How Clean is “Refined Coal”? An Empirical Assessment of a Billion-Dollar Tax Credit Brian C. Prest and Alan Krupnick Report 19-05 June 2019; rev. Nov. 2019, Feb. 2020, and Aug. 2020 How Clean is “Refined Coal”? An Empirical Assessment of a Billion-Dollar Tax Credit i About the Authors Brian C. Prest Brian Prest is an economist at Resources for the Future specializing in climate change, oil and gas, and electricity markets. Prest uses economic theory and econometric models to understand energy supply dynamics and improve the design of environmental policies. In his current work, he is assessing the impacts of poor incentive structures in electricity markets on plant emissions and negative prices. He is also working to establish an empirical basis for determining discount rates used in the social cost of carbon. His past work includes econometric analysis of the US oil and gas industry, modeling the intertemporal dynamics of climate change policy under policy uncertainty, and assessing household responses to dynamic electricity pricing. His work has appeared in the Journal of the Association of Environmental and Resource Economists, Energy Economics, and The Energy Journal. Prior to joining RFF, Prest earned his PhD at Duke University and previously worked in both the public and private sectors. At the Congressional Budget Office, he developed economic models of various energy sectors to analyze the effects of proposed legislation, including the 2009 Waxman-Markey cap-and-trade bill and related Clean Electricity Standards. At NERA Economic Consulting, he conducted electricity market modeling, project valuation, and discounted cash flow analysis of various infrastructure investments in the United States, Latin America, Europe, Africa, and Southeast Asia, with a focus on the power sector. Alan Krupnick is a Senior Fellow at Resources for the Future. Krupnick’s research focuses on analyzing environmental and energy issues, in particular, the benefits, costs and design of pollution and energy policies, both in the United States and abroad. He leads RFF’s research on the risks, regulation and economics associated with shale gas development and has developed a portfolio of research on issues surrounding this newly plentiful fuel. Krupnick also served as senior economist on the President‘s Council of Economic Advisers, advising the Clinton administration on environmental and natural resource policy issues. In 2011 he was elected President of the Association of Environmental and Resource Economists and earlier that year was named an AERE Fellow. He has served on the Editorial Boards of a number of journals. He co-chaired a federal advisory committee counseling the U.S. Environmental Protection Agency on the implementation of new ozone and particulate standards. He is a regular member of expert committees from the National Academy of Sciences, the USEPA and various Canadian government and non-governmental institutions. Krupnick also consults with state governments, federal agencies, private corporations, the Canadian government, the European Union, the Asian Development Bank, the World Health Organization, and the World Bank. He received his PhD in Economics from the University of Maryland in 1980. Resources for the Future i About RFF Resources for the Future (RFF) is an independent, nonprofit research institution in Washington, DC. Its mission is to improve environmental, energy, and natural resource decisions through impartial economic research and policy engagement. RFF is committed to being the most widely trusted source of research insights and policy solutions leading to a healthy environment and a thriving economy. The views expressed here are those of the individual authors and may differ from those of other RFF experts, its officers, or its directors. Sharing Our Work Our work is available for sharing and adaptation under an Attribution- NonCommercial-NoDerivatives 4.0 International (CC BY-NC-ND 4.0) license. You can copy and redistribute our material in any medium or format; you must give appropriate credit, provide a link to the license, and indicate if changes were made, and you may not apply additional restrictions. You may do so in any reasonable manner, but not in any way that suggests the licensor endorses you or your use. You may not use the material for commercial purposes. If you remix, transform, or build upon the material, you may not distribute the modified material. For more information, visit https://creativecommons.org/licenses/by-nc-nd/4.0/. How Clean is “Refined Coal”? An Empirical Assessment of a Billion-Dollar Tax Credit ii How Clean is \Refined Coal"? An Empirical Assessment of a Billion-Dollar Tax Credit Brian C. Prest∗ and Alan Krupnicky August 4, 2020 Abstract US tax law provides nearly $1 billion annually in tax credits for\refined coal", which is supposed to reduce local air pollution. Eligibility for the credit requires firms to demonstrate legally specified emissions reductions for three pollutants. Firms typically demonstrate