Grow It Here, Make It Here, Part 2

A progressive tax credit, or tax futures, should not be a license to print money -- but rather, an opportunity to make money in reasonable market conditions.

By JIM LANE, Editor & Publisher, Biofuels Digest

Jim Lane SquareThis is part two of a two-part piece. Part one can be found here.

Risk, Volatility & Opening New Markets

If there is one area of focus that would ensure the steady conversion to domestic manufacturing, and domestic jobs, through transition to the bio-based economy — it is in the reduction of market volatility. The market risk (and the policy risk, in the lack of long-term policy to address the problems of volatility), is what chills the financing of bio-based industry at scale.

A simple, flexible tax provision could change all this. U.S. income taxes are progressive — those doing well pay more, those less well-off pay less. Yet fuel taxes are fixed. Why not make them progressive?

When markets create crush spread conditions that favor bio-based industry — such as in the 2005 to 2007 ethanol boom market, why can’t bio-based industries pay a higher tax rate? When market conditions are unfavorable, why can’t fuel taxes be lower or even reverse into tax credits?

Over time, as bio-based industry gains stability and technological advancement, and oil continues to become more volatile and expensive, the long-term tax outlook would be stronger. The nation would earn more in the long run from fostering a strong industry that can pay higher rates in the favorable conditions that are generally expected over the long term. While industry is at small scale and the long-term advantage for bio-based over fossil-based has not yet fully emerged, the industry would benefit from a tax advantage.

Essentially, this is the goal of government policies that provide tax credits and incentives — only, because they provide fixed subsidies and fixed timelines, they inevitably are too much or too little, laying too long or for not long enough. Flexibility could take the agony out of energy tax policy, and simply make the fuel taxes progressive and make the wealthy pay their fair share — only, in this case, wealthy companies with strong, established technologies.

Tax Futures as a Stability Vehicle

Now, one of the difficulties of these systems is that the costs become uncertain — no one could say for sure how long the credits would run and cost, because no one can accurately predict future oil prices, and hence the advantage that bio-based production would have over fossil-based fuels and products.

So, another possibility is to provide time-denominated tax futures. Now, what are those? Well, let’s say that the crush spread for a given advanced biofuels company in 2014 is insufficiently advantaged over oil prices, because oil prices have unexpectedly dipped. In today’s setup, that biorefinery would have to shut down production — creating a repayment crisis for the company’s construction debt and possible bankruptcy, and a loan guarantee crisis if the company had received one. Bad news all around.

In our proposal, the company would receive, say, a tax credit that would cover that shortfall — enabling the company to continue production, pay its loans and keep its workers employed. The difference between the credit and its normal tax rate would become a note, repayable by 2029, bearing interest at the government inter-bank rate (today it’s at 0.25 percent).

The company would retire the note by paying, in essence, higher taxes during good times. The U.S. government would recoup all the expected tax dollars, plus interest. The company would have a mechanism to assure its lenders, communities and employees of business continuity. Over time, as bio-based became stronger and fossil-based became weaker (i.e. oil prices rose higher and higher), the program would be used less and less.

Let Markets Work in Picking Technology Winners

Now keep in mind, this is not a credit for the difference between a company’s production price and market price — it addresses feedstock volatility, period. If a company’s process is only yielding , say, 50 gallons per ton of biomass, instead of a hoped-for 100 gallons per ton, that is technology risk, and companies that fall short can and should be crushed in the marketplace.

A progressive tax credit, or tax futures, should not be a license to print money — but rather, an opportunity to make money in reasonable market conditions. The government could easily lay off these obligations by selling them in the open market in convertible form.

For example, let’s say that Company A racked up $10 million in future tax obligations in the form of notes payable in 2029. The government might sell those for, say, $9 million, in the open market to outside investors, who would acquire not only the debt, but also conversion rights into equity. Provisions like these would protect the government from holding excessive amounts of debt, and ensuring that there is pressure on the board of directors (facing dilution) to repay their obligations as fast as possible.

Betting on Good Ol’ American Know-How (Or Brazilian, Indian or Chinese …)

Sure, it’s a bet on bio-based and good ol’ American know-how, and a bet that domestic manufacturing will win in the long term. But it’s a bet that national governments should be comfortable in making — in essence, it is the country backing itself to win in the long term.

And it’s a mechanism that can be used in Brazil, India, China, Australia or the EU just as easily as in the United States. And that might bring on a better world, faster and cheaper. Bring it on.

To read part one of this two-part series, please click hereCopyright 2012; Biofuels Digest