Researchers who concluded in 2019 that U.S. taxpayers might not be getting what they pay for with a refined coal tax credit published a new study finding that the program may also be driving power generators to increase greenhouse gas emissions. The refined coal tax credit was added to the tax code by the American Jobs Creation Act of 2004.

Resources For the Future researchers Brian Prest and Alan Krupnick published a June 2019 study indicating that many of the companies collecting an annual total of nearly $1 billion from the refined coal tax credit were not actually achieving the required 20% nitrogen oxide and 40% mercury and sulfur dioxide emissions reductions. New follow-up research by the pair shows that the tax program, which attracted the scrutiny of the Internal Revenue Service and some members of Congress, is more problematic than the team initially thought.

The credit is for companies treating coal with chemicals to reduce emissions of certain air pollutants from coal-fired power plants. However, the 2019 research from the independent nonprofit determined that the use of lab tests rather than field tests was not appropriately reflecting the amount of pollution emitted. That allows some coal plants to fall short of lawmakers' intended emission reductions, even if they may technically be in legal compliance with IRS guidelines allowing either test.

"Worse, the tax credit delays the retirement of otherwise uneconomic coal plants, which increases CO2 emissions and exacerbates climate change," Prest said in an email about the new study. "Taxpayers should be concerned that we are paying for a process that doesn't work as well as it is supposed to."

The study found that this effect is somewhat offset by the program, with cuts in CO2 emissions from coal plants burning unrefined coal. However, the new research concluded that the policy still leads to a net rise in CO2 emissions. The overall effect is that the costs of the program outweigh the health benefits from reduced nitrogen oxide, sulfur dioxide and mercury emissions even if the plants achieve targeted reductions.

The research concluded that the tax credit's social welfare cost of about $7 per ton of refined coal burned, or about $1 billion per year, is dwarfed by the net climate and health effects and that it may be advisable to eliminate the credit altogether.

"The policy's costs are nearly five times larger than its benefits," Prest said. "At the very least, this suggests that the policy would be more effective if the IRS required evidence that the emission reductions targets are actually achieved at the power plants in question, and not just in a lab test. "

Third-party investors typically own the coal refining facilities, which are relatively cheap to build and often located on-site at coal-fired power plants. Refiners can buy the coal and then sell it back to the utility below costs as they collect the tax credits and even pass some of the benefits to power plant owners.

The study noted that about one-fifth of the coal burned in the U.S. power sector was refined coal, comprising about 128 million tons in 2017.

Sens. Sheldon Whitehouse, D-R.I., Elizabeth Warren, D-Mass., and Sherrod Brown, D-Ohio, called on the IRS to justify its award of the tax credits in June 2019. In December 2019, the same group asked the Government Accountability Office to audit the program. They said the program permitted refiners to claim roughly $1 billion in tax write-offs based on "questionable pollution data" and noted that many of the refiners were owned by financial services companies.

Illinois-based global insurance brokerage and risk management services firm Arthur J. Gallagher & Co. is one of the companies the senators said benefits from the program through investments in refined coal facilities. CFO Douglas Howell has taken credit for creating a "machine" using the refined coal tax program and said during a March 2018 investor meeting that it generated multiples of up to 500%.

Gallagher & Co.'s annual report shows the company owns 34 commercial clean coal production facilities qualified to produce refined coal. The tax credit expired for 14 of the plants at the end of 2019, and the remainder will no longer qualify for the program after 2021.

The company began generating tax credits from the program in 2009 and collected $1.36 billion in offsets from the program as of the end of 2019. Gallagher & Co. used about $427.0 million to offset U.S. federal tax liabilities and plans to have the remainder available for future years.

However, negative publicity and concern from members of Congress about the tax program may "call into question the validity of existing tax credits," the company warned in its annual report. Gallagher & Co. said the IRS is auditing several of its refined coal partnerships, and one received a notice disallowing co-investors from claiming tax credits. That partnership prevailed in tax court in August 2019, but the IRS appealed the ruling.

Federal disclosures show that Gallagher & Co. paid two companies a total of $127,500 in the fourth quarter of 2019 to lobby Congress for issues related to tax credits, including a push to extend the life of the refined coal tax credit.