Solar Energy Toolkit: The Federal and State Context: Policies Affecting Solar Energy Development

Updated August 2021

Local governments have many tools at their disposal to encourage solar energy growth. At the same time, decisions made at the federal and state levels set the context for local action and help communities choose the most effective strategies for their jurisdictions. This section of Solar Energy: SolSmart’s Toolkit for Local Governments presents a high-level overview of federal and state policies and programs with an impact on solar energy development.

Federal Programs and Policies

At the federal level, several key policies, programs, and regulations help promote solar energy deployment. Many of these policies help reduce the capital costs associated with developing new solar projects, making solar a more attractive option for communities across America. Other federal programs provide useful data and research to help local governments develop their own solar programs. The most important federal programs, initiatives, and agencies include:

• The Federal Investment Tax Credit (ITC), which provides a tax benefit for installing residential, commercial, and utility-scale solar.
• The Modified Accelerated Cost Recovery System (MACRS), which reduces the income subject to federal taxes for solar project owners.
• The Public Utilities Regulatory Act (PURPA), which can mandate that utilities purchase energy from solar and other qualifying facilities.
• The Federal Energy Regulatory Commission (FERC), an independent agency that regulates power markets.
• The Solar Energy Technologies Office, which oversees the solar-related programs and activities at the U.S. Department of Energy (DOE).
• The U.S. Energy Information Administration, which provides comprehensive data on U.S. energy markets.

THE INVESTMENT TAX CREDIT

The Solar Investment Tax Credit (ITC) is a federal tax incentive enacted into law to encourage the deployment of solar energy in the United States. This federal tax credit is claimed against the tax liability of residential, commercial, and utility-scale investors in solar energy projects. When a homeowner purchases a residential solar energy system, the tax credit is applied against the homeowner’s personal income tax. For commercial and utility-scale projects, as well for residential projects owned by third parties, the tax credit is claimed by the business that owns the solar energy system.

The amount of the tax credit is determined based on the capital investment required to build a solar project. The credit provides a dollar-for-dollar reduction in the income taxes a person or company would otherwise pay to the federal government. (In contrast, a tax deduction only reduces the amount of income subject to taxes.)

The solar ITC was first established in 2005 as a tax credit of 30 percent on eligible properties. Several legislative extensions have kept the ITC in place over the past two decades. The ITC was most recently extended in the Consolidated Appropriations Act enacted in 2020.

Currently, the ITC provides a 26 percent tax credit for projects that begin construction through 2022. In 2023, the ITC will step down to 22 percent. In 2024, the commercial and utility-scale tax credit will drop to 10 percent, while the residential credit will be eliminated.^[1]

MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS)

The Modified Accelerated Cost Recovery System (MACRS) is another federal tax policy that encourages solar energy deployment. MACRS is a common way to assess depreciation, which is a non-cash expense reflecting the fact that equipment is subject to wear and tear over time and will eventually need to be replaced.^[2] Therefore, taking a depreciation expense reduces the income subject to federal income taxes.

Under Section 168 of the tax code, equipment which uses solar energy to generate electricity qualifies for a five-year accelerated depreciation schedule. The value of MACRS to the owner of the solar energy project is a function of the owner’s tax rate. The higher the tax rate, the more valuable the MACRS deduction. When the solar ITC is claimed in conjunction with MACRS, the owner of the solar project must reduce the project’s depreciable basis by one-half the value of the ITC.

THE PUBLIC UTILITIES REGULATORY ACT OF 1978 (PURPA)

The Public Utilities Regulatory Act of 1978 (PURPA) is a federal policy designed to conserve electricity, improve utility-sector energy efficiency, and promote equitable electricity rates.^[3] In recent years, PURPA has played a significant role in expanding the growth of solar energy in many parts of the United States. This is a result of PURPA’s mandate that utilities purchase power from small renewable energy producers when the cost of that electricity is less than what the utility would pay to deliver its own power.

Specifically, PURPA requires utilities to purchase from energy producers known as qualifying facilities (QFs). Power producers can qualify as a QF by meeting one of two standards:^[4]

• Small power production facilities: Facilities that are 80 MW or less in capacity and generate renewable energy (such as solar, wind, and geothermal).
• Cogeneration facilities: Facilities that simultaneously produce both electric and thermal energy, with the latter having a productive use (for example, combined heat and power).

