Economic Instruments: Incentives
The energy transition is the shift from fossil fuels to renewable energy sources in an effort to reduce CO2 emissions.
Economic instruments facilitate this transition in two ways. Carbon pricing discourages the production and use of fossil fuels by charging heavy emitters for each tonne of CO₂ produced. Incentives on the other hand are policy tools or financial mechanisms aimed at encouraging individuals, businesses, and governments to adopt cleaner energy practices by making these options more appealing or cost-effective.
There are different types of financial incentives that can be used to accelerate transition to clean energy.
1. Tax incentives
Tax incentives are measures that reduce tax liability for individuals or businesses to encourage the use of clean energy sources.
- Tax credits
Tax credits reduce tax liability. For example, if a company owes €5,000 in taxes and is eligible for a €2,200 tax credit, the amount they owe decreases to €2,800 after the tax break is applied. Investment tax credits provide a tax reduction for individuals or companies that invest in renewable energy equipment, like solar panels or wind turbines while production tax credits offer tax reductions based on the amount of renewable energy generated, providing a financial reward for consistent renewable energy production.
The United States’ Inflation Reduction Act, signed into law by President Biden on 16th August, 2022 is the most significant action Congress has taken on clean energy and climate change in the nation’s history. The Act includes several tax provisions and significant grant and loan programs to support deployment of innovative clean energy technologies. It includes several tax provisions that are meant to assist families save money on their energy bills and accelerate the deployment of clean energy, clean vehicles, clean buildings, and clean manufacturing1.
Investment Tax Credits (ITCs) and Production Tax Credits (PTCs) stand out as the most powerful tools for driving the clean energy transition2. They are intended to incentivize investment in disadvantaged communities and ensure newly-created jobs are good-paying jobs. The ITC and PTC provisions have helped drive deployment of wind farms and solar arrays in the United States, resulting in clean energy providing a majority of all electricity capacity additions. Both provisions are meant to run till the end of 2024, at which point they sunset in favor of technology-neutral, emissions-based credits, the Clean Electricity PTC and Clean Electricity ITC.
The ITC offers up to a 10-percentage point bonus credit for projects allocated in an energy community. They also offer another 10-percentage point bonus allocated investment credit for qualified solar and wind facilities located in a low-income community or on tribal land and a 20-percentage point bonus for projects that are part of a qualified low-income residential building project or a qualified low-income economic benefit project.
The PTC and ITC are also structured in a way to ensure that new clean energy projects create good-paying jobs. They offer bonus credit to projects that pay the prevailing wage or use registered apprentices. They also offer bonus credit for projects that meet certain domestic content requirements for steel, iron, and manufactured products, a provision designed to strengthen America’s manufacturing base and the good-paying jobs needed to support it.
On 29th December 2023, France introduced tax credits for investments in green energy projects, those dealing with the production of batteries, solar panels, wind turbines, and heat pumps. The tax credit ranges from 20 to 60 per cent depending on the size of the company and the location of the investments3.
In June 2024, in a bid to grow a clean economy and allow Canada to remain competitive in attracting investment in clean energy projects, the Canadian government signed into law four new refundable investment tax credits (ITCs)4:
The Clean Technology ITC: which offers a refundable tax credit of up to 30% of investments in eligible property acquired and available for use on or after March 28, 2023 and before 2034.
The Clean Technology Manufacturing ITC: which offers a refundable tax credit of 30% of investments in eligible property to be used in clean technology manufacturing and critical mineral extraction and processing that is acquired and available for use in 2024 to 2031. This tax credit would reduce to 20% for 2032, 10% for 2033 and 5% for 2034.
The Clean Hydrogen ITC: which offers a refundable tax credit of up to 40% of investments in projects that produce hydrogen and become available for use on or after March 28, 2023 and before 2034. For investments that become available for use in 2034, this tax credit would generally be reduced by one-half.
The Carbon Capture, Utilization and Storage (CCUS) ITC: which offers a refundable tax credit for expenditures incurred between 1st January 2022 and 31st December 2030 of :
- up to 60% of qualified carbon capture expenditures incurred to capture carbon from ambient air;
- up to 50% of qualified carbon capture expenditures incurred to capture carbon other than directly from ambient air; and
- up to 37.5% of qualified carbon transportation expenditures, qualified carbon storage expenditures and qualified carbon use expenditures.
For the first three ITCs, no tax credit would be available after 2034. For the CCUS ITC, the tax credit would be reduced by one-half for the period 1st Jan 2031 to 31st December, 2040. No tax credit would be available after 2040.
- Reduction in VAT
Value Added Tax (VAT) is a tax on the consumption of goods and services. It is paid by the final consumer, but businesses collect and remit it to the government. A reduction in VAT can help make renewable energy technologies more affordable and accessible to households and businesses, which in turn can help accelerate the shift toward a more sustainable energy system.
