Order Code IB10054
Issue Brief for Congress
Received through the CRS Web
Energy Tax Policy
Updated June 27, 2002
Salvatore Lazzari
Resources, Science, and Industry Division
Congressional Research Service ˜ The Library of Congress

CONTENTS
SUMMARY
MOST RECENT DEVELOPMENTS
BACKGROUND AND ANALYSIS
Introduction
Background
Energy Tax Policy from 1918-1970: Promoting Oil and Gas
Energy Tax Policy During the 1970s: Conservation and Alternative Fuels
Reagan’s Free-Market Energy Tax Policy
Energy Tax Policy After Reagan
Energy Tax Proposals in the 107th Congress
Tax Provisions in the Comprehensive Energy Policy Legislation
The Senate Energy Bills (S. 389, S. 596, and S. 517)
The House Approved Bill (H.R. 4)
Bush Administration Proposals
Tax Issues Relating to Electricity Restructuring
LEGISLATION


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Energy Tax Policy
SUMMARY
Historically, federal energy tax policy
the supply of alternative fuels and the demand
promoted the supply of oil and gas. However,
for technologies that use these fuels. How-
the 1970s witnessed 1) a significant cutback in
ever, the Administration is emphasizing the
the oil and gas industry’s tax preferences, 2)
environmental benefits from reducing green-
the imposition of new excise taxes on oil, and
house gases and addressing possible global
3) the introduction of numerous tax prefer-
climate change.
ences for energy conservation, the develop-
ment of alternative fuels, and the commercial-
A significant expansion of energy tax
ization of the technologies for producing these
incentives has been proposed as part of
fuels (renewables such as solar, wind, and
comprehensive energy policy reform legisla-
biomass, and non-conventional fossil fuels
tion in the 107th Congress. Several energy tax
such as shale oil and coalbed methane).
issues are addressed in these bills: 1) tax
incentives to increase the supply of oil and
The Reagan Administration, using a free-
gas, and the demand for coal; 2) energy tax
market approach, advocated repeal of the
issues relating to energy conservation and
windfall profit tax on oil and the repeal or
energy efficiency; 3) energy tax issues relating
phase-out of most energy tax preferences —
to alternative fuels; 4) selected issues relating
for oil and gas, as well as alternative fuels.
to electricity restructuring; and 5) expiring
Due to the combined effects of the Economic
energy tax provisions. Legislative interest has
Recovery Tax Act and the energy tax subsi-
focused on the House and Senate versions of
dies that had not been repealed, which to-
H.R. 4, approved by the House on August 2,
gether created negative effective tax rates in
2001, and by the Senate on April 25. The
some cases, the actual energy tax policy dif-
Senate Finance Committee approved energy
fered from the stated policy.
tax bill (the Energy Tax Incentive Act of
2002) was modified somewhat and added as
The Bush and Clinton years witnessed a
Amendment #2917 to the Senate’s compre-
return to a much more activist energy tax
hensive energy policy bill (originally intro-
policy, targeted, as in the 1970s, to energy
duced as S. 517, the Securing America’s
conservation and alternative fuels. While the
Future Energy Act, but renamed the Energy
ultimate concern is to reduce the demand for
Policy Act of 2002).
imported oil, energy tax policy is being view-
ed as a tool for achieving environmental and
President Bush has issued a comprehen-
fiscal objectives. The current posture of en-
sive energy policy initiative, and more
ergy tax policy is weighted toward energy
recently, a global climate change initiative,
conservation — particularly petroleum in
which include limited energy tax measures.
transportation — and alternative fuels supply.
The Bush Administration had originally criti-
cized such measures as being inconsistent
The Clinton Administration’s energy tax
with its free market philosophy. Certain en-
policy was focused on reducing the demand
ergy tax provisions that had expired were
for petroleum by encouraging energy effi-
extended retroactively as part of the economic
ciency and providing incentives to promote
stimulus bill (P.L. 107-147).

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MOST RECENT DEVELOPMENTS
On April 25, the Senate approved the Securing America’s Future Energy Act, a
substitute to the House energy bill H.R. 4. On March 9, President Bush signed the Job
Creation and Worker Assistance Act of 2002 (P.L. 107-147), a $42 billion, ten-year tax cut
that retroactively extends several energy tax provisions that had expired on December 31,
2001. On August 2, 2001, the House approved H.R. 4, a comprehensive energy policy bill
that includes numerous energy tax incentives, which were marked up as H.R. 2511 ( the
Energy Tax Policy Act of 2001) by the House Committee on Ways and Means on July 18,
2001. A conference committee is currently meeting, and is expected to last until fall to
resolve differences in the two versions of H.R. 4.

BACKGROUND AND ANALYSIS
Introduction
Energy tax policy involves the use of the government’s main fiscal instruments – taxes
(financial disincentives) and tax subsidies (or incentives) – to alter the allocation or
configuration of energy resources to either correct a problem or distortion in the energy
markets or to achieve some social, economic (efficiency, equity, or even macroeconomic),
environmental, or fiscal objective.
The idea of applying tax policy instruments to the energy markets is not new, but until
the 1970s energy tax policy had been little used. Recurrent energy related problems since the
1970s – oil embargoes, oil price and supply shocks, wide petroleum price variations and
price spikes, large geographical price disparities, tight energy supplies, rising oil import
dependence, as well as increased concern for the environment – have caused policymakers
to look toward energy taxes and subsidies with greater frequency.
This issue brief discusses the history, current posture, and the outlook for federal energy
tax policy. It also discusses recent energy tax proposals, focusing on the major energy tax
policy reform bills in the House (H.R. 4), and Senate (S. 389, S. 596, and S. 517, the Senate
approved version of H.R. 4). (For a general economic analysis of energy tax policy, see CRS
Report RL30406, Energy Tax Policy: An Economic Analysis.)
Background
The history of federal energy tax policy can basically be divided into four eras: the oil
and gas period from 1916 to 1970, the energy crisis period of the 1970s, the free-market era
of the Reagan Administration, and the post-Reagan era, including the most recent three year
period since 1998 – which has witnessed a plethora of energy tax proposals to address
recurring energy market problems.
