Cities, states, municipalities, and nonprofit organizations want to build green-energy infrastructure. But in the past, the federal government has incentivized green energy mostly through tax credits—a system that doesn’t help the public and nonprofit sectors. To get a tax credit, you need to have tax liabilities, which these entities rarely have. But starting this year, something will be different: As a result of the Inflation Reduction Act’s “direct pay” feature, the federal government will provide subsidies straight to these groups, without needing to go through private investors.
There’s debate in left-liberal spaces about how to characterize the Inflation Reduction Act, the large climate bill the Democrats passed in 2022. The IRA allocates $369 billion to clean energy, around $270 billion of which is in the form of tax incentives for investments by individuals and organizations. Will these billions primarily support the private sector? Even as the new law brings down carbon pollution, is it a missed opportunity to challenge the status quo?
Not necessarily, since the direct-pay part of the IRA creates an opportunity for the public sector to start building things again. If it’s executed well, the IRA can expand state capacity, which can then be extended from green energy to all kinds of other public investment. It could help transform what local governments can do.
Tax credits are valuable only to those who owe taxes. (This is one problem with the current child tax credit and child-care tax credit; they really only help if you owe the IRS a lot.) This means tax credits benefit the private sector more than the public sector. Before the IRA, if a public entity or a nonprofit wanted to use these subsidies, it needed to enter into a complicated arrangement with “tax equity markets” managed by Wall Street firms, giving the financial sector a cut of the public funding.
Such a convoluted process slows down investment and holds back innovation: Tax equity markets are limited and often prefer faster, cheaper, and more mature technologies. This more than likely tilts funding away from cutting-edge projects.
But under the IRA, the subsidies can now help anyone who wants to invest in green energy—no matter whether they have a tax liability or not. In this sense, the money functions like a grant, allowing the vast range of nonprofit and public entities to claim the full value of the credit, just as private firms can. Because Wall Street won’t be siphoning off some of the funds, direct pay could double the impact of every federal dollar spent, according to the Bipartisan Policy Center.
The IRA’s direct-pay feature is already piquing interest. According to the National League of Cities, Athens, Ohio, is planning to take advantage of direct pay to install solar panels on its city hall, its wastewater treatment plant, and a parking garage.
These funds are also uncapped, which means they won’t run out in the middle of the green transition. Public entities and nonprofits can keep drawing on them as long as they can plan and execute the investment projects. As a result, according to a recent paper presented at the Brookings Papers on Economic Activity conference, the tax credits alone could cost as much $780 billion, almost three times the initial estimate. The paper’s authors found that given the scale of the climate change threat, the investments easily pass a cost-benefit test, even at these high levels. This is a major win for those who want to transition to a green economy while also reinvesting in our infrastructure.
There’s also an opportunity to rebuild the public sector. As Paul E. Williams, the executive director of the Center for Public Enterprise, told me, “Decades ago, state and local public agencies built all kinds of things: housing, transit, energy, infrastructure, utilities, but a lot of that capacity has gone away. Direct pay can create an engine for building capacity within the public sector itself, especially as they get the funding and get in the business of making things again.”
It will also allow public entities to address other crises, whether it’s inflation, the crisis in care work, or housing prices. Their success will depend on how the federal government implements the programs in the coming months, and even more will depend on getting public agencies to take advantage of them. The IRA’s direct-pay grants are crucial investments that will pay both climate and governing dividends for decades to come.