The 2026-27 Budget: Governor’s Sustainable Aviation Fuel Tax Credit Proposal

analysis full 2026-27 BUDGET The 2026-27 Budget: Governor’s Sustainable Aviation Fuel Tax Credit Proposal GABRIEL PETEK | LEGISLATIVE ANALYST | FEBRUARY 2026 SUMMARY The Governor proposes budget trailer legislation to create a new tax credit against diesel excise tax liability to incentivize the use of sustainable aviation fuel (SAF) in California. The administration estimates this credit could reduce diesel excise tax liability by as much as $165 million per year initially, then ultimately growing to $300 million per year. In our assessment, the proposed tax credit is not a cost-effective approach to reducing greenhouse gas emissions (GHGs) and may result in lower than anticipated environmental benefits. Moreover, the implementation of the tax credit could have negative implications for transportation funding—potentially even larger than those estimated by the administration—and would not be consistent with the spirit of voter-approved restrictions on the use of diesel tax revenues. In light of these concerns, we recommend the Legislature reject the Governor’s proposed tax credit. Background non-petroleum-based alternatives known as SAF. SAF can be made from a variety of plant Aircraft Produce Relatively Small Share of and animal-based feedstocks—such as distillers GHG Emissions… Aircraft are not among the corn oil (a byproduct of the production of corn largest contributors to GHG emissions. According ethanol), used cooking oil, and animal tallow— to the California Air Resources Board’s (CARB’s) as well as some alternative processes. A key GHG inventory, aviation accounts for only roughly advantage of SAF is that, due to its chemical 1 percent of the state’s emissions. While this similarity to conventional jet fuel, it can be used estimate may be somewhat understated, as it only in place of traditional fuel without modifications accounts for intrastate travel, estimates of the to aircraft engines or infrastructure. Conversely, relative contribution of aircraft to national and global a major barrier to the use of SAF is its relatively GHG emissions are still relatively modest, totaling high production cost, resulting in prices that are about 3 percent. generally at least twice those for conventional …But Are Particularly Hard to Decarbonize. jet fuel. In large part due to this cost differential, Despite the aviation sector’s relatively small currently only a small share—less than 2 percent— contribution to GHG emissions, policymakers have of aviation fuel used in the United States is SAF. shown significant interest in addressing aircraft SAF Production Occurs Alongside Other emissions as the sector is viewed as among the Renewable Fuels. Currently, a few refineries in the more difficult to decarbonize. For example, while United States are set up to convert feedstocks into batteries are a feasible—if sometimes relatively both renewable diesel (RD)—which accounts for the expensive—alternative to gasoline and diesel for majority of diesel purchased in California—and SAF. cars and trucks, they are not currently viewed as These refineries can shift production between these viable for aircraft due to their weight, size, and two types of fuels with relative ease depending on potential fire hazards. market conditions, as the industrial processes for SAF Is a Non-Petroleum Alternative to producing RD and SAF are similar, using the same Conventional Jet Fuel. One of the main existing feedstocks and much of the same equipment. approaches to help reduce the aviation sector’s There also are a number of other refiners in the GHG impacts is reducing the carbon emissions United States that currently produce RD and could, from aviation fuel. This can be done by replacing with the purchase of some additional equipment, conventional, petroleum-based jet fuel with www.lao.ca.gov 1 analysis full 2026-27 BUDGET be converted to produce SAF in addition to, or The above policies work together to create a instead of, RD. In either case, as a result of the “stack” of incentives for SAF production. The total interchangeability of the production processes value of this stack depends on various factors for these two fuels, without significant additional such as LCFS and RFS credit prices, as well as investments in overall production capacity for the feedstocks used, but cumulatively could total renewables or innovation in the production process, a couple dollars per gallon for SAF producers. an increase in SAF production likely would result in State Imposes Excise Taxes on Aviation a roughly equivalent decrease in RD production. and Other Transportation Fuels. The state State and Federal Governments Have Various levies per-gallon excise taxes on various fuels Existing Policies to Incentivize SAF. In recent sold and consumed in the state. These include years, both the state and federal governments a 2-cent-per-gallon excise tax on jet fuel, which have implemented various policies that encourage is applied to both petroleum-based jet fuel and the adoption of renewable fuels, including SAF. SAF. The tax generates about $4 million