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Energy Tax Policy from 1918-1970: Promoting Oil and Gas
Historically, federal energy tax policy was focused on increasing domestic oil and gas
reserves and production; there were no tax incentives for energy conservation or for
alternative fuels. Two oil/gas tax code preferences embodied this policy: 1) expensing of
intangible drilling costs (IDC’s) and dry hole costs, which was introduced in 1916, and 2)
the percentage depletion allowance, first enacted in 1926 (coal was added in 1932).
Expensing of IDC’s (such as labor costs, material costs, supplies, and repairs associated with
the drilling of a well) gave oil and gas producers the benefit of fully deducting from the first
year’s income (“writing off”) a significant portion of the total costs of bringing a well into
production, costs that would otherwise (i.e., in theory and under standard, accepted tax
accounting methods) be capitalized (i.e., written off during the life of the well as income is
earned). For dry holes, which comprised on average about 80% of all the wells drilled, the
costs were also allowed to be deducted in the year drilled (expensed) and deducted against
other types of income, which led to many tax shelters that benefitted primarily high income
taxpayers. Expensing accelerates tax deductions, defers tax liability, and encourages oil and
gas prospecting, drilling, and the development of reserves. The percentage depletion
allowance for oil and gas permitted oil and gas producers to claim 27.5% of revenue as a
deduction for the cost of exhaustion or depletion of the deposit, allowing deductions in
excess of capital investment (i.e, in excess of adjusted cost depletion) — the economically
neutral method of capital recovery for the extractive industries. Percentage depletion
encourages faster mineral development than cost depletion (the equivalent of depreciation
of plants and equipment).
These and other tax subsidies discussed later (e.g., capital gains treatment of the sale
of successful properties, the special exemption from the passive loss limitation rules, and
special tax credits) reduced marginal effective tax rates in the oil and gas industries, reduced
production costs, and increased investments in locating reserves (increased exploration).
They also led to more profitable production and some acceleration of oil and gas production
(increased rate of extraction), and more rapid depletion of energy resources than would
otherwise occur which increases oil import dependency and reduces energy security. Such
subsidies tend to channel resources into these activities that otherwise would be used for oil
and gas activities abroad or for other economic activities in the United Relatively low oil
prices encouraged petroleum consumption (as opposed to conservation) and inhibited the
development of alternatives to fossil fuels, such as unconventional fuels and renewable forms
of energy. Oil and gas production increased from 16% of total U.S. energy production in
1920 to 71.1% of total energy production in 1970 (the peak year).
Energy Tax Policy During the 1970s: Conservation and Alternative
Fuels

Three developments during the 1970s caused a dramatic shift in the focus of federal
energy tax policy. First, large the revenue losses associated with the oil and gas tax
preferences became increasingly hard to justify in the face of a progressively worsening fiscal
picture – increasing federal budget deficits – and in view of the long-standing economic
arguments against the special tax treatment for oil and gas. Second, heightened awareness
of environmental pollution and concern for environmental degradation, and the increased
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importance of distributional issues in policy formulation (i.e., equity and fairness), lost the
domestic oil and gas industry much political support. Thus, it became more difficult to justify
percentage depletion and other subsidies, largely claimed by wealthy individuals and big
vertically-integrated oil companies. More importantly, during the 1970s there were two
energy crises: the oil embargo of 1973 – also known as the first oil shock – and the Iranian
Revolution in 1979, which focused policymakers’ attention on the problems (alleged
“failures”) in the energy markets and how these problems reverberated throughout the
economy causing stagflation, shortages, productivity problems, rising import dependence,
and other economic and social problems.
These developments caused the increased use of fiscal subsidies or incentives – special
tax credits, deduction, exclusions etc.– to shift from of oil and gas supply toward energy
conservation (reducing oil and gas demand) through: 1) a direct demand response (i.e.,
curbing energy use through higher prices, and reduced service or utility levels by reducing
the number of miles driven or turning down thermostats in homes during the winter, etc.);
2)substitution of more energy-efficient for less energy-efficient technologies (i.e., reduced
energy demand through an increased demand for more energy-efficient houses, vehicles,
industrial equipment and other energy-using capital goods); and 3) an increased supply of
alternative and renewable fuels (solar, wind, biomass, ethanol fuel, and non-conventional
fossil fuels such as shale oil, and coalbed methane), and stimulating investment in, and
demand for, technologies that used these alternative (such as renewable) sources of energy.
Three broad actions through the tax code were taken to implement the new energy tax
policy during the 1970s: First, the oil industry’s two major tax preferences — expensing of
IDCs and percentage depletion — were significantly reduced, particularly the percentage
depletion allowance, which was 1) completely eliminated for the major integrated oil
companies (which produce about 75% of all the oil in the United States), and 2) reduced for
the remaining producers. Other oil and gas tax benefits were also cut back during this period.
For example, oil-and gas-fired boilers used in steam generation (for example, to generate
electricity) could no longer qualify for accelerated depreciation as a result of the Energy Tax
Act of 1978 (as discussed below).
The second broad policy action was the imposition of several new excise taxes on oil
and gas (and later coal). Chief among these was the windfall profit tax (WPT) on oil first
enacted in 1980 (P.L. 96-223). The WPT imposed an excise tax of 15% to 70% on the
difference between the market price of oil and a predetermined (adjusted) base price. This
tax, which was repealed in 1988, was part of a political compromise that decontrolled oil
prices (between 1971 and 1980 oil prices were controlled under President Nixon’s Economic
Stabilization Act of 1970 – the so-called “wage-price freeze”). Another, but relatively small,
excise tax on petroleum was instituted in 1980: the environmental excise tax on crude oil
received at a U.S. refinery. This tax, which was part of the Comprehensive Environmental
Response, Compensation, and Liability Act of 1980 (P.L. 96-510), otherwise known as the
“Superfund” program, was designed to charge oil refineries for the cost of releasing any
hazardous materials which resulted from the refining of crude oil. The tax rate was set
initially at 0.79¢ ($0.0079) per barrel, and was subsequently raised to 9.7¢ per barrel. This
tax expired at the end of 1995 but legislation has been proposed since then to reinstate it as
part of Superfund reauthorization. (See CRS Issue Brief IB10011.)