The The EU VAT Directive5 stipulates standard rules on VAT which may be applied differently in each EU country. There are various types of VAT rates that are applied in EU countries. The rates depends on the product or service involved in the transaction. There are also special rates which were set according to VAT rates implemented in EU countries before they joined the EU.
Each EU country has a standard rate which applies to the supply of most goods and services. This rate cannot be less than 15%. Then there are one or two reduced rates that may be applied to the supply of specific goods and services (based on the list in Annex III of the VAT Directive). Some EU countries are allowed to apply special VAT rates on certain supplies. These special rates are i) super-reduced rates of less than 5%, which are applied to the sales of a limited list of goods and services in certain EU countries, ii) zero rates, applied to certain sales by some EU countries and iii) parking rates which are applied by some EU countries to certain supplies of goods and services that aren’t included in Annex III of the VAT Directive6.
Zero VAT rates apply to, among others, the supply and installation of solar panels on and adjacent to private dwellings, housing and public and other buildings used for activities in the public interest (see Annex III, point 10c of the VAT Directive).
In the Netherlands for example, the standard VAT rate is 21%. Since 1st Jan 2023, there is a special zero VAT rate that applies to the supply and installation of solar panels used as roofing materials. The zero VAT rate only applies if the solar panels are intended to be installed on or in the immediate vicinity of private dwellings or housing. The purpose of the VAT zero rate on solar panels is to reduce administrative burdens for solar panel owners and the tax authorities, and to stimulate investments in solar panels7.
In Ireland, the standard VAT rate is 23%. Since 1st May 2023, the zero rate applies to the supply and installation of solar panels on or adjacent to private dwellings or recognised schools8. The term ‘on or adjacent’ allows that the solar panels can be fitted onto the private dwelling (e.g. to the roof) or ground mounted beside it9.
One of the mitigation programs highlighted in Ireland’s Climate Action Plan 202410 is the National Retrofit Plan. Through this plan, the government of Ireland targets to retrofit the equivalent of 500,000 homes to a BER of B2/cost-optimal and install 400,000 heat pumps in existing homes to replace older, less efficient heating systems by the end of 2030. To facilitate this, as part of the 2025 State Budget, the government announced that the VAT charged for the supply and installation of heat pumps would be reduced from the standard 23% to 9%, starting 1st January, 202511.
2. Grants
A grant is a sum of money given by a government, organization, or institution to fund a specific project or purpose, without the expectation that it will be paid back.
The Innovation Fund12, which is financed by the EU Emissions Trading System13 is one of the world’s largest funding programs for innovative low-carbon technologies. This Innovation Fund has a budget of around €20 billion between 2020-2030. Its aim is to help companies invest in clean energy and industry to boost economic growth. Additionally, the funds creates future-proof local jobs and strengthens Europe’s technological leadership on a global scale. It funds large and small-scale projects focusing on innovative low-carbon technologies, and processes in energy-intensive industries. It also includes projects on carbon capture and utilization (CCU) construction, as well as operation of carbon capture and innovative renewable storage (CCS)14.
The European Green Deal15 is a growth model based on a clean and circular economy. It aims to ensure zero emissions by 2050, making Europe the first climate-neutral continent in the world. To contribute to the goals laid out in this deal and make a difference for a greener Europe, Iceland, Liechtenstein and Norway, through the EEA and Norway Grants’ green programmes16, are funding projects that have a sustainable positive impact on the environment. The grants aim to fast-track the deployment of clean energy technology and more energy-efficient solutions by bringing together private, public and civil society organisations around environmental protection, air and water quality, as well as waste management issues. The EEA and Norway Grants complement EU funding schemes by bridging funding gaps for strategic priorities. The grants make a significant difference by focusing on specific areas such as hydropower and geothermal energy, working with smaller municipalities in the beneficiary states, and supporting novel and sometimes experimental approaches17.
In Ireland, the government through SEAI (Sustainable Energy Authority of Ireland), offers home renovation grants which are designed to help homeowners make their homes more energy-efficient. These grants cover a range of energy upgrades, from insulation to heating systems, making it easier and more affordable for people to improve their homes’ energy performance18.
3. Feed-in-Tariffs
A feed-in-tariff is a policy mechanism used to encourage the generation of renewable energy by offering guaranteed payments or fixed prices to individuals or companies who produce energy from renewable sources (such as solar, wind, or biomass). In other words, the mechanism allows you to sell your unused solar energy back to the grid. These payments are typically made for a set period, such as 10 to 20 years, and are designed to help offset the initial cost of renewable energy systems, like solar panels or wind turbines. For example, a homeowner installs solar panels on their roof and generates excess electricity that they don’t use. The utility company agrees to buy the excess electricity at a fixed, higher-than-market rate for the next 15 years. This provides the homeowner with an income from selling the energy back to the grid. Utilities are required to buy renewable energy from independent producers (homeowners, businesses, etc.) at the agreed-upon price. When designed properly, FiTs can provide substantial financial benefits to solar customers.
