Following is a discussion of the ways in which rules and regulations relating to municipal taxation might be modified in order to allow for the large scale financing of energy efficiency measures and/or renewable energy among smaller energy consumers.
These days, governments are looking for ways to sensitize citizens to the fight against climate change and the need to manage energy consumption. Through subsidies, the government encourages reduced energy consumption and greenhouse gas (GHG) emissions. Without addressing the energy consumption of existing buildings, it will be difficult for provincial and federal governments to attain their energy efficiency and GHG reduction targets. In Québec, residential, commercial and institutional emissions represented 12.5 per cent of total GHG emissions province-wide in 2008, according to the inventory of the Minister of Sustainable Development, Environment and Parks published in 2010. This constitutes an improvement of 4.8 per cent in relation to 1990 figures. However, despite this positive showing, the percentage of GHG emissions in this sector as it relates to the whole of the province’s emissions merits our attention. In Québec, the reduction of domestic electricity consumption frees up pools of electricity for export and helps ensure supply for future demands such as the electrification of transportation services.
Paying for the execution of energy efficiency measures and renewable energy with the savings generated by such measures for large-scale buildings is a proven business model. The problem with renewable energy programs and/ or energy efficiency measures on a small scale, is that the initial capital costs are often too high for the potential consumer, even in the presence of subsidy programs such as Rénoclimat in Québec. Under this program, the incentive for geothermal systems can be up to $3,000 or just less than 10 per cent of the total cost.
In the absence of sufficient funds to pay for these measures, individuals or small enterprises must borrow, providing security to guarantee the repayment of the loans. This can be problematic for banks and other institutional lenders as the targeted buildings are often already subject to a lien. Furthermore, where security is available, lenders are not amenable to structuring loans based on the energy savings of the building.
A solution to this problem is an instrument designed for municipal governments which allows them to stimulate a local green economy. Energy efficiency and renewable energy projects are financed by funding programs targeting residential and commercial owners in the municipality.
Developed in California in 2009, Property Assessed Clean Energy (PACE) bonds are now permitted by legislation in 25 states in the United States. In some states, laws relating to municipal taxation already allowed PACE bondtype structures, whereas in others, legislative modifications were required. To our knowledge, the only similar programs in Canada are in Vancouver, where the city is planning to offer “On-bill Financing” in 2011, and in Halifax, with its Community Solar project. In both cases, the cities require legislative amendments to allow the programs to be put in place.
The finer details of PACE bond programs may vary, but in general, they function as follows:
- A local government creates an energy efficiency program that extends to the municipality as a whole or to a specified improvement area.
- The local government finds a financial partner that procures the necessary funds either public or private.
- If the funds are private, the municipality will issue a bond to reimburse the money provided by the financial partner. This bond will be guaranteed by a land tax on the buildings within the participating improvement area.
- Participation is voluntary and only those participating are taxed.
- The product of the sale of the bond is then used to finance the renewable energy and/or energy efficiency projects as approved by the technical advisers, which allows for a relatively accurate projection of the energy savings generated, which can be either public or private.
- Where an application for renovation by a landowner is accepted, the city pays a contractor to perform the work and, upon completion, imposes a special land tax on the building in question which appears on the owner’s property tax bill.
- The tax payment is fixed and generally structured such that, for a time, the annual payments do not exceed the energy cost savings generated by the energy efficiency measures.
- Like other real estate taxes, in the event of foreclosure this tax is paid before any mortgage creditor on the property: only taxes in arrears are prior.
- There is little or no cost for the landowner and, if the property is sold before the end of the reimbursement period, the new owner inherits, not only the improvements, but also the obligation to pay the tax until full payment is received.
One of the most interesting aspects of a PACE bond-type program is the positive effects it has on all parties.
Landowners benefit from:
- The elimination of cost barriers to improvements to residential or commercial buildings that will result in the adoption of renewable energy and/or improvements to the energy efficiency.
- Loan costs which can be structured to be lower than the cost savings, freeing up revenue for other purposes.
- Lower energy bills and therefore reduced vulnerability to increases in energy prices.
- The transfer of the property tax to the new owner at the time of sale which frees the former owner from the continuing obligation to “pay” for the improvements.
Provinces, cities and municipalities benefit from:
- Immediate job creation and increased business opportunities for the suppliers of smallscale renewable energy and energy efficiency solutions.
- Reduction of GHGs, energy consumption and energy dependence in addition to improved quality of life.
- A program that is a natural complement to the efforts of a municipality to reduce its own GHG emissions, but which does not control those generated by commercial and residential buildings.
- Low or no costs for the municipality.
- Increased capacity of the electric grid to service new technologies (i.e., electric cars).
- The voluntary nature of the program: only participating landowners have payment obligations.
Financiers benefit from:
- Reimbursement that is guaranteed by a tax, where any default will be remedied by a subsequent purchaser.
Existing mortgage lenders benefit from:
- Increased liquidity for the mortgagee, which can reduce the risk of mortgage default.
- Increased value of the secured property in that it is more energy efficient.
- Low levels of prior ranking debt represented by the arrears in the special property tax, which, in the event of default, will represent a marginal amount in relation to the value of the secured property.
In the United States, PACE programs have come up against opposition primarily from the Federal Housing Finance Agency (FHFA), Fannie Mae and Freddy Mac. The FHFA’s objection relates to the existence of a new indebtedness that will rank above the mortgage lender’s security in relation to the secured property. The FHFA also raises the possibility that the work executed will fail to produce the desired results, which would have a negative effect on the market value of the building. Arguments raised against these fears include the following:
- In the event of a default, only the arrears rank ahead of the mortgage creditor, a situation that already exists for other municipal taxes.
- Programs can be structured to give increased protection around the evaluation of the efficiency or execution of the measures. Guarantees of all kinds, including performance bonds and guarantees, may be used.
Although in many provinces, capability to establish a PACE bond program might be inherent in existing municipal tax regimes, it may be preferable that a separate law be enacted. A specific law would allow the governments to correctively address aspects of these programs which have raised objections in the United States.
The adoption of the PACE bond program would allow provincial and municipal governments to reduce GHGs created by the use of small commercial and residential buildings, a category where reductions are difficult to achieve due to costs associated with such projects. According to the site www.pacenow.org, the results of a pilot project in Sonoma County, California demonstrated a reduction of 1,900 tonnes of CO2e equivalent over the 1,148 residences and 22 commercial properties that adhered to program.
In parts of Canada, where our historical wealth of renewable energy might suggest that reductions in electricity consumption do not result in significant reductions in GHG emissions as compared to jurisdictions where energy is created using fossil fuels, a PACE bond program can have a secondary GHG reduction effect in that it will free up renewable energy for export. Also, a reduction in energy generated from fossil fuels would allow the more rapid increase of infrastructure for electric transport (such as, for example, charging posts or stations for electric cars or other modes of electric transportation).
We believe that the adoption of a municipal tax structure facilitating PACE bond programs would allow Canada to distinguish itself internationally in terms of the strength of its support for a green economy. Indeed, the adoption of such measures will open a new pool of customers to contractors offering green building solutions.
The genius of this idea is that it allows provincial governments to create the mechanism whereby a market need can be matched with a financial service, without necessarily creating an additional demand on the financial resources of provincial or municipal governments.