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The third broad action taken during the 1970s to implement the new and refocused
energy tax policy was the introduction of numerous tax incentives for energy conservation,
the development of the supply of alternative fuels (renewable and non-conventional fuels),
and the commercialization of energy efficiency and alternative fuels technologies. Most of
these new tax subsidies were introduced as part of the Energy Tax Act of 1978 (ETA, P.L.
95-618), and expanded under the WPT, which also introduced additional new energy tax
subsidies. The following list describes these:
! The Residential and Business Energy Tax Credits. The ETA provided
income tax credits for homeowners and businesses that invested in a variety
of energy conservation products (e.g., insulation and other energy-
conserving components) and for solar and wind energy equipment installed
in a principal home or a business. The business energy tax credits were 10%
to 15% of the investment in conservation or alternative fuels technologies
such as synthetic fuels, solar, wind, geothermal, and biomass. These tax
credits were also expanded as part of the WPT but they generally expired
(except for business use of solar and geothermal technologies) as scheduled
either in 1982 or 1985. President Clinton’s FY2001 budget included a solar
credit that is very similar to the 1978 residential energy tax credits (see “Tax
Credits for Solar Energy Equipment,”). A 15% investment tax credit for
business use of solar and geothermal energy, which was made permanent,
is all that remains of these tax credits.
! Tax Subsidies for Alcohol Fuels. The ETA also introduced the excise tax
exemption for gasohol, currently at 5.3¢ per gallon (out of a gasoline tax of
18.4¢/gal.). Subsequent legislation extended the exemption and introduced
the alcohol fuels “blenders” tax credits (which are in lieu of the exemption),
and the 10¢/gal., small ethanol producers tax credit. The 1998
Transportation Equity Act (P.L. 105-178) extended the exemption, which
was scheduled to expire, but at reduced rates. (For more information see:
CRS Report 98-435 E, Alcohol Fuels Tax Incentives.)
! The Gas Guzzler Tax. The ETA created a federal tax on “gas guzzlers,” a
graduated excise tax on the sale of vehicles that do not meet the Corporate
Average Fuel Economy (CAFÉ) standards established by the Environmental
Protection Agency. The tax rate currently ranges from $1,000 for a vehicle
rated between 21.5 and 22.5 MPG (miles per gallon) to $7,700 for a vehicle
rated at less than 12.5 MPG. This tax is still in effect.
! Percentage Depletion for Geothermal. The ETA made geothermal deposits
eligible for the percentage depletion allowance, at the rate of 22%.
Currently the rate is 15%.
! The §29 Tax Credit for Unconventional Fuels. The 1980 WPT included a
$3.00 (in 1979 dollars) production tax credit to stimulate the supply of
selected unconventional fuels: oil from shale or tar sands, gas produced from
either geo-pressurized brine, Devonian shale, tight formations, and coalbed
methane, gas from biomass, and synthetic fuels from coal. Adjusted for
inflation, this credit, which is still in effect for wells, mines, or plants placed
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in service by June 30, 1998 (for coal and biomass facilities) and December
31, 1991 (for all other facilities and wells), was over $6.00 per barrel of
liquid fuels and about $1.00 per thousand cubic feet (MCF) of gas in 1999.
The credit for tight sands gas has been fixed at the 1979 rate of $0.50 per
MCF. (For more information, see CRS Report 97-679 E, Economic Analysis
of the Section 20 Tax Credit for Unconventional Fuels
.)
! Tax-Exempt Interest on Industrial Development Bonds. The WPT made
facilities for producing fuels from solid waste exempt from federal taxation
of interest on industrial development bonds (IDBs). This exemption was for
the benefit of the development of alcohol fuels produced from biomass, for
solid-waste-to-energy facilities, for hydroelectric facilities, and for facilities
for producing renewable energy. IDBs, which provide significant benefits
to state and local electric utilities (public power), had become a popular
source of financing for renewable energy projects.
(During the 1970s there was also a significant increase in the number of energy laws and
regulations, such as the CAFÉ (Corporate Average Fuel Economy) standards to reduce
transportation fuel use, and other interventions through the budget and the credit markets.
This included some of the most extensive energy legislation ever enacted. These non-tax
policy measures are not discussed here.)
Reagan’s Free-Market Energy Tax Policy
The Reagan era, the period from 1981-1989, witnessed the first attempt to create a more
free-market energy tax policy by deregulating the energy markets, and by both reducing taxes
and eliminating tax subsidies, both for conservation, alternative fuels, and for oil and gas.
President Reagan’s free-market views were well known prior to his election. During
the 1980 Presidential campaign, he proposed repeal of the WPT, the deregulation of oil and
natural gas, and the minimization of government intervention, including reduced spending
and taxes. The Reagan Administration opposed using the tax law to promote either oil and
gas development, energy conservation, or the supply of alternative fuels. The idea was to
have a more neutral and less distortionary energy tax policy, which would make energy
markets work more efficiently and generate benefits to the general economy. The Reagan
Administration believed that the responsibility for commercializing conservation and
alternative energy technologies rested with the private sector and that high oil prices – real
oil prices (corrected for inflation) were at historically high levels in 1981 and 1982 – would
be ample encouragement for the development of alternative energy resources. High oil prices
in themselves create conservation incentives, stimulate oil and gas production, and render
tax breaks for alternative resource generally ineffective, and wasteful, as a policy tool.
The Administration’s energy tax policy was professed more formally in several energy
and tax policy studies, including its 1981 National Energy Policy Plan and the 1983 update
to this plan; it culminated in a 1984 Treasury study on general tax reform, which also
proposed fundamental reforms of federal energy tax policy. In terms of actual legislation,
many of the Reagan Administration’s objectives were realized, although as discussed below
there were unintended effects. In 1982, the business energy tax credits on most types of non-
renewable technologies – those enacted under the ETA of 1978 – were allowed to expire as
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scheduled; other business credits and the residential energy tax credits were allowed to expire
at the end of 1985, also as scheduled. Only the tax credits for business solar, geothermal,
ocean thermal and biomass technologies were extended. And as mentioned above, today the
tax credit for business investment in solar and geothermal technologies, which has since been
reduced to 10%, is all that remains of these tax credits. A final accomplishment was the
repeal of the WPT, but not until 1988, the end of the Reagan term.