In Australia, during the billing cycle, if one ends up earning more money than their power bill, most energy retailers apply a credit rather than issue a refund. This credit can then be used to offset future electricity bills. That way, they can still keep you on their network. The scheme works in a way that during the day, because most people are away, there’s a lot of unused energy. In the evenings when people return home from school or work and begin using electrical appliances, energy will be drawn from the grid again. Initially, when solar became available, the number of feed-in-tariffs was very high as the government incentivised adoption of solar energy. With time, as more and more households started adopting solar, and prices for panels dropped, the feed in tariffs dropped as well19. Because of operational challenges due to surplus generation of electricity, especially during peak solar generation hours, the government introduced ‘Sun Tax’, with the hope that the tax will help manage grid congestion and stabilise the energy system by balancing supply and demand, and ensuring that the grid remains functional and electricity prices stable20.
The Micro-generation21 Support Scheme (MSS) in Ireland is an incentive that allows homeowners and businesses to sell their generated excess energy back to the grid. Previously, households with solar panels returned any excess electricity to the grid for free. In February 2022, the Irish government introduced the Clean Export Guarantee (CEG) scheme, guaranteeing payment for any surplus energy exported to the grid. The electricity supplier, who sets the tariff rate, provides the payment. Currently, there is a tax exemption of €400 per year on any income made by small-scale microgenerators. This tax exemption runs till 31st December 202522.
In Germany, the first feed-in-tariff was anchored in the Renewable Energy Sources Act (EEG) which regulates, among other things, the remuneration rates and conditions under which the green electricity produced is remunerated. EEG came into force in 2000 with a significantly high remuneration to create incentives for investment in renewable energy, and has since been amended several times due to the various changes to the EEG, which often reduced the remuneration. This policy gave people the chance to invest in renewable energy projects, leading to an enormous increase in the share of renewable energy. It has been the most effective instrument for reducing GHG emissions and combating climate change in Germany. The feed-in tariff per kilowatt hour (kWh) for photovoltaic systems depends, among other things, on the size of the system, measured in kilowatt peak (kWp). For systems with an output of up to 10 kWp, the initial compensation rates in January 2024 were 8.1 cents per kWh for partial feed-in23 and 12.9 cents per kWh for full feed-in24. The feed-in-tariff was set to be reduced by 1 percent every six months, to create new funding conditions for operators of photovoltaic systems. This digressive adjustment of the compensation rates reflects the ongoing development and cost reductions in the photovoltaics industry. After 20 years have passed, the regulated feed-in tariffs no longer apply and plant operators are encouraged to consider, in a timely manner, alternative ways of remuneration such as direct marketing of the energy they produce25 26.
There are several benefits to consider when it comes to feed-in-tariffs. Households can earn a steady income and reduce payback time by selling their surplus energy. The system also helps with lowering bills and saving money by buying less electricity from suppliers. Due to the use of clean energy sources, they can lower carbon emissions and reduce their carbon footprint. With feed-in-tariffs, households can monitor and control their energy usage with insights from their smart meter and app (if available). Despite the benefits, feed-in-tariffs also come with certain disadvantages. The cost of installing solar panels can be high and unattainable for many households. Households are also forced to purchase and sell their energy to the same supplier (or switch to one that offers feed-in tariffs). Export tariffs are subject to changes in government policy and supplier rate fluctuations. Finally, battery storage could work better for some households.
Footnotes
France introduces tax credits for investments in green energy projects↩︎
Monitoring of VAT zero rate for solar panels: Impact and Budgetary Assessment, June 11, 2024↩︎
A recognised school is one which provides primary education or post-primary education to students in accordance with the Education Act 1998↩︎
Innovation Fund: 18 cleantech projects to receive €173 million in EU funding↩︎
The Upcoming ‘Sun Tax’ in Australia: What You Need to Know↩︎
Microgeneration is the small-scale generation of electricity from renewable sources by homes, businesses or farms. The energy produced can be used to power homes or businesses, sold back to the grid via an energy supplier and stored in a battery for later use. Solar panels are the most popular micro-generators.↩︎
With a partial feed-in tariff, the producer consumes some of the generated electricity on-site and only feeds the excess energy back into the grid. For the portion of energy fed back to the grid, the producer receives a lower fixed tariff than they would with a full feed-in tariff, but they save money by reducing their dependence on the grid. This model is common for homeowners or small businesses that generate energy and wish to lower their electricity bills by using what they produce.↩︎
Under a full feed-in tariff, all electricity generated by the renewable energy system (e.g., solar panels) is fed directly into the national grid. Producers receive a fixed payment for each kilowatt-hour (kWh) they supply to the grid, but they do not use any of the generated energy themselves. The full feed-in tariff rate is generally higher because the producer is fully supporting the grid and not benefiting directly from the energy.↩︎
Photovoltaic feed-in tariff 2024: Current rates and changes at a glance↩︎