PURPA mandates that utilities purchase electricity from QFs if the electricity can be provided at an “avoided cost.” The avoided cost is defined as the cost the utility would have incurred to generate or otherwise acquire the electricity from a third party. In recent years, PURPA has had a particularly significant impact in regions where there are few other state-level incentives for solar energy development.

THE FEDERAL ENERGY REGULATORY COMMISSION (FERC)

The Federal Energy Regulatory Commission (FERC) is an independent agency that regulates the interstate transmission and distribution of oil, natural gas, and electricity.^[5] With regard to electricity, FERC focuses on wholesale power markets, market-based rates, demand response and advanced metering, electric reliability, transmission investment, transmission planning and cost allocations, and mergers and corporate transactions. FERC does not regulate retail electricity sales to customers or approve the construction of electric generation facilities, which are jurisdictional responsibilities largely handled at the state level.

SOLAR ENERGY TECHNOLOGIES OFFICE

The Solar Energy Technologies Office (SETO) is part of the U.S. Department of Energy Office of Energy Efficiency and Renewable Energy and funds innovations in solar technologies. In its own words, SETO “supports early-stage research and development in three technology areas: photovoltaics (PV), concentrating solar-thermal power (CSP), and systems integration with the goal of improving the affordability, reliability, and domestic benefit of solar technologies on the grid.”^[6] Funding from SETO supports all facets of the solar market, including improvements in the technical efficiencies of PV systems; improvements in grid performance and reliability; and the creation of new business models.

A sub-program within SETO works to lower the “soft costs” of going solar, which are the non-hardware costs that drive up the expense of installations. Local government processes in areas such as permitting, inspection, and planning and zoning can drive up solar soft costs. To reduce these costs, SETO provides networking and technical assistance, data analysis, business innovation, and training. One program funded by SETO is SolSmart, which provides official designation to local governments that reduce soft costs by addressing obstacles to solar energy development. SolSmart provides no-cost technical assistance to help communities achieve designation.

Beginning in 2011, DOE set a goal for solar electricity to become economically competitive with traditional forms of electricity by 2020 without subsidies (formerly known as the SunShot initiative). The solar industry moved much faster than anticipated toward achieving this goal, prompting more ambitious cost targets.

For utility-scale solar, the DOE goal is to reduce 4.6 cents per kilowatt-hour (kWh) for utility-scale solar in 2020 to 2 cents/kWh by 2030. The goal for residential solar is to reduce costs from 12.8 cents/kWh in 2020 to 5 cents/kWh in 2030. For commercial-scale solar, the goal is to reduce costs from 9 cents/kWh in 2020 to 4 cents/kWh in 2030. (In 2010, the costs per kWh for residential, commercial, and utility-scale solar were 50 cents, 39 cents, and 27 cents, respectively.)^[7]

U.S. ENERGY INFORMATION ADMINISTRATION (EIA)

The U.S. Energy Information Administration (EIA) is a non-partisan statistical agency within DOE that collects comprehensive U.S. energy data and prepares analyses, market forecasts, and long-term outlooks.^[8] The EIA surveys and collects data on a variety of energy markets, including petroleum, coal, and natural gas, as well as renewable energy sources including solar.

This data is accessible free of charge, making the EIA an important resource for local governments. The EIA provides several resources that are particularly useful, notably the State Energy Data System (SEDS). The SEDS database contains a variety of state-specific data, including information on all types of energy consumption by source and sector; energy production; electricity generation; and energy prices. The EIA also provides interactive maps that show the location of energy infrastructure. Additional information can be found in the Electric Power Annual, which includes monthly distributed solar data by state.^[9]

In addition, the EIA publishes an annual report, the Annual Energy Outlook, which makes projections on the future of national energy markets.^[10] This includes projections for the growth of both the utility-scale and distributed solar markets to 2040, based on current laws and policies. The EIA also releases short publications daily with updates on data trends.