The Administration’s other energy tax policy proposals, however, were not adopted.
The tax incentives for oil& gas were not eliminated, although they were pared back as part
of the Tax Reform Act (TRA) of 1986:
! ‘Expensing’ was retained, but there were cutbacks for integrated oil
producers, (who would only be allowed to expense 70% of such costs
and amortize – deduct evenly over time – the remaining 30%) and
other reductions;
! Percentage depletion would not apply to lease bonuses, advance
royalties, or any other payments made without regard to actual
production from the property. This amendment applied to geothermal
wells as well as oil and gas properties. Another section of TRA denied
capital gains treatment on certain dispositions of interest in oil and gas
property (and to geothermal property);
! The TRA replaced the old minimum taxes with a new alternative
minimum tax that placed limits on the tax benefits to oil/gas
producers from the expensing of IDCs and the percentage depletion
allowance. (Taxpayers must compute both the standard income tax
and the alternative minimum tax imposed on a variety of tax
preferences or subsidies, and pay the larger of the two.) However, in
an effort to mitigate any burdensome effects of this new tax, only the
excess of the deduction above 65% of net income was to be treated as
a preference item;
! Investments in oil and gas properties were exempted from the passive
loss limitation rules that were intended to curb tax shelter investments
– a working interest in an oil and gas property was not treated as a
passive activity. Thus any losses and credits derived from oil and gas
investments activity could be used as a tax shelter to offset the
taxpayer’s other income without limitations under the passive loss
rules.
Perhaps the key characteristic of the Reagan Administration energy tax policy, however,
was the extent to which its objectives of neutrality and efficiency were compromised by the
combined effect of its energy tax policy and its other tax policies. While the objective was
to create a free-market energy policy, significant liberalization of the depreciation system and
reduction in marginal tax rates – both the result of the Economic Recovery Tax Act of 1981
(ERTA, P.L. 97–34) – combined with the regular investment tax credit and the business
energy investment tax credits, resulted in negative effective tax rates for many investments
including investments in alternative energy investments such as solar and synthetic fuels.
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(See, for instance: CRS Report 84-85 E. Effective Tax Rates on Solar/Wind and Synthetic
Fuels as Compared to Conventional Energy Resources
.) Also, the retention of percentage
depletion and expensing of IDC’s (even at the reduced rates) rendered oil and gas
investments still favored relative to investments in general. Other energy tax policy
developments during the Reagan era were as follows:
! The Deficit Reduction Act of 1984 (P.L. 98-369) tinkered with several
energy tax provisions including the WPT and percentage depletion.
provision of the Tax Reform Act of 1975. Also, the 1984 tax law extended
several of the tax incentives for alcohol fuels: (1) the tax exemption for
alcohol fuels mixtures was raised from 5¢ to 6¢; (2) the law retained the
prior 9¢-per-gallon exemption for neat alcohol fuels, i.e., those that are at
least 85% alcohol, derived from alternative substances, but it provided for
a new exemption of 4.5¢ per gallon for alcohol fuels derived from natural
gas; (3) the alcohol “blenders” credit was raised from 50 to 60¢ per gallon;
and (4) the duty on alcohol imported for use as a fuel was increased from 50
to 60¢ per gallon.
! In 1986 two environmental excise taxes were enacted on oil: 1) Under the
Superfund Amendments and Reauthorization Act of 1986 (P.L. 99-499), an
increase in the Superfund oil tax from 0.79¢ to 8.2¢-per-barrel on domestic
oil received and to 11.7¢ per barrel on imported petroleum. This tax
differential violated the General Agreements on Tariffs and Trade (GATT)
and the Steel Trade Liberalization Program Implementation Act of 1989
(P.L. 101-221) made the rates uniform at 9.7¢ per barrel; and 2) Under the
Omnibus Budget Reconciliation Act of 1986 (P.L. 99-510), imposition of
the Oil Spill Liability Trust Fund excise tax at 1.3¢ per barrel tax, which was
subsequently raised to 5.0¢/barrel. Both these taxes expired at the end of
1995.
! In addition, the TRA of 1986 reduced the excise tax exemption for “neat”
alcohol fuels, from 9¢ per gallon to 6¢ per gallon. It also permitted alcohol
imported from certain Caribbean countries to enter free of the 60¢-per-
gallon duty. The TRA also repealed the tax-exempt financing provision for
alcohol-producing facilities and for certain steam-generating facilities.
Energy Tax Policy After Reagan
After the Reagan Revolution, several major energy and non-energy laws were enacted
that amended the energy tax laws in several ways, some major:
! Revenue Provisions of the Omnibus Reconciliation Act of 1990. President
Bush’s first major tax law included numerous energy tax incentives: 1) for
conservation (and deficit reduction), the law increased the gasoline tax by
5¢/gal. and doubled the gas-guzzler tax; 2) for oil and gas, the law
introduced a 10% tax credit for enhanced oil recovery expenditures,
liberalized some of the restrictions on the percentage depletion allowance,
and reduced the impact of the alternative minimum tax on oil and gas
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investments; 3) for alternative fuels, the law expanded the §29 tax credit for
unconventional fuels and introduced the tax credit for small producers of
ethanol used as a motor fuel.
! Energy Policy Act of 1992 (P.L. 102-486). This broad energy measure
introduced the §45 tax credit, at 1.5¢ per kilowatt hour, for electricity
generated from wind and “closed-loop” biomass systems( poultry litter was
added later. (This tax credit expired at the end of 2001 for new facilities.)
In addition, the 1992 law: 1) added an income tax deduction for the costs,
up to $2,000,of clean fuel powered vehicles; 2) liberalized the alcohol fuels
tax exemption; 3) expanded the §29 production tax credit for non-
conventional energy resources; 4) liberalized the tax breaks for oil and gas.
! Omnibus Budget Reconciliation Act of 1993 (P.L. 103-66). President
Clinton proposed a differential Btu tax on fossil fuels (a broadly-based
general tax primarily on oil, gas and coal based on the British Thermal Units
of heat output), which was dropped in favor of a broadly-applied 4.3¢/gal.
increase in the excise taxes on motor fuels with revenues allocated for
deficit reduction rather than the various trust funds.
