technologies from 20 years to 10 years, bringing smart grid tax treatment in line with other high-technology systems. These tax code adjustments became effective upon enactment of the law. Accelerated depreciation will allow utilities to take larger tax deductions on investments in smart grid technology each year, creating incentives for increased spending on smart meters and related equipment. This modification to the depreciation schedule is estimated to be worth $915 billion over ten years.
These changes to the tax code target three specific, interrelated barriers that have impeded smart grid growth over the years:
The high cost of smart meters and related equipment relative to conventional technology has inhibited greater utility spending on smart grid technology. A smart meter typically costs three times as much as a traditional meter. High incremental costs have become particularly problematic in a context of high wholesale power prices and utility preoccupation with cost recovery.
The high degree of risk-aversion exhibited by utilities has resulted in minimal investment in new technologies such as those required for the smart grid. With a few notable exceptions, questions and uncertainties about new systems have prevented utilities from moving beyond the pilot phase of smart grid technology deployment. This has led some observers to describe current circumstances in terms of a “pilot plague.”
The high speed of technical innovation in the smart grid space has discouraged spending on equipment that may become obsolete in a short period of time. The twenty year depreciation rate has run counter to the rapid pace of technological advance and turnover that characterize smart grid innovations. This brief “shelf life” acts as a disincentive to investments in smart grid technology that can only be recovered over the long term.
While there are many connections between these barriers (for example, high cost and high risk-aversion are mutually reinforcing, as are high risk-aversion and rapid innovation), each one represents a unique impediment to the wider adoption of advanced meters and other smart grid technologies. Proponents of the tax code changes believe that tax incentives for smart grid technology will help overcome each of the interlinked obstacles.
Significance of the legislation
There are several significant ramifications of the new depreciation legislation. First, larger deductions deriving from accelerated depreciation will help compensate for the comparatively high cost of smart grid technology. The tax advantages associated with smart grid investments will be more sizable, and this will likely encourage greater spending on smart meters and other technologies. Lower effective costs will also make public utility commissions more agreeable to providing cost recovery by wrapping smart grid spending by utilities into electric rates.
Second, compressing the depreciation period from 20 to 10 years will accommodate utilities’ aversion to risk by reducing their long-term investment exposure. Accelerated tax deductions will lower the risk of stranded investments by allowing utilities to recover investments in smart grid systems more quickly. Proponents hope that accelerated depreciation will encourage more robust smart grid deployment beyond the pilot stage.
Third, reducing the depreciation rate will take greater account of the pace of advances in smart grid technology. Rather than basing smart grid investment decisions on a 20-year timeframe that is misaligned with rapid innovations in advanced meters and related equipment, a 10-year depreciation schedule will more closely track the swift pace of technological development in the smart grid industry. Shortening the investment time horizon will encourage more aggressive spending on smart grid technology by utilities that will feel less locked into systems with the potential to be quickly outmoded.
Smart grid advocates contend that the overall impact of accelerated depreciation for smart grid technologies will be to accelerate deployment and development of the smart grid nationwide. Current smart grid initiatives are mainly confined to California and a few other states, but federal tax incentives will help drive broader grid upgrades, deeper market penetration of advanced meters and other smart equipment, and faster diffusion of smart grid infrastructure and demand response practices. In short, the compressed depreciation schedule is designed to galvanize deployment of the smart grid.
Some remaining concerns
Despite all these positive impacts of the legislation, other factors may act to frustrate the realization of these intended benefits. Given the present economic slowdown and potential for recession, the impact of the tax changes on utility investments in smart grid technology is unclear. Utilities with advanced meter and related programs already underway are likely to benefit from the change to the depreciation schedule, as their cash flows will increase as a result. But utilities that have not yet launched smart grid initiatives may be unlikely to view accelerated depreciation as a strong enough incentive to undertake smart grid programs. Significant capital outlays by utilities, such as comprehensive smart meter installation, are likely to be constrained under current economic conditions.
Furthermore, accelerated depreciation may have the perverse effect of aggravating the political difficulties faced by state utility commissions considering utility spending on smart technology. Increased deductions resulting from a compressed depreciation schedule will mean larger expenses wrapped in the rate base. With commissions sensitive to requests for significant capital expenditures, particularly under challenging economic conditions exacerbated by high energy prices, the tax revisions may actually increase opposition to smart grid investments by adding to pressures for higher electric rates. Ironically, commissions may find it more, not less, difficult to approve smart grid capital requests from utilities now that the depreciation schedule has been altered. For commissioners, the benefits associated with a more rapidly depreciated asset base may be more than offset by the costs represented by increased expenses. The result could be heightened resistance to smart grid deployment.
Legislation is the culmination of long battle
Despite its uncertain effects, accelerated depreciation is viewed as the most forceful step taken by Congress in recent years to encourage development of the smart grid. The Energy Policy Act of 2005 (2005 EPACT) mandated that utilities offer rates that vary along with wholesale electricity prices. The Energy Independence and Security Act of 2007 (EISA) authorized $100 million per year in federal spending on smart grid initiatives, although the funds have not been appropriated. But the reduced depreciation schedule represents the first comprehensive set of tax incentives designed to spur major private investment in the smart grid sector.
The passage of revised smart grid tax provisions is due in large part to the Demand Response and Advanced Metering Coalition (DRAM), an industry trade association that lobbied hard on behalf of accelerated depreciation. DRAM is composed of firms from the demand response industry and associated sectors, including smart technology manufacturers and service providers, communications companies, demand response contractors, utilities, and related businesses. Coalition members include: Aclara, Cellnet + Hunt, Comverge, CPower, Direct Energy, Eka Systems, Elster Electricity, eMeter, EnergySolve, EnerNOC, IBM, Ice Energy, Itron, Landis + Gyr, Orion Energy Systems, Sensus Metering Systems, Silver Spring Networks, SureGrid, SmartSynch, Tendril, Trilliant Networks, and Ziphany.
DRAM has pressed for enhanced federal tax incentives for years, primarily through congressional lobbying and education campaigns. The coalition previously called for a smart technology depreciation rate of only five years. Until now, however, these efforts were hindered by chronic disputes over how to pay for such incentives. The less aggressive ten-year schedule was finally accepted in the midst of a determined drive to gain quick passage of the emergency financial rescue plan. The accelerated depreciation schedule was one of many “sweeteners” incorporated by sponsors into the bill in order to secure adequate support.
Coalition members cheered adoption of the provision. Dan Pfeiffer, Vice President of Regulatory Affairs for Itron and a member of the DRAM Executive Committee, stated, “The accelerated depreciation for meters and other technologies that Congress has passed today will help make the transition to new technologies faster, less costly and more certain.” He continued, “We are especially pleased as a Coalition to see final passage. DRAM initiated the effort to put this provision in place a number of years ago and it is gratifying to see that our educational efforts have resulted in Congress as well as other stakeholders recognizing the benefits of smart meters and smart grid technologies. We hope that this will be the first of many supportive steps that Congress takes to help advance the use of demand response and smart technologies.”
The next move for DRAM is likely to involve intensive promotion of smart meters as “green meters,” as Congress moves closer toward serious climate change legislation and a possible domestic cap-and-trade system. DRAM and other smart grid proponents argue that demand response and the smart grid should figure as key components of any national effort to control carbon emissions. Proposed policy measures include: an Investment Tax Credit (ITC) to stimulate spending on smart technology; a Reduction Tax Credit (RTC) for energy savings achieved through smart meters and related equipment; and a federal Systems Benefits Charge (SBC) to support smart grid investments.
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