State Programs and Practices

Many policies that advance the growth of solar energy are established at the state level. This can include state tax incentives for solar, which provide an additional tax benefit on top of the federal ITC. Other state policies, discussed below, can include:

• Renewable Portfolio Standards (RPS)
• Renewable Energy Certificates (RECs) and Solar Renewable Energy Certificates (SRECs)
• Net Metering and Virtual Net Metering
• Third-Party Financing, including Power Purchase Agreements (PPAs) and solar leases
• Clean Energy Funds
• Low-Interest Loans
• On-Bill Financing and repayment

RENEWABLE PORTFOLIO STANDARDS (RPS)

A Renewable Portfolio Standard (RPS) is a policy or regulation that requires utilities to produce a certain percentage of their energy from renewable sources. These renewables typically include solar, wind, biomass, geothermal, and hydropower.^[11] Since 2000, just under half of all renewable energy generation and capacity is associated with state RPS requirements.^[12]

While the specifics vary by state, an RPS always requires electricity suppliers to source a certain amount of renewable energy over a pre-determined time frame. This is measured either as a percentage of the total energy demand (e.g., 30 percent renewable energy by 2030), or as a quantity of energy produced in MWh. To meet the RPS, utilities can develop their own renewable resources; purchase renewable electricity from third parties; or acquire what are known as Renewable Energy Certificates (RECs), which are discussed below in more detail.

In some cases, utilities can meet the state RPS target using any renewable technologies of their choice. Other times, the RPS will include specific targets for each type of renewable generation, often termed “carve-outs” or “set-asides.”^[13] Set-asides can require that a percentage of the electricity be provided by distributed generation, which in practice often means residential solar installed on rooftops. Without set-asides, larger renewable generation projects, such as wind farms and utility-scale solar, tend to be prioritized due to their lower costs per MW. A distributed energy set-aside creates an opportunity for the growth of rooftop solar and other small-scale renewable generation.

An RPS is usually set statewide and applies to investor-owned utilities. As of 2021, 30 states plus the District of Columbia have adopted an RPS.^[14] Sometimes, however, cooperative and municipal utilities establish an RPS that does not apply to the rest of the state.

RENEWABLE ENERGY CERTIFICATES (RECS) AND SOLAR RENEWABLE ENERGY CERTIFICATES (SRECS)

A Renewable Energy Certificate (REC) equals one MWh of renewable energy. Solar Renewable Energy Credits (SRECs) are a type of REC created specifically by the generation of solar energy. Typically, one SREC is created for each MWh of electricity generated by a solar energy system.^[15]

SRECs are created in markets that include a solar set-aside as part of the RPS.^[16] To meet set-aside mandates, utilities need to either own solar energy installations or acquire SRECs from retail customers who install rooftop solar. Therefore, SRECs can provide a financial incentive for utilities, homeowners, and businesses to install solar energy. Utilities can either purchase SRECs directly from customers or acquire them in the marketplace from SREC brokers.

The price of SRECs can fluctuate dramatically depending on supply and demand. If a state’s RPS targets are well above current solar energy production, utilities will demand more RECs or SRECs, raising the price. The highest price for an SREC is typically set by what is known as an Alternative Compliance Payment (ACP). If a utility does not acquire enough SRECs to meet the RPS, it is subject to fines by the regulator at the ACP level (expressed in dollars per MWh). Since a utility would never pay more for an SREC than the ACP, this effectively caps the market price of SRECs.

As of 2019, states with SREC markets include New Jersey, Massachusetts, Maryland, Delaware, North Carolina, Illinois, Pennsylvania, Ohio, and California, along with the District of Columbia. Many other states participate in REC markets without a carve-out for solar.^[17]

Figure 3: The Life Cycle of an SREC.

NET METERING

Net energy metering, commonly referred to as “net metering,” is designed to compensate utility customers for the electricity they export to the grid.^[18] Most distributed solar PV systems are designed so that the electricity produced is used directly in the residence or business, with any excess amount sent back to the utility. Net metering provides a financial credit to customers based on the value of the electricity not used on-site.

A net metering program typically works as follows. At the end of each billing cycle, the amount of electricity imported from the grid is netted against the electricity exported to the grid. If the imported amount exceeds the exported amount, the customer is billed for the net electricity consumed. If the exported amount exceeds the imported amount, the customer receives a credit that can be used to offset electricity bill payments in future billing cycles. Depending on the policy, these credits can either roll forward indefinitely or expire at the end of some fixed term, such as the end of the calendar year.^[19] Each state enacts policies to set limits on the size of individual systems and on the overall capacity allowed to be net-metered on the grid. These system-wide limitations also help assure grid stability. Tiered policies help ensure that residential-scale PV systems get installed without the overall net metering capacity being filled up with larger-scale net metering projects.