! Taxpayer Relief Act of 1997 (P.L. 105-34). This tax cut legislation also
included a variety of excise tax provisions pertaining to motor fuels excise
taxes, some of which involved tax reductions on alternative transportation
fuels, and some of which involved increases such as on kerosene, which on
balance further tilted energy tax policy toward alternative fuels.
! Tax Relief and Extension Act ( H.R. 2923). Enacted as part of P.L. 106-170,
the Ticket to Work and Work Incentives Improvement Act of 1999, Title V
of the law, the Tax Relief and Extension Act of 1999, extended and
liberalized the 1.5¢ renewable electricity production tax credit, and renewed
the suspension of the net income limitation for the percentage depletion
allowance for marginal oil and gas wells.
As this list suggests, the post-Reagan energy tax policy returned more to the
interventionist course established during the 1970s and primarily was directed at energy
conservation and alternative fuels, mostly for the purpose of reducing oil import dependence
and enhancing energy security. However, there is an environmental twist to energy tax policy
during this period, particularly in the more recent years, as the discussion of President
Clinton’s proposals will demonstrate. Fiscal concerns, which for most of that period created
a perennial search for more revenues to reduce budget deficits, has also driven energy tax
policy proposals during the post-Reagan era. This is underscored by proposals, which have
not been enacted, to impose broad-based energy taxes such as the Btu (British Thermal
Units) tax or the carbon tax to mitigate greenhouse gas emissions.
Another interesting feature of the post-Reagan energy tax policy is that while the
primary focus continues to be energy conservation and alternative fuels, no energy tax
legislation has been enacted during this period that does not also include some, relatively
minor, tax relief for the oil and gas industry, either in the form of new tax incentives or
liberalization of an existing tax breaks (or both).
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As an indication of the current posture of federal energy tax policy, Table 1 on page 16,
summarizes current energy tax provisions and the corresponding revenue effects. A “-” sign
indicates revenue losses, which means that the provision is a tax subsidy or incentive,
intended to increase the subsidized activity (energy conservation measures or the supply of
some alternative and renewable fuel or technology); no minus sign means that the provision
is a tax, which means that it either reduces supply of, or the demand for, the taxed activity
(either conventional fuel supply, energy demand, or the demand for energy using
technologies, such as cars).
Energy Tax Proposals in the 107th Congress
Over the last 4 years there have been a steady stream of energy tax policy measures,
culminating in comprehensive energy policy reform legislation – the measure approved by
the House (H.R. 4) and that pending in the Senate (S. 517). To understand the context of
these measures, one needs to review both the recurrent energy market problems over this
time period, which some had viewed as an “energy crisis.”
First, there have been wide fluctuations in crude oil prices. Domestic crude oil prices
reached a low of just over $10 per barrel in the winter of 1998-1999, among the lowest crude
oil prices in history after correcting for inflation. From 1986-1999 oil prices averaged about
$17.00 per barrel, fluctuating from between $12 and $20 per barrel. Low oil prices hurt oil
producers (upstream operations), reducing profits and output, while benefitting oil refiners
(downstream operations). In addition, they also encourage consumption (are disincentives
to conserve and invest in energy efficiency technologies) and discourage production of
alternative fuels and renewable technologies. To address the low oil prices, there were many
tax bills introduced during the first session of the 106th Congress (1999) to provide economic
relief through the tax code for the ailing domestic oil and gas producing industry, particularly
small independent drillers and producers. Proposals mainly focused on production tax credits
for marginal or stripper oil, but they also included carry back provisions for net operating
losses, and other fossil fuels supply provisions.

By the summer of 1999, crude oil prices had recovered to about $20 per barrel; and by
the summer of 2000 prices peaked at well over $30 per barrel, due largely to output
reductions by the Organization of Petroleum Exporting Countries (OPEC), but also due to
the increased energy demand accompanying increasing growth in the world (particularly the
Asian) economies. To address the high crude prices, which also caused high gasoline, diesel,
and heating oil prices, legislative proposals focused on many of the same energy tax
proposals made during 1999 to address the low crude prices: production tax credits and other
supply incentives. The rationale was not tax relief for a depressed industry but tax incentives
to increase output, reduce prices, and provide price relief to consumers.
But in addition to high petroleum prices there were forces – some of which were
understood (factors such as environmental regulations and pipeline breaks) and others which
are still are not so clearly understood – that caused the prices of these petroleum products to
spike. In response to these energy market problems, there were many proposals in the spring
and summer of 2000 to temporarily either reduce (or totally eliminate) the federal excise tax
on gasoline and diesel fuel, and other special motor fuels. These proposals were viewed as
a way of helping consumers (including truckers) cushion the financial effect of the price
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spikes. (For an analysis of this legislation, see CRS Report RL30497, Suspending the Gas
Tax: Analysis of S. 2285
.) The spike in gasoline prices in the Midwest during the summer
of 2000 kept interest in these excise tax moratoria alive; they also engendered some interest
in proposals to impose a windfall profit tax on oil companies, which were, by then, earning
substantial profits due to the high prices. (For more detail on the windfall profit tax on crude
oil that was imposed from 1980 until its repeal in 1988, see CRS Report 90-442, The
Windfall Profit Tax on Crude Oil: Overview of the Issues.)

Despite the numerous proposals to address these energy problems over the last 4 years,
no major energy tax bill has been approved, although there have been three relatively minor
amendments to energy tax provisions as part of non-energy tax bills during this period.
Examples are Title V of the Ticket to Work and Work Incentives Improvement Act of 1999,
P. L. 106-170, signed by President Clinton on December 17, 1999, and the Job Creation and
Worker Assistance Act of 2002 (P.L. 107-147), ) signed into law by President Bush on
March 9, 2002. The latter is a $42 billion, ten-year tax cut that retroactively extends several
energy tax provisions:
! The §45 Tax Credit for Electricity Produced From Wind, Biomass, and
Poultry Waste. The 1.5¢ per kilowatt hour (in real, 1992 dollars) tax credit
for electricity produced from wind technologies, "closed-loop" biomass, and
poultry waste (as described above), is available for 10 years after the
generating facility is placed in service, which was before January 1, 2002.
The tax cut bill extended this deadline to December 31, 2003.
