The Inflation Reduction Act finally gave the U.S. a real climate change policy
The Inflation Reduction Act (IRA) was signed into law a year ago this week. It is widely seen as the crown jewel of the “industrial policy” agenda of the Biden administration. While no piece of legislation is perfect, the full potential of the IRA to deliver a radically better future is often underrated. In this post, we highlight many of the IRA’s huge steps forward and also talk about the unfinished agenda for securing faster, fairer, and greener growth in the U.S. economy.
Put simply, the IRA puts the U.S. on a path where meeting its global climate change commitