Energy Conservation and Climate Change:

Factors to Consider in the Design of the Nonbusiness Energy Property Credit

GAO-12-318: Published: Apr 2, 2012. Publicly Released: May 2, 2012.

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Michael Brostek
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What GAO Found

Under criteria for evaluating a tax credit design, both the performance-based and cost-based credits have advantages and disadvantages with neither design being unambiguously the better option based on current information. Both a cost-based and a performance-based credit are designed to reduce energy use and CO2 emissions by providing incentives for energy conservation investment. However, they differ in their relative effectiveness and costs. In general, a performance-based credit is more likely to effectively reduce energy use and CO2 emissions because it rewards energy savings from the investment rather than the cost-based credit’s rewarding of spending regardless of whether this spending results in energy savings. However, the performance-based credit may have significant up-front costs for energy audits, not required by the cost-based credit, which could reduce its effectiveness by discouraging investment. In addition, for taxpayers who do invest, these up-front costs may mean that a performance-based credit may have significantly higher taxpayer compliance and IRS administrative costs than a cost-based credit. A credit’s fairness depends on subjective judgments of how a credit varies with a taxpayer’s income level.

For those taxpayers claiming the 2009 credit, under both base definitions used in our simulations, the total amount of credit claimed fell but taxpayers had a greater incentive to spend more on qualifying products. The incentive was measured as the average effective rate of credit that would apply to additional spending by taxpayers. In 2009, when no base was present, a dollar of additional spending would earn, on average, an additional 10 cents of credit. When the base derived from average spending was introduced in the simulations, a dollar of additional spending earned an estimated 14 to 18 cents of credit. However, because the simulations do not include behavioral responses, the overall effect on revenues and spending of introducing a base is uncertain. For example, introducing a base amount, while likely to limit windfall credits for qualified spending that would have been done anyway, would also make the credit less generous and some taxpayers might no longer use it.

Why GAO Did This Study

The nonbusiness energy property credit is one of a number of federal initiatives that seek to address concerns about U.S. reliance on foreign energy sources and the impact of carbon dioxide (CO2) emissions on the climate. Enacted as part of the Energy Policy Act of 2005, the nonbusiness energy property credit was intended to increase homeowners’ investment in energy conserving improvements by reducing their after-tax costs. The credit is calculated as a percentage of qualified spending on such improvements as insulation systems, exterior windows and metal roofs up to a maximum claimable credit. The maximum credit was set at $500 in 2006 and 2007, raised to $1,500 in 2009 and 2010, and lowered back to $500 in 2011.

This report compiles and expands upon information previously presented to Congress in response to congressional request, which asked us to examine factors relating to the nonbusiness energy property credit. To address the request, we (1) evaluated factors to consider in deciding whether the credit should be cost-based or performance-based; and (2) estimated how requiring that only spending above a minimum amount be eligible for the credit, or introducing a base amount for the 2009 credit may have affected measures such as the amount of credit claimed, the revenue cost to the federal government, and incentives for taxpayers to increase their spending on energy efficiency improvements.

What GAO Recommends

We are not making new recommendations based on this review. This work is intended to assist Congress in considering different ways that the credit can be structured to achieve the stated goals of reducing CO2 emissions and minimizing U.S. reliance on foreign energy sources.

For more information, contact J. Christopher Mihm at (202) 512-6806 or

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