! Tax Credit for Electric Vehicles. The onset of the phase-out of the $4,000
tax credit for the purchase of electric vehicles began on January 1, 2002.
The tax cut bill deferred the onset of the phase-out date by two years.
! Deduction for Clean-Fuel Vehicles and Certain Refueling Property. The
deduction for clean fuel vehicles, which ranges from $2,000 to $50,000, is
to be phased out over 3 years beginning on January 1, 2002. This was
extended by two years to January 1, 2004.
! The Dyed Fuels Mandate. Beginning on January 1, 2002, registered
terminals were required to store both dyed diesel fuel and dyed kerosene as
a prerequisite for being allowed to sell undyed diesel and kerosene. The tax
cut bill repeals this mandate effective on January 1, 2002.
! Percentage Depletion Allowance. The 100% net income limitation for the
percentage depletion allowance on marginal wells had been suspended since
December 31, 1997, but this expired on January 1, 2002, thus reinstating the
limitation. The tax cut bill reinstates the suspension, thus repealing the
limitation through December 31, 2003.
While no tax bill was passed that reduced taxes on oil and gas, the 106th Congress did
enact a package of $500 million in loan guarantees for small independent oil and gas
producers, which became public law (P.L. 106-51), in August 1999.
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Tax Provisions in the Comprehensive Energy Policy Legislation
At the convening of the 107th Congress, policymakers witnessed not only the usual
gamut of energy market problems just described, there was also an electricity crisis in
California, and spiking natural gas prices, which increased steadily during 2000 and reached
$9 per cubic foot at the outset of the 107th Congress. (At one point on the spot market prices
reached about $30 per cubic foot, the equivalent of $175/barrel of oil). Recurrent energy
problems had developed into an “energy crisis.”
The Republican leadership resuscitated their energy plan of the 106th Congress,
particularly measures which focused on tax relief to the oil and gas industry, and proposed,
a more general or comprehensive policy including major energy tax measures that would
address fundamental energy problems of supply and demand. The ideas and measures in this
plan were incorporated into Senator Murkowski’s comprehensive energy policy reform
legislation S. 389, and other Senate bills and into H.R. 4 (in the House).
The Senate Energy Bills (S. 389, S. 596, and S. 517). On February 26, 2001,
Senator Murkowski introduced S. 389, the comprehensive energy bill that includes
significant expansion of tax incentives for energy supply, energy efficiency, and alternative
fuels. (The tax incentives are title IX of S. 389, which comprises over half of the bill; the
non-tax provisions were introduced on the same date as S. 388). On March 22, 2001, Senator
Bingaman introduced the Democratic version of comprehensive energy policy legislation,
also comprising two bills, which have separate titles: S. 596, the Energy Security Tax and
Policy Act of 2001 (essentially the tax component of the comprehensive legislation) and S.
597, the Comprehensive and Balanced Energy Policy Act of 2001 (the non-tax component
of the legislation). This bill is based largely on Senator Bingaman’s bill in the 106th Congress
( S. 2904). Many of the tax measures in S. 389 and S. 596 are similar. However, S. 396 is
weighted more toward production and supply than is S. 596 which is, on balance, slightly
more weighted toward energy efficiency and alternative fuels. (For a comparison of these two
bills, see CRS Report RL30953, Energy Tax Incentives: A Comparison of the National
Energy Security Act of 2001 (S. 389) and the Democratic Alternative (S. 596).
)
On December 5, the Democratic leadership in the Senate introduced S. 1766, a newer
version of comprehensive energy legislation, without tax provisions, which appears to be a
revised version of Senator Bingaman’s bill, S. 597. S. 1766 was replaced by a substitute bill,
S. 517, which is largely the same as the original bill but which includes dramatic increases
in fuel economy standards.
As to the energy tax provisions of the bills, the Senate Finance Committee (SFC) held
three hearings on the major Senate energy tax proposals during the first session of the 107th
Congress; the Senate leadership had stated that the energy situation, was one of the key
issues to be taken up after the August, 2001 recess. But declining federal budget surpluses,
the waning of the electricity crisis in California, declining petroleum and natural gas prices,
the terrorist situation, and economic recovery issues put this legislation on hold. On
February 13, 2002, however, the SFC approved the Energy Tax Incentives Act of 2002,
which was an amendment (Amendment #2917) to S. 517 on the floor added to S. 517, the
Senate’s energy policy bill. S. 517 was formally renamed the Securing America’s Future
Energy Act when the Senate approved the measure on April 25 as an amendment in the
nature of a substitute to the House counterpart H.R. 4.
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The House Approved Bill (H.R. 4). In the House, the major energy tax measure is
the Energy Tax Policy Act of 2001, a package of $33.5 billion of energy tax incentives (over
10 years) for energy supply and conservation introduced on July 17, 2001. H. R. 2511 was
marked up by the House Committee on Ways and Means on Wednesday, July 18, 2001.The
marked up bill was a substitute amendment offered by Ways and Means Committee
Chairman William Thomas. The bill was approved 24-17 and has been incorporated in the
Republican leadership’s comprehensive energy legislation, H.R. 4, which was approved by
the House on August 2, 2001.
The energy tax provisions of H.R. 4 are generally very similar to those in the two initial
Senate bills discussed above (S. 389 and S. 596), although the mix of provisions differ. As
between the two versions of H.R. 4 are in conference committee, the House bill proposes
larger energy tax cuts (net of some energy tax increases), and is broader in scope than the
Senate bill. H.R. 4, which reduces energy taxes by about $33 billion over 10 years, as
compared with the Senate bill, which reduces energy taxes by about $15 billion over 10
years. Both bills provide tax incentives for both energy conservation – i.e., incentives that
reduce the demand for energy – and the supply of conventional fossil fuels, particularly oil
and gas (including nonconventional gas). But overall the House version appears to be
weighted more toward stimulating the supply of conventional fuels, including capital
investment incentives to stimulate production and transportation of oil and gas as well as
production and transmission of electricity than is the Senate version. This seems to
predicated on the belief that many of the recurring energy problems recently are due to
supply and capacity shortages in the face of rapidly increasing demand, which has been
increasing due to rapid economic growth and relatively low energy prices. The conservation
incentives in the House bill are weighted more toward promoting alternative fuels rather than
energy efficiency.