Figure 4: States with Net Metering Policies as of June 2020.^[20]

Net metering is a very important tool for making distributed solar economical for consumers. Without it, many rooftop solar installations, especially at the residential level, would not generate enough savings to justify the investment. As of 2020, 40 states, in addition to Washington, D.C, American Samoa, the U.S. Virgin Islands, Guam, and Puerto Rico, have mandatory net metering policies. In addition, some utilities have voluntarily offered net metering arrangements to customers (for example, in Idaho and Texas).^[21]

The compensation level for net metering varies by state. Many states mandate that utilities compensate net metering customers at the full retail rate for electricity. Other states set compensation at a different level, such as the much lower wholesale rate, while others set it at a midpoint between wholesale and retail. Net metering policies are under active discussion in many states and the topic of spirited debate, particularly as market conditions change and increasing numbers of residential consumers go solar. Utilities sometimes object that net metering unfairly exempts distributed solar consumers from paying their fair share of costs to support the maintenance of the grid. However, distributed solar also provides many benefits to the grid, which can include deferring the need for investment in new capacity, creating local jobs, reducing greenhouse gas emissions, and generating energy at the local level.

NET METERING PROGRAM DESIGN

Net metering policies usually include the following details:

• Eligible Technologies: Net metering policies stipulate which renewable energy sources can be net metered, typically including solar PV, wind, geothermal, biomass, and fuel cells.
• System Size Caps: Net metering policies will often specify the maximum allowable system size that can be net metered. These size caps can either be in terms of total capacity (e.g., kW) or percentage-based (e.g., percentage of maximum daily load).
• Program Size Caps: Net metering policies usually set a size cap on the total amount of net metering systems installed in a particular region or utility territory. When these programs size caps are reached, many states reevaluate the net metering policies, often acting to increase the program size cap.
• Customer Type: Net metering policies specify which electricity customers are eligible (e.g., residential, commercial, etc.).
• Net Excess Generation: Net metering policies establish how the customers will be billed for excess electricity distributed to the grid (e.g., whether customers are credited at retail rate or less than retail rate, as well as when credits expire).
• Ownership of RECs: Most net metering policies allow customers to maintain ownership of the RECs associated with their electricity output.

VIRTUAL NET METERING

A variation on net metering policies is known as virtual net metering, which uses the same compensation mechanism and billing methods without requiring that a customer’s PV system be located on-site.^[22] Rather, customers can own a share of an off-site solar project (also known as community solar, shared solar, or a solar garden) and receive a credit on their electricity bill for their share of the energy produced. Virtual net metering is one of the key policies that is necessary for a community solar program to be successful.

THIRD-PARTY FINANCING

Third-party financing, also known as third-party ownership, is available in many states for customers who are unable or unwilling to finance the cost of a solar project themselves. Historically, it has been one of the most popular methods for installing residential and commercial solar energy systems.^[23] More recently, however, as costs have come down, an increasing number of residential customers are using cash purchases and loans.^[24] Third-party financing typically takes the form of one of two models. In one approach, a customer signs a power purchase agreement (PPA) to pay a third party a specified rate for the electricity generated each month. In the second model, a customer signs a solar lease and pays a monthly rate for the use of a PV system. Below is a brief overview of how these two financing models work.

POWER PURCHASE AGREEMENTS (PPAS)

Under the power purchase agreement model of third-party ownership, a customer signs a PPA for the project developer to sell electricity at a rate determined in the contract. The developer builds, owns, and operates a solar energy system at the customer’s home or business (with the customer referred to as the “host”). Most often, the electricity rate the developer charges is comparable to, if not less than, the retail rate of electricity. A PPA allows the customer to enjoy the benefits of solar energy without paying the up-front capital cost of installing a PV system. The project developer is also responsible for system operations and maintenance.