annually The main such policies affecting California include: and supports airports and other aviation-related activities. The state also imposes an excise • California Low Carbon Fuel Standard tax on diesel fuel, which is assessed on both (LCFS). LCFS establishes statewide “carbon petroleum-based diesel and RD. Diesel is primarily intensity” (CI) standards for diesel and used by medium- and heavy-duty trucks, buses, gasoline supplied in California. LCFS uses and other large vehicles. The diesel excise tax is a system of tradeable credits to determine currently 46.6 cents per gallon and is adjusted each compliance with the program. Entities that July for inflation. In 2026-27, the tax is projected supply regulated fuels with a CI above the to increase to 48.2 cents per gallon and generate standard accrue deficits, whereas those that about $1.5 billion. Diesel excise tax revenues supply fuels with a CI below the standard support state and local transportation activities. generate credits. Unlike diesel and gasoline, These include (1) support for the California jet fuel is not regulated under LCFS. However, Department of Transportation (Caltrans) and its producers of SAF can voluntarily participate in highway maintenance and rehabilitation programs, the program and receive credits for the gallons (2) direct suballocations to cities and counties they supply to California. These producers for local streets and roads, and (3) competitive can then sell the credits they generate, infrastructure grants on freight corridors through producing revenue that serves as a subsidy for the Trade Corridor Enhancement Program (TCEP). SAF production. • Federal Renewable Fuel Standard (RFS). Governor’s Proposal At the federal level, RFS is a policy that Provides Tax Credit for Producers of SAF. requires a designated level of renewable The Governor proposes budget trailer legislation fuels to be sold annually in the United States. that would create a new diesel excise tax credit for Refiners and importers must either sell their producers of SAF meeting at least a specified CI share of the required volumes themselves as calculated by CARB, with the goal of lowering or buy credits (known as Renewable the state’s GHG emissions by encouraging airlines Identification Numbers or RINs) from other to use more SAF instead of petroleum-based jet producers that generate an excess of credits. fuel. The credit would be worth $1 to $2 per gallon Because producers of SAF can sell the RINs of SAF produced for use in California—higher they generate, this program can provide an for production that CARB determines to be less additional production subsidy. carbon intensive—and apply to production between • Federal Tax Credit. The federal government January 2026 and December 2035 (though the also currently offers a tax credit of up credit could not be claimed by taxpayers until to $1 per gallon for SAF that meets November 2027). Producers could only claim the certain requirements. credit if they also have diesel excise tax liability 2 LEGISLATIVE ANALYST’S OFFICE analysis full 2026-27 BUDGET within the state—that is, if they also sell diesel fuel most cost-effective approaches to reducing in California. However, the proposal allows for a GHGs prior to undertaking more difficult and carryover period wherein producers would be able costly ones. We acknowledge that reasons might to claim the credit on any diesel excise tax liability exist to deviate from this general principle under they incurred over a five-year period after producing certain circumstances. For example, supporting the SAF. The administration estimates the tax credit more costly approaches could make sense if they would lead to foregone diesel excise tax revenue help bring new, transformative technologies into of as much as $165 million in 2027-28, potentially the marketplace that substantially bring down climbing to $300 million annually in the long run. long-term costs or achieve other societal benefits (such as reducing local air pollution). However, LAO Assessment in our assessment, the Governor’s proposal is Proposal Represents Relatively Expensive not structured to incentivize the development or Approach to Decarbonization. According to the implementation of novel technologies for SAF administration, the main purpose of the proposal production. Instead, it appears more likely to is to reduce GHGs. We find that encouraging SAF increase in-state use of SAF made from established is a relatively costly approach to achieving this approaches. The administration asserts that while goal. SAF is much more expensive to produce the proposal may not be the most cost-effective than conventional fuel, so enabling it to be cost approach to reducing GHGs, encouraging SAF competitive requires subsidies—in aggregate still is important as aviation is very difficult to across all policies—that are quite large relative to its decarbonize and very few, if any, viable alternatives potential emission reduction benefits. Specifically, exist. In our view, this argument might make more we estimate that the proposed tax credit alone sense in the future, once other