The Senate bill either eliminates or significantly reduces most of incentives for fossil
fuels production and supply and for nuclear power that were in H.R. 4. There are also some
reductions in tax incentives for energy efficiency. The tax incentives for alternative and
renewable fuels are increased over H.R. 4. As a result of these differences with the energy
tax provisions of H.R. 4, which were heavily weighted toward fossil and nuclear supply, the
Senate bill is evenly balanced with about half of the tax cuts accruing to fossil fuel and
production and nuclear power, and the other half accruing to energy efficiency and
alternative (and renewable) fuels.
Bush Administration Proposals
The Bush Administration, which has proposed its own comprehensive plan to address
the energy crisis, was initially against a significant expansion of energy tax incentives
(whether for supply, efficiency, or alternative fuels). It has, however, recommended a limited
number of energy tax measures, some of which appear in the Administration’s FY2002
budget proposal and others which are incorporated in its National Energy Policy
Development Group (NEPDG) report. (See CRS Report RL31096. Bush Energy Policy:
Overview of Major Proposals and Legislation.
) Some of these energy tax measures in the
Administration’s FY2002 budget and the NEPDG report also appear in the FY2003 budget,
and the Presidents’ global climate change initiative.
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Tax Issues Relating to Electricity Restructuring
The proposed restructuring of the electricity supply industry envisions a transition from
a regulated and vertically integrated monopoly to a deregulated and more competitive
industry, primarily in the generation sector, with all the projected benefits: lower costs and
prices, technological innovation, and greater economic efficiency (including dynamic
economic efficiency) both within the industry itself and economy-wide. But some of the
provisions of the federal tax code, as they relate to electric utilities, evolved within the
monopoly/regulatory structure or regime and thus may be inconsistent with a more
competitive restructured industry. Comprehensive as well as stand-alone restructuring
legislation was introduced in the 106th Congress, but no comprehensive electricity
restructuring legislation has been enacted at the federal level.
Open Access and Tax Exempt Bonds. Current federal tax provisions, as they relate
to the use of tax-exempt bonds by state and local government utilities (public power)
effectively preclude them from participating in open-access restructuring because of the tax
code’s private-use rules; i.e., the bonds cannot be used for any private purpose. The private
use restrictions are intended to ensure that the benefits from the tax exempt financing accrue
to the general public for the welfare of all rather than to individual private entities. Opening
up a public power entity’s transmission lines to privately owned utilities can jeopardize the
tax exempt status of its outstanding bonds – it could make the bonds retroactively taxable.
If public power utilities comply with Order 888 of the Federal Energy Regulatory
Commission (FERC) by providing other utilities comparable access to their transmission
facilities; if they join independent regional system operators; if they let other power
marketers use their distribution facilities; and if they sell excess power outside their
traditional markets; all these could jeopardize the tax-exempt status of any outstanding
bonds.
The Tax Treatment of the Sale of Transmission and Distribution Lines. In general,
most analysts argue that competitive electricity markets cannot work well unless the
transmission systems, which are owned primarily by investor owned utilities (IOU’s), are
subject to independent ownership and management. For this reason, federal rules are
encouraging, and certain states are mandating, IOU’s to sell or divest themselves of assets
used in the transmission and distribution of electricity to independent systems operators.
However, under current tax rules such sales or conversions could, under typical
circumstances, trigger a taxable gain, which could inhibit the sale or spin-off of the assets.
Several tax bills (for example, H.R. 1459 and S. 2967) propose that these sales or spin-offs
be treated as involuntary conversions, which are not taxable events provided that the funds
are used to invest in similar property within two years.
Contributions in Aid of Construction. Payments received from land developers (and
builders) or prospective customers in reimbursement of the costs of constructing facilities
and power lines needed to connect these customers to the grid and extend electricity service
to them have to be reported as income to the utility subject to tax. The fees that utilities
charge customers for connecting them to their homes or businesses to the distribution lines
are also treated as taxable income. The utility is allowed to depreciate these types of
investment expenditures, which are treated as contributions in aid of construction. Under
IRC§118 contributions in aid of construction are not treated as contributions to capital. Prior
to 1986, such contributions in aid of construction were tax exempt as contributions to a
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corporation’s capital, although no depreciation was allowed on the capital. The Tax Reform
Act of 1986 (P.L. 99-514) made such contributions taxable. For example, if an IOU generally
requires prospective customers to pay for the cost of extending the existing wires to the
customer’s premises, the IOU is required to include such payments in income, although it
can depreciate the additional wires. The tax on contributions in aid of construction applies
to IOU’s. It does not apply to public power entities, which, as government enterprises, are
not taxable entities. IOU’s would like to amend the tax laws and make contributions in aid
of construction tax exempt, thus reverting to pre-1986 tax treatment. This proposal does not
hinge on the restructuring of the electric industry. It is rather part of a compromise which
includes continuation of the tax breaks for investors who purchased tax-exempt bonds for
public power entities.
Nuclear Decommissioning. Owners of nuclear power plants are required to establish
independent trust funds, and to make contributions to those funds, to ensure that funds are
available to decommission those plants when they are retired. Under present law, money set
aside for the future decommissioning of nuclear power plants receives special tax treatment.
Basically, the contributions into the fund are tax deductible in the year they are made, rather
than in the year in which the actual decommissioning takes place as economic and
accounting principles dictate. Any income earned by the fund, say from investments, is taxed
at a flat rate of 20%.
The rules spelling out the tax treatment of nuclear decommissioning costs – the current
deduction for accrual (as opposed to cash) basis taxpayers of costs not yet incurred, but also
the 20% income tax on such funds – were enacted during a time when all nuclear power
plants were operated by regulated public utilities, and when any transfers of plant assets
occurred between such regulated entities. One such rule states that the amount deductible
cannot exceed the amount of nuclear decommissioning costs collected from ratepayers under
the cost-of-service regulation. Thus, a public service commission must authorize that the
costs be approved into the rate base. Under rate deregulation in a more competitive industry,
there would be no cost of service amount for the nuclear generating plant owners, hence zero
deduction for contributions into the nuclear decommissioning fund.