eligibility through laboratory tests, but results from the lab can differ from those in practice. Using a nationally comprehensive boiler-level panel dataset, we find that emission reductions in practice are only about half of the levels required, and even then only arise when certain pollution controls are installed. We also show that the policy reduces social welfare, resulting in costs more than seven times the benefits, in part because of a \rebound" effect in which the subsidy increases coal use by extending the operational life of some coal plants. Because the tax credit is up for reauthorization in 2021, our work has immediate policy relevance. Keywords: coal, electricity, air pollution, taxes and subsidies ∗Corresponding author. Resources for the Future, 1616 P St NW, Washington, DC 20036. E-mail: prest@rff.org. We appreciate helpful comments, suggestions, and data provided by Jeremy Schreifels and Justine Huetteman, as well as comments from seminar participants at Resources for the Future, the En- vironmental Protection Agency Clean Air Markets Division, the AERE 2019 summer conference, and the ASSA 2020 annual conference, including our discussant Glenn Sheriff. We also appreciate suggestions from Daniel Shawhan and adept research assistance by Paul Picciano in running the E4ST model. The authors received no specific funding for this research. The paper was written while Prest was a Postdoctoral Fellow generously funded by the Alfred P. Sloan Foundation. yResources for the Future, 1616 P St NW, Washington, DC 20036. E-mail: krupnick@rff.org. 1 Introduction A significant and growing number of coal-fired power plants in the United States are using coal that has been \refined" prior to burning to supposedly emit less nitrogen oxides (NOx), sulfur dioxide (SO2), and mercury (Hg). This \refined" coal|if it meets certain restrictions and targeted reductions in these pollutants|qualifies for a tax credit of approximately $7 per ton of coal. This subsidy is not small. In 2017 this tax credit cost the US Treasury an estimated $1 billion, and this figure has been growing. The tax credit can be claimed by owners of coal refining facilities, which are often built on-site at power plants but are typically owned by third-party investors, who range from members of the pharmaceutical industry to large financial services companies.1 Because these third party investors who claim the credit are often distinct from the power plant owners, the investors typically have no role in the operation of the power plant. Coal power plant owners do benefit indirectly, however, as refiners pass on a portion of the tax credit to them in exchange for the right to refine the coal before it is burned. As tax instruments have a long history in economics dating back to Pigou (1920) as tools for achieving environmental goals, this policy might be socially valuable if the tax credit was designed well and actually led to the required reductions in these pollutants. In this paper, we find the policy fails on both counts. Not only is the policy's design economically inefficient, but the emissions reductions are often much smaller than the targets stipulated 2 in the tax law. We estimate emission rates of NOx, SO2, and Hg from burning refined coal and its unrefined counterpart. The tax law requires 20 percent reductions in NOx emissions rates (i.e., NOx emitted per unit of thermal energy burned) and 40 percent reductions in SO2 or Hg emissions rates, which are typically verified through laboratory tests unrelated to actual plant operations. By contrast, we estimate that in practice plants achieve negligible reductions in SO2 emissions rates, and the reductions in NOx and Hg rates fall far short of the targets in the tax law. One reason for this is that refined coal is only effective at reducing emissions when certain other pollution control technologies are installed (a necessary, but not suffi- cient, condition), but the tax law does not include any requirements regarding those other technologies. Further, even when those technologies are installed, we find that refined coal still does not achieve the 20 percent and 40 reduction requirements set forth in the tax 1According to Reuters, one firm alone has claimed a total of $850 million from this tax credit over the past decade (McLaughln 2019). 2While there are no academic papers looking at the performance of refined coal, the story in Reuters (McLaughln 2019) reports that total NOx emissions actually increased at many plants but did not control for other factors (such as electricity generation), or estimate emissions rates, which are the target of the refined coal legislation. 1 law. We find no evidence that any particular plant achieves the law's reduction targets{and significant evidence that on average they do not. Our analysis is robust to a number of sensitivity analyses, including considering possible changes in the use of NOx control devices and changes in coal sulfur or mercury content, which we present in the appendix.