easier and more implies a carbon price of over $170 per metric cost-effective approaches to reducing GHGs ton of carbon dioxide equivalent. (That is, if all have been exhausted. However, given the existing the estimated carbon emission reductions from ample availability of other, likely more cost-effective each gallon of SAF are attributed exclusively to GHG-reduction programs and policies, such a the proposed policy, we estimate that the cost costly focus on the aviation sector is not compelling per metric ton for these reductions would be over to us at this time. $170.) When considered along with the other Environmental Benefits of Incentivizing SAF existing incentives for SAF production, however, Are Uncertain. The environmental benefits of the total cost of each ton of carbon reduced would SAF are subject to substantial uncertainty and be significantly larger, perhaps several hundred some research indicates they could be notably dollars in aggregate per ton. These costs are smaller than certain estimates suggest. This is well above the costs of a variety of other possible in part because—due to interactions with other approaches to reducing GHGs. For example, existing policies and the interchangeability of the amount emitters recently have had to pay for many production inputs and processes discussed each ton of carbon dioxide equivalent they emit above—any additional SAF production induced through the cap-and-invest program has been by this proposed policy could correspondingly below $30 per ton and LCFS credits have been result in lower RD production. To the extent this is between $50 and $70 per ton. (In our view, these the case, the policy would result in “shuffling,” or cap-and-invest allowance and LCFS credit prices replacing one lower carbon fuel with another rather can serve as very rough proxies for the marginal than simply increasing overall use, thus limiting any costs these programs assess for near-term net environmental benefits. Moreover, even if the GHG emission reductions.) policy were to increase the overall use of renewable With Limited Exceptions, Makes Sense to fuels, we note that the academic literature contains Focus on Most Cost-Effective Approaches significant disagreement on the environmental to Reducing GHGs. In our view, generally the benefits that these fuels produce. For example, state should focus on pursuing the easiest and some research suggests that existing calculation www.lao.ca.gov 3 analysis full 2026-27 BUDGET methodologies used by CARB may overstate the show that California consumes more RD than is environmental benefits of SAF and other renewable produced in the entire United States, indicating fuels, such as by underestimating indirect effects that producers have responded strongly to existing on carbon emissions of diverting resources to state policy incentives for renewable fuels by produce such fuels. If CARB’s methodology selling in California. Some experts we consulted is not adequately robust and the actual GHG indicated that the proposed tax credit may be large benefits ultimately are less than it assumes, the enough to encourage a dramatic shift toward SAF cost-effectiveness of the proposed policy would sales in California, suggesting that foregone tax also be less than projected. revenues could be substantially higher than the Magnitude of Diesel Excise Tax Revenue administration estimates. Reduction Is Uncertain, but Could Be Much Reducing Diesel Excise Tax Revenues Smaller or Larger Than Anticipated. The Would Negatively Impact Transportation complexity of renewable fuel production and Programs. While the size of the revenue losses distribution—as well as the overlapping state and from the Governor’s proposed tax credit is federal policies—also create significant uncertainty somewhat uncertain, they have the potential for in estimating the fiscal impact of the Governor’s negative impacts on transportation programs. For proposed credit. In discussions with our office, example, based on the administration’s near-term the Department of Finance indicated that it based estimate of potential foregone diesel excise tax its fiscal estimate on existing SAF producers’ revenues—$165 million per year beginning in total diesel excise tax liability, which it believes 2027-28—the proposal would result in the following represents a rough upper bound on the size of the impacts based on the existing statutory allocations potential revenue loss. However, actual claims and of these revenues: associated revenue loss could be much less or • Caltrans. Annual reduction of $70 million to more than this estimate. If SAF production costs Caltrans and its highway maintenance and remain high enough to limit demand, even with rehabilitation programs. This reduction would the credit, revenue losses could be much smaller. specifically affect Caltrans’ State Highway Conversely, if the credit makes SAF production Operation and Protection Program (SHOPP), more attractive than RD for some producers, it which funds rehabilitation, reconstruction, and could cause a dramatic increase in SAF sales in safety projects on the state highway system. California, both