Also, restructuring, with its separate ownership of generating, transmission, and
distribution and retailing, is likely to lead to the sale or disposition of nuclear generating
plants to parties that are not regulated public utilities as the law requires for tax exempt
transactions. Under present tax rules, the transfer of decommissioning fund assets as part of
the sale of a nuclear power plant is not a taxable transaction as long as both the seller and the
buyer are regulated public utilities. This raises questions as to the tax treatment of the nuclear
decommissioning funds in a sale to a non-utility, which is somewhat ambiguous under
current tax laws. Under certain conditions, the purchaser may be required to recognize gain
as taxable income.
The Size of the Tax Burdens on Public Power Relative to Investor Owned Utilities
(IOUs). Public power utilities are not only exempt from federal taxes (as compared with
investor owned utilities, which must report and pay tax on their income), but the interest on
the bonds used to finance their capital investments is also exempt from federal taxation.
Restructuring could lock in the competitive advantage of public power (and cooperatives)
rendered by the current tax code provisions.
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Tax Exempt Status of Electric Cooperatives. Electric cooperatives are exempt from
federal taxes as long as 85% or more of their annual income comes from members. Non-
member, unrelated business income is fully taxable. Under restructuring, the fees that
cooperatives would receive for retail wheeling of electricity, combined with other member
income, could exceed 15%, which may jeopardize the cooperatives’ tax-exempt status.
LEGISLATION
H.R. 2511 (McCrery)
The Energy Tax Policy Act of 2001. Amends the Internal Revenue Code of 1986 to
provide tax incentives to encourage energy conservation, energy reliability, and energy
production. Introduced on July 17, 2001. Marked up on Wednesday, July 18, 2001, by the
House Committee on Ways and Means. The marked up bill was a substitute amendment
offered by Ways and Means Committee Chairman William Thomas. The bill was approved
24-17 and has been included as part of H.R. 4, the comprehensive energy legislation
currently moving through the Congress.
Securing America’s Future Energy Act (Amendment in the Nature of a Substitute
to H.R. 4)
The tax provisions are basically those approved the Senate Finance Committee (SFC)
as the Energy Tax Incentives Act of 2002. Amends the Internal Revenue Code of 1986 to
provide about $15 billion (over 10 years) of tax incentives for energy conservation and fossil
fuels production. Marked up by the SFC on Wednesday, February 13, 2002. The bill, which
was approved by voice vote, was a somewhat expanded version of the bill introduced by
Senator Baucus on February 11. Added to S. 517 on the floor as Amendment #2917. The
tax provisions embodied in Division H. of the Senate energy bill are a modified version of
Amendment 2917.
S. 596 (Bingaman)/H.R. 2108
The Energy Security Tax and Policy Act of 2001. Amends the Internal Revenue Code
by providing tax credits and deductions for: (1) energy efficient property used in business;
(2) residential energy systems; (3) electricity facilities and production; (4) commercial
applications of advanced clean coal technologies; (5) heating fuels and storage; and (6) oil
and gas production and petroleum products. Senator Bingaman introduced two bills
representing what was then the Democratic version of comprehensive energy policy
legislation: S. 596 (essentially the tax component of the comprehensive legislation) and S.
597, the Comprehensive and Balanced Energy Policy Act of 2001 (the non-tax component
of the legislation). Introduced on March 22, 2001; referred to the Senate Finance Committee.
S. 389 (Murkowski)
The National Energy Security Act of 2001. A bill to protect the energy and security of
the United States and decrease America's dependency on foreign oil sources to 50% by the
year 2011 by enhancing the use of renewable energy resources, conserving energy resources,
improving energy efficiencies, and increasing domestic energy supplies. Introduced on
February 26, 2001; referred to the Senate Finance Committee.
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Table 1. Current Energy Tax Provisions and Revenue Effects (FY2001, in $ mil.)
Category
Provision
Major Limitations
Revenue Effect
CONVENTIONAL FOSSIL FUELS SUPPLY (bpd = barrels per day; < indicates less than)
% depletion–oil/gas
15% of sales (higher
for indep.,up to 1,000 or
- $300
for marginal wells)
equiv. bpd
Expensing of
100% deductible in
corporations expense only
- 600
IDC’s–oil/gas & other
first year
70% of IDC’s
fuels
Enhanced Oil Recovery
15% of the costs
only for specific tertiary
- 200
Credit
methods
% depletion–coal and
10% for coal
must be < 50% of taxable
- < 50
other fuels
income
coal excise tax (fy2000)
$1.10/ton (0.55 for
not to exceed 4.4% of sales
527
surface mines)
price
ALTERNATIVE AND RENEWABLE FUELS
§29, production tax
$6.25/bar. (or
biogas, coal synfuels,
- 1,500
credit
$1.00/mcf)
coalbed methane, etc.
5.3¢ exemption for
exemption from motor
for biomass ethanol only
- 880
gasohol
fuels taxes
§45 credit for renewable
1.7¢/kWh.
wind, closed loop biomass,
- 100
electricity
and poultry waste
exclusion of interest on
interest income exempt
for hydroelectric or
-100
S&L bonds
from tax
biomass facilities used to
produce electricity
tax credits for alcohol
53¢/gal+ 10¢/gal for
only for biomass ethanol
- < 50
fuels
small producer credit
(e.g., corn)
deduction for clean-fuel
$2,000 for cars;
CNG, LNG, LPG,
- < 50
vehicles
$50,000 for
hydrogen, neat alcohols,
trucks;$100,000
and electricity; phases out
deduction for refueling
over 2002-2004
facilities
tax credit for electric
10%, up to $4,000
phase-out from 2002-2004
- < 50
vehicles
credit for solar &
10% investment tax
utilities excluded
- < 50
geothermal tech.
credit for businesses
ENERGY CONSERVATION
fuels taxes (fy2000)
18.4¢/gal of gas
4.4¢-24.4¢ for other fuels
33,500
mass trans. subsidies
exclusion of $65/month
up to $175/month for
- 3,600
parking benefits
gas-guzzler tax (fy2000)
$1,000-$7,700/car
to limos and vehicles
71
weighing 6,000 lbs. or less
exclusion for utility
subsidies not taxable as
any energy conservation
- < 50
conservation subsidies
income
measure
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