In a PPA contract, the project developer receives a combination of revenues and incentives which help offset the capital cost of the project. These include electricity sales to the host and proceeds from any SREC sales to third parties, as well as any state and federal tax incentives. In most cases, at the end of a PPA contract term, property owners have the option to extend the contract, purchase the system from the PPA provider, or have the system removed from their premises. As of June 2019, 28 states along with Washington, D.C. and Puerto Rico allow PPAs.^[25]

SOLAR LEASES

Solar leases are similar to PPAs in many respects. The difference is that the monthly rate covers the solar system itself, rather than the cost of electricity. Under the solar lease model, customers sign a contract with a solar developer and agree to pay a specified rate over the life of the lease, which typically covers 10-20 years. As with PPAs, solar lease customers do not own the PV system and the project developer is responsible for system operations and maintenance. The project developer typically receives any SRECs and all federal or state tax benefits available. At the end of the lease contract, the customer can extend the lease, buy the system, or have the system removed. In certain markets where PPAs are not permitted by law, solar leases may be the only third-party option available. In other states, however, neither solar leases nor PPAs are permitted.

CLEAN ENERGY FUNDS

State clean energy funds are another way to support renewable energy, energy efficiency, or low-income energy programs. They are capitalized by a small surcharge on electricity consumption, as well as by voluntary donations and utility settlements. These funds can directly pay for renewable energy projects, support rebate programs for renewable energy systems, or provide loan support mechanisms. They can also be used to fund research and development, demonstration projects, and consumer outreach and education.^[26]

LOW-INTEREST LOANS

Some states, often through their clean energy funds, offer low-interest loans or loan guarantees to support improvements in energy infrastructure, including distributed solar projects. Terms and interest rates vary on a state-by-state basis. As an example, Massachusetts recently offered the Mass Solar Loan program, which made low-interest loans available for solar installations and provided additional loan support for lower-income borrowers. The program supported nearly 5,800 projects, more than half of which were held by low-income consumers.^[27]

ON-BILL FINANCING AND REPAYMENT

On-bill financing and repayment is a way for utilities to help customers invest in renewable energy projects. On-bill financing typically refers to financing that is provided directly by the utility, whereas on-bill repayment typically refers to a third party providing the financing with the repayment being made through the utility bill. Customers receive loans from a state energy office, a financial institution, or the utility itself. Loan payments are directly incorporated into the utility bill and are repaid monthly by the customer.^[28]

On-bill financing has two distinct advantages compared to a traditional loan. The first is that the loan pays for investments that result in lower electricity costs, so both the cost savings and the loan payment will be reflected on the same bill. Ideally, the electricity savings will offset the loan repayment costs and demonstrate the value of the investment. A second advantage is that since the loans are tied directly to utility service, the utility is able to suspend service to customers who fail to make the loan payments, which helps to deter loan defaults.^[29] In practice, however, utilities can be hesitant to suspend service, and regulations often limit their ability to cut off a customer’s power.

ENDNOTES

[1] Solar Energy Industries Association, Solar Investment Tax Credit, https://www.seia.org/initiatives/solar-investment-tax-credit-itc (accessed Aug. 21, 2021).

[2] IRS, A Brief Overview of Depreciation, https://www.irs.gov/businesses/small-businesses-self-employed/a-brief-overview-of-depreciation (accessed June 1, 2017).

[3] Alexandra Aznar, Word of the Day: PURPA, National Renewable Energy Laboratory, April 10, 2015, https://www.nrel.gov/state-local-tribal/blog/posts/word-of-the-day-purpa.html.

[4] American Public Power Association, The Public Utility Regulatory Policies Act of 1978, https://www.publicpower.org/policy/public-utility-regulatory-policies-act-1978 (accessed August 21, 2020).

[5] Federal Energy Regulatory Commission, https://www.ferc.gov/ (accessed June 1, 2017).

[6] U.S. Department of Energy, About the Solar Energy Technologies Office, https://www.energy.gov/eere/solar/about-solar-energy-technologies-office (accessed August 20, 2021).

[7] U.S. Department of Energy, Goals of the Solar Energy Technologies Office, https://www.energy.gov/eere/solar/goals-solar-energy-technologies-office (accessed Aug. 20, 2021).

[8] Cara Marcy, Top five sources for solar data available at EIA, National Renewable Energy Laboratory, July 8, 2016, https://www.nrel.gov/state-local-tribal/blog/posts/top-five-sources-for-solar-data-available-at-eia.html.