among existing SAF producers and SHOPP is supported by a combination of state among other producers and distributors who sell and federal funds and is projected to receive diesel in the state. The only limit on the amount of around $4.4 billion annually—meaning this credits that eligible producers could claim under proposal would result in a reduction of about the proposed policy is the amount of their California 2 percent each year. diesel excise tax liability—currently totaling about • Local Streets and Roads. Annual reduction $1.5 billion across all producers—and the amount of $49 million to transportation funding that of SAF that could be produced or imported to the state provides to cities and counties for California. Researchers at the University of Illinois work on their local streets and roads. State and the United States Department of Agriculture transportation funding suballocated to cities recently estimated national SAF production and counties for these purposes is projected capacity at more than 800 million gallons per to be around $3.9 billion annually—meaning year (though the exact amount is uncertain due this proposal would result in a reduction of to the proprietary nature of refinery operations). about 1 percent each year. This means that more than $1 billion in credits • TCEP. Annual reduction of $46 million to could be claimed if all available SAF were sold TCEP. The program is supported by state and in California, even if no additional production federal funds and receives around $540 million capacity were created. While such a scenario may annually—meaning this proposal would result seem far-fetched, the most recent federal data in a reduction of about 9 percent each year. 4 LEGISLATIVE ANALYST’S OFFICE analysis full 2026-27 BUDGET Overall, these reductions would result in fewer state’s surface transportation system. California state and local transportation projects being voters have signaled their support for this general funded each year. Additionally, the administration approach by amending the State Constitution projects the credit could grow over time, potentially to restrict the use of gasoline and diesel fuel tax reaching about $300 million annually—nearly revenues for streets, highways, and certain mass doubling the reductions and corresponding fiscal transit activities. In our view, the administration’s and programmatic impacts. Moreover, should proposal deviates from the spirit of these the amount of the tax credit that is claimed end voter-approved restrictions, as a portion of the up even larger than currently anticipated—as diesel tax revenues that historically have been used discussed above—the reductions to transportation to support the streets and highways that benefit funding would increase accordingly. We note drivers would instead be used to subsidize the that the state is already projected to face future decarbonization of the aviation sector. In our view, transportation funding challenges due to existing the administration has not articulated a sufficiently trends and policies that increase zero-emission strong rationale for deviating from the state’s vehicle (ZEV) adoption, which in turn will reduce longstanding approach. diesel and gasoline excise tax revenues. These Recommendation pressures are expected to grow as the state works to further increase ZEV adoption to meet its Reject Proposed Tax Credit. We recommend ambitious climate goals, as we discuss in our 2023 the Legislature reject the proposed budget trailer report, Assessing California’s Climate Policies— legislation establishing a credit against diesel Implications for State Transportation Funding and excise tax revenue for sale of SAF in California. Programs. The Governor’s SAF proposal would The proposal appears to be a relatively expensive expedite and add to those projected fiscal and approach to reducing GHGs and may not result programmatic impacts. in the full anticipated environmental benefits. Moreover, the implementation of the proposed Deviates From Spirit of Transportation tax credit could have negative implications for Funding Approach Embraced By Voters. transportation funding—potentially even larger than Historically, the state has used the revenues those estimated by the administration—and would from the taxes that road users pay to support not be consistent with the spirit of voter-approved activities that benefit those users, such as for the restrictions on the use of diesel tax revenues. operation, maintenance, and improvement of the www.lao.ca.gov 5 analysis full 2026-27 BUDGET 6 LEGISLATIVE ANALYST’S OFFICE analysis full 2026-27 BUDGET www.lao.ca.gov 7 analysis full 2026-27 BUDGET LAO PUBLICATIONS This report was prepared by Alexander Bentz, Frank Jimenez, and Helen Kerstein, and reviewed by Rachel Ehlers and Ross Brown. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. To request publications call (916) 445-4656. This report and others, as well as an e-mail subscription service, are available on the LAO’s website at www.lao.ca.gov. The LAO is located at 925 L Street, Suite 1000, Sacramento, California 95814. 8 LEGISLATIVE ANALYST’S OFFICE