The Inflation Reduction Act’s (IRA) Renewable-Energy Tax Credits: Where is the Money Going?

In March of 2024, Avangrid Renewables, the U.S.-based subsidiary of the global energy firm Iberdrola, completed the initial phase of America’s first large-scale offshore wind farm, Vineyard Wind. Located in the Atlantic Ocean, 15 miles south of Martha’s Vineyard, the 806MW power project will eventually provide enough energy to supply roughly 330,000 homes. Its revenue, of course, will come from selling electricity. But that’s not all. Vineyard Wind will also be the beneficiary of a large federal government subsidy, equivalent to roughly 30 percent of the $4.1 billion cost of building the project. There are two distinctive aspects of this subsidy. First, it won’t be a cash payment. Instead, it will take the form of a tax credit, an IRS-issued IOU that, when applied to one’s tax bill, reduces it dollar-for-dollar. Second, it won’t go to Avangrid! It will go to a syndicate of banks — J.P. Morgan, Bank of America, and Wells Fargo. It is these banks, not Avangrid, that will see their tax bill decrease thanks to the Investment Tax Credit (ITC). 

Does this make any sense? The purpose of the ITC is to incentivize the development of renewable energy generation. Is this purpose consistent with lowering the tax bill of some large banks? Are the banks getting a portion of the government subsidy rather than the intended recipient, the wind farm developer? 

Background

To understand the answers to these questions, it’s helpful to take a step back. Tax credits for renewable energy date back as far as the Carter Administration in the 1970s. The context back then wasn’t climate change, but instead the OPEC-related 1970s Energy Crisis with its iconic photos of long lineups at the gas pump. The 2000s saw substantial growth in the tax credits, both in scope and in dollars. While they’ve been an important catalyst for the industry, they’ve also suffered from an unforeseen consequence. The beneficiaries of the subsidies — the renewables developers — typically haven’t had enough tax liability to use the tax credits. It’s like incentivizing people to read more by giving them books written in a foreign language! 

Unsurprisingly, Wall Street came up with a solution. Renewables developers would form partnerships with tax equity investors, typically large banks with enough tax liability to use the tax credits. Both parties would contribute funds to build the wind (and solar) farms, but the banks’ returns would come mostly in the form of tax credits and other tax benefits. In the Vineyard Wind project, for example, the banks are contributing $1.2 billion of the $4.1 billion required, and in return will receive almost all of the project’s tax benefits (along with some cash required to make them IRS-compliant equity investors). 

Back to the Questions

Are the banks extracting some portion of the ITC subsidy for themselves? The answer depends on the terms of the tax-equity investment. Suppose, for instance, that it’s a ‘fair deal,’ meaning that the value of the cash the banks put in is equal to the value of the tax benefits (and cash) that they take out. Economists call this a zero net present value (NPV) investment. If the banks’ NPV were to be zero, then the entire value of the subsidy would be going to the wind farm developer. The ultimate outcome would be the same as that of a cash payment from the government to the developer, without any tax-credit complications. The banks would simply be playing the role of policy facilitators and there would be no sense in which their reduced tax bills represent a misdirection of public funds. 

The issue, then, boils down to the NPV of the banks’ tax-equity investment. There’s good reason to believe that it’s positive. The reason is related to the structure of the bank-developer partnership. It’s called a partnership flip. The way it works is that the banks contribute a fraction of the project funds up-front, and then receive a stream of tax benefits and cash up until the date at which their realized investment return hits a pre-defined threshold called the flip yield. After the flip yield has been achieved, the payments in the partnership flip so that, going forward, the banks get very little and the developer gets almost everything. The net effect is that the banks’ investment return is guaranteed. It isn’t quite riskless — the time required to earn it is uncertain — but, according to my research, the risk is small. The flip yield, therefore, should be close to the risk-free interest paid to holders of government bonds. This would constitute a zero-NPV, fair deal. In reality, flip yields tend to be at least 4 or 5 percent higher than the prevailing risk-free rate. This indicates a positive NPV for the banks, so that part of the government subsidy is indeed going to them. In Telmer and Wu (2025) my co-author and I find that, for the typical wind farm transaction, the fraction of the total government subsidy enjoyed by the banks is roughly 25 percent. 

Interpretation

How should we think of the good deal that the banks seem to be enjoying? Does it reflect opportunistic behavior generated by flawed policy? Several responses are as follows. First, if the tax credit policy is flawed, then what’s the alternative? Cash payments instead of tax credits, for instance, may give rise to costly incentive and monitoring issues. The positive NPV enjoyed by Wall Street may be an unfortunate but necessary cost of using a subsidy in lieu of what economic theory suggests in the face of carbon pollution, a carbon tax. Second, and related, it’s possible that the banks are actually contributing value through their due diligence process, helping to weed out poor projects and monitor/advise those that remain. If so, then some part of the NPV is illusory, representing instead payment for services rendered. Finally, it’s possible that the positive NPV does represent a good deal for the banks, reflecting a lack of competition. The opacity of the tax-equity market, the high concentration of tax-equity providers (a small number of banks provide a large amount of the financing), and the (supposed) insufficient supply of tax-equity investors, all give credence to this possibility. These issues, and more, are the subject of ongoing research.

Policy Implications

There are a number of policy implications. Their importance has been amplified by the Inflation Reduction Act (IRA), which, once again, expands the size of the tax-credit policies. Increased transparency is high on the list. The tax-equity partnerships that are the bedrock of U.S. solar and wind financing are the beneficiaries of large amounts of public funds. These partnerships represent roughly half of the financing of all wind, solar, and storage investments in the United States. It’s hard to justify the fact that the public can’t see how the funds are allocated. Policy should also emphasize increased competition. Much of the raison d’être of the tax-equity partnership is a restrictive and complex set of rules governing how the tax credits can be transferred and to whom. Fewer and simpler restrictions should lead to enhanced competition which should lead to more effective policy. The IRA contains some good news on this front. Developers can now sell their tax credits directly to investors instead of doing so indirectly, via a partnership. A vibrant market seems to be emerging. So far, the prices in this nascent market are consistent with more of the value of the government subsidy going to its intended recipient. 

Reference

Telmer, Christopher and Sarah (Yue) Wu. (2025). Tax Equity Financing of U.S. Renewable Electricity Generation. Working Paper. Tepper School of Business, Carnegie Mellon University.