[9] U.S. Energy Information Administration, Electric Power Annual, https://www.eia.gov/electricity/annual/ (accessed December 10, 2018).

[10] U.S. Energy Information Administration, Annual Energy Outlook 2021, Feb. 3, 2021, https://www.eia.gov/outlooks/aeo/.

[11] Sadie Cox, et al., Solar Power: Policy Overview and Good Practices, Clean Energy Solutions Center, 2015, http://www.nrel.gov/docs/fy15osti/64178.pdf.

[12] Galen Barbose, U.S. Renewables Portfolio Standards 2021 Status Update: Early Release, Lawrence Berkeley National Laboratory, February 2021, https://emp.lbl.gov/publications/us-renewables-portfolio-standards-1.

[13] Sadie Cox, et al., Solar Power: Policy Overview and Good Practices, Clean Energy Solutions Center, 2015, http://www.nrel.gov/docs/fy15osti/64178.pdf.

[14] Galen Barbose, U.S. Renewables Portfolio Standards 2021 Status Update: Early Release, Lawrence Berkeley National Laboratory, February 2021, https://emp.lbl.gov/publications/us-renewables-portfolio-standards-1.

[15] Lori Bird et al., Solar Renewable Energy Certificate (SREC) Markets: Status and Trends, National Renewable Energy Laboratory, 2011, http://www.nrel.gov/docs/fy12osti/52868.pdf.

[16] Jenny Heeter et al., Implications of the Scheduled Federal Investment Tax Credit Reversion for Renewable Portfolio Standard Solar Carve-Out Compliance, National Renewable Energy Laboratory, 2015, http://www.nrel.gov/docs/fy15osti/64506.pdf.

[17] SRECTrade, Solar Renewable Energy Certificates,” https://www.srectrade.com/markets/rps/srec/ (accessed Aug. 20, 2021).

[18] “Net Metering,” NREL: State, Local, & Tribal Governments, https://www.nrel.gov/state-local-tribal/basics-net-metering.html (accessed May 27, 2017).

[19] “Net Metering,” NREL: State, Local, & Tribal Governments, https://www.nrel.gov/state-local-tribal/basics-net-metering.html (accessed May 27, 2017).

[20] Detailed Summary Maps, DSIRE, NC Clean Energy Technology Center, http://www.dsireusa.org/resources/detailed-summary-maps/ accessed August 21, 2020.

[21] Detailed Summary Maps, DSIRE, NC Clean Energy Technology Center, http://www.dsireusa.org/resources/detailed-summary-maps/ (accessed August 21, 2020).

[22] “Net Metering,” NREL: State, Local, & Tribal Governments, https://www.nrel.gov/state-local-tribal/basics-net-metering.html (accessed May 27, 2017).

[23] Solar Energy Industries Association, Third-Party Solar Financing, http://www.seia.org/policy/finance-tax/third-party-financing (accessed June 2, 2017).

[24] Mike Munsell, Share of Third-Party-Owned Systems at Record-Low Levels in US Residential Solar, Greentech Media, May 1, 2018, https://www.greentechmedia.com/articles/read/share-of-third-party-owned-systems-at-record-low-levels-in-us-resident#gs.gHfW1WI.

[25] Detailed Summary Maps, DSIRE, NC Clean Energy Technology Center, http://www.dsireusa.org/resources/detailed-summary-maps/ (accessed August 21, 2020).

[26] Michael Mendelsohn and Claire Kreycik, Federal and State Structures to Support Financing Utility-Scale Solar Projects and the Business Models Designed to Utilize Them, National Renewable Energy Laboratory, April 2012, http://www.nrel.gov/docs/fy12osti/48685.pdf.

[27] MASS Solar Loan, Program Metrics, https://www.masssolarloan.com/program-metrics, (accessed Aug. 21, 2020).

[28] U.S. Department of Energy, On-Bill Financing and Repayment Programs, https://energy.gov/eere/slsc/bill-financing-and-repayment-programs (accessed June 5, 2017).

[29] Philip Henderson, On-Bill Financing: Overview and Key Considerations for Program Design, Natural Resources Defense Council, July 2013, https://www.nrdc.org/sites/default/files/on-bill-financing-IB.pdf.