Death and Taxes (and ESG)

By Matt Davis

“…but in this world nothing can be said to be certain, except death and taxes.” – Benjamin Franklin

Taxes are a necessary part of life. While we can endlessly debate everything from what our tax rates are to how our tax dollars are spent by our elected representatives, they enable our country to function. While taxes are timeless, in recent years, we, as a society, have become increasingly aware of the negative impact we have on our environment. Corporations, investors and individuals are more than ever focusing on the importance of ESG (environment, social, governance). 

Tax credit investing offers investors an opportunity to do two things in a very efficient manner: 1) generate a positive investment return on capital earmarked to service federal and state tax liabilities, and 2) invest dollars allocated for taxes into ESG enabling projects.  

The tax credit market provides a powerful tool for corporations and individuals to further ESG impact investment objectives. Let’s examine how the tax credit market is becoming a valuable component in a cycle of ESG success.

Corporations: Most companies are actively pursuing an ESG agenda. Corporations are actively reducing their energy consumption, improving their water usage, diversifying their hiring standards and boards, and giving back to their communities. Many of these companies have utilized tax credits historically because it provides a powerful return on dollars that are earmarked for state and federal tax liabilities. They are now realizing the positive impact these investments have on their ESG strategies.

Asset Managers: Asset managers are constructing mutual funds, ETFs and managed portfolios that integrate ESG principles into their investment criteria. Asset management companies like BlackRock have been at the forefront of this movement. Citing preliminary studies, many asset managers believe investing in companies with sound ESG policies will outperform investing in companies without such policies.  These portfolio managers and analysts are looking beyond traditional financial and business cycle metrics that have driven their investment process for generations. They are now also weighing a target company’s efforts to successfully manage their businesses while incorporating ESG principles. They demand that the companies in which they invest are working to reduce their carbon footprints, improve their transparency, diversify their workforces and management teams, and support the communities where they operate. 

Rating Agencies: Investors of all kinds rely on rating agencies and their invaluable work to monitor the financial health of the companies they cover. Companies like Morningstar, Moody’s, S&P and Fitch provide critical analysis and ratings for a wide swath of corporate America that are an indispensable component of investors’ valuation process. There are companies like MSCI, SASB and Sustainalytics that are focusing specifically on the ESG metrics of the companies they monitor. This evolving function will be critical for investors to analyze companies and ultimately determine where capital will be allocated based on the perceived effectiveness of corporate ESG programs and policies. 

The Cycle of ESG Success in Action:

Here’s how tax credit investments can contribute to an ESG cycle of success:

1. CORPORATE INVESTS – A corporation invests $25 million into a federal Solar ITC partnership.  This investment is funded with capital earmarked for federal tax payments. This investment directly combats climate change, which positively impacts all of our futures.
2. POSITIVE ENVIRONMENTAL IMPACT – This investment adds 66 MWdc of clean, renewable energy to the utility grid. It reduces carbon emissions by 60K metric tons per year. It also reduces the company’s federal tax liability and improves their earnings per share.
3. RATING AGENCY RECOGNITION – Rating agencies that incorporate ESG metrics into their rating criteria capture the positive benefits of this company’s investment in renewable energy.
4. INVESTOR PARTICIPATION – Asset managers responding to their clients’ needs are constructing ESG favorable portfolios. Along with their own expertise, they rely on the work of credit agencies to identify companies that are actively improving their ESG profiles. Our corporation’s $25 million investment in the Solar ITC is a material positive that ratings agencies and investors reward.
5. STAKEHOLDER VALUE – This company’s positive investment in solar energy has a direct positive impact on the environment. This positive impact can be highlighted in the annual report raising the visibility of the company with ESG savvy investors, thereby raising its share price.

This cycle of ESG success offers a potential roadmap of how tax credit investments can generate benefits that are quantifiable and repeatable. ESG related investments are becoming more imperative to any sustainable, long-term corporate strategy. Building a framework that synthesizes the efforts of corporations, asset managers, rating agencies and individual investors is progressing. As we move forward, a critical tipping point has certainly been crossed. We now assess what we do through an ESG lens. While the tax credit market is fairly mature, there are tremendous opportunities for growth as companies, individuals and investors realize the powerful positive impacts tax credit investing can make.