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Financial incentives

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Financial incentives have been widely implemented by governments around the world to support scaled up deployment of e.g. renewable energy and energy efficiency technologies and practices. In terms of private funds, governments set the rules for the markets in which investors seek profits. If current market rules are failing to attract or drive private investors into lower-carbon, more climate-proof alternatives, governments can introduce policies or incentives to help address these market failures. 

Responds to the following needs

  • Promotion of climate mitigation and adaptation policies
  • Reduced GHG emissions
  • Behavioural change

Suitable for

  • Planners and decision-makers

Relevant CTCN Technical Assistance

Methodologies

Internationally, UNFCCC identifies the key regulatory mechanism required to ensure that CO2 abatement opportunities are pursued in the industrial sector to be a stable financial incentive to invest in low GHG emitting technology, such as a CO2 price. A global CO2 price would be best, as regional differences could cause distortions. Financial incentives to reduce the capital cost of more efficient equipment and to provide incentives for small-scale CCS technologies would also be useful. To reduce non-CO2 industrial emissions, a cap and trade system or performance standards are likely to be more efficient than technology standards, as they would spur innovation and stimulate the large number of diverse measures needed for abatement.

Examples of national financial incentives:

  • Taxes and charges to make the polluter pay (polluter-pays-principle)
  • Taxes on emissions (carbon tax)
  • Emissions trading (cap-and-trade)
  • Subsidies and incentives to pay innovators
  • Subsidies for
    • sequestration
    • alternative crops
    • cross-compliance with standards
    • research and extension
  • Feed-in tariffs for renewable energy and renewable energy credits
  • Financial incentives for behavioural change 

Economic Policy Instruments (EPIs) are incentives designed and implemented with the purpose of adapting individual decisions to collectively agreed goals. EPIs have received widespread attention over the last three decades in climate, energy, and air policy-making and are traditionally classified in pricing (e.g. water tariffs), environmental taxes and charges, subsidies (on products and practices); trading (e.g tradable permit for pollution or water abstraction, compensation mechanisms, payments for environmental services); and voluntary agreements and risk management schemes such as insurances or liabilities.  EPIs can significantly improve an existing policy framework by incentivising, rather than commanding, behavioural changes that may lead to adaptation.

Economic policy instruments can spur behavioural change through incentives or disincentives; change conditions to enable economic transactions; or reduce risk. Rather than specifying a particular type of behaviour that the regulatee has to comply with, economic instruments create the economic incentives (e.g. price signals) to encourage or discourage certain behaviour, but leave it to the regulatee to devise his / her own way of dealing with this incentive.

The main advantage of these instruments is economic efficiency, i.e. the ability to distribute the burden of the distortion reduction where it is cheaper to do so. The drawbacks are on the equity side, as they affect differently different agents or social groups not necessarily in a progressive way, and strictly linked to this, on the political feasibility side.

See the IEA/IRENA Joint Policies and Measures Database for an overview of National level economic instrument policies related to renewable energy. 

Financial incentives for clean energy deployment

Content is provided from NREL and Clean Energy Solutions Center's report Financial Incentives to Enable Clean Energy Deployment

Financial incentives have been widely implemented to support renewable energy and energy efficiency market development globally. Learning continues to progress as countries design innovative measures to align with evolving renewable energy and energy efficiency markets. The key financial incentive design elements described below provide a starting point for considering a country-specific and tailored financial incentive policy portfolio aligned with unique national circumstances and goals.

Tax measures have been applied in various ways around the world to accelerate renewable energy and energy efficiency deployment and can be adapted to unique national circumstances. Common types of tax incentives are highlighted below:

  • Corporate income tax incentives can be tax deductions or credits for on-site use of renewable energy or energy efficiency technologies or for large-scale renewable energy that is fed into the grid. In relation to renewable energy, corporate investment tax credits are based on initial cost of renewable energy systems, while production tax credits are based on actual energy produced. Therefore, production tax credits can be more effective in incentivizing maximization of energy production over the long term. However, other tax incentives may also be required to address potentially high upfront investment costs.
  • Personal income tax incentives are tax deductions or credits, normally based on investment or cost of a renewable energy system or energy efficiency technology.
  • Property tax incentives are utilized when renewable energy systems (distributed or utilityscale) or energy efficiency technologies are implemented to improve a property. These incentives reduce the level of taxes associated with the property improvements.
  • Sales or value-added tax (VAT) incentives lessen or eliminate sales or VAT taxes for energy efficiency and renewable energy technologies (applied at both the distributed and utility-scale levels) for individuals and/or businesses.
  • Accelerated depreciation quickens renewable energy fixed asset depreciation and thus, through reducing taxable income, defers tax liability in the early stages of renewable energy project development

Rebates, grants, and performance-based incentives can be designed to support renewable energy and energy efficiency action and technology deployment. Rebates, grants, and performance-based incentives provide a direct cash incentive to support energy efficiency and renewable energy and typically do not require repayment. Grants can be provided before a technology is installed (e.g., for research, development, and demonstration; business development; or feasibility studies) or after a system is fully operational. Rebates are typically applied to discrete purchases such as appliances and vehicle purchases, and are often provided after purchase and/or installation. Performance-based incentives are provided based on actual performance of an installed technology (e.g., cents per kilowatt-hour payment). Selected examples of direct cash incentive programs are highlighted below.

  • Rebates are often provided by utilities and funded through utility customer payments. Rebates are commonly used for energy efficiency home improvement and construction, energy efficiency appliances, energy efficiency vehicles, and on-site renewable energy systems.
  • Grants are normally provided by local governments, utilities and/or non-profit institutions. Grants commonly fund research and development, feasibility studies, system demonstration, installation, and operation, and/or business development. Through hybrid approaches, grants can also be combined with subsidized loans to support renewable energy and energy efficiency deployment.
  • Performance-based incentives are often provided by utilities and funded through utility customer payments. Performance-based incentives commonly support renewable energy systems based on performance, and/or whole building energy efficiency upgrades based on overall energy saved. Hybrid rebate and performance-based incentives can also support upfront investment and ongoing performance of renewable energy and energy efficiency systems.

Loan programs, guarantees, and credit enhancements can also be designed in various ways to support renewable energy and energy efficiency technology deployment. Selected examples of renewable energy and energy efficiency loan incentive programs and products are presented below.

  • Subsidized traditional revolving loans reduce loan interest rates for energy efficiency and renewable energy technologies by providing a loan loss reserve fund or similar mechanism that serves as a form of insurance in the event of loan failure. Successful revolving loan funds are designed in such a way that the revenue from repaid loans (i.e., interest payments) covers net losses to the fund, and thus the fund can issue loans in perpetuity).
  • Mortgage-related loan programs include property-assessed programs that provide funding for small-scale renewable energy systems and upfront energy efficiency improvements on a property that are paid back over time by commercial and residential property owners. Mortgage loans for energy efficient homes can also incorporate special loan terms (e.g., allowing higher debt to income and loan to value ratios) because the mortgages assume future energy savings for the homeowner.
  • Credit enhancements reduce credit risk associated with renewable energy and energy efficiency investments through various mechanisms such as interest rate buy-downs and reserve accounts. Loan guarantees are common credit enhancement incentives that support reduced loan interest rates by providing assurance to a lender that loans will be fully or partially repaid in the event of borrower default.
  • Green banks can provide loans and other incentives through public-private partnerships and innovative financing approaches, reducing the need for ongoing public funding. Green banks can “bundle” financial incentives to support various phases or aspects of energy efficiency and renewable energy deployment (e.g., grants could be used to support renewable energy business model development and loans could be used to support renewable energy technology installation and initial operation).

Product examples

Case studies

  • Chile: Catalyzing Finance in Chile through Effective Design of Financial Incentives: To address key finance barriers to renewable energy and energy efficiency deployment in Chile, the Chilean Economic Development Agency (CORFO) implemented a concessional loan program to support commercial banks in providing low interest loans for renewable energy and energy efficiency technologies. The program was successful in catalyzing finance, with one third of Chilean banks now engaged in the provision of affordable financing for renewable energy and energy efficiency technologies and projects.
  • Mauritius: Solar Water Heating Grants in Support Low-Income Households To support renewable energy development in Mauritius, the Ministry of Renewable Energy and Public Utilities developed a policy to catalyze deployment of solar water heaters (SWH) through the provision of grants. To align with broader national development goals, in 2016 the program will target vulnerable and lower income households and communities to enable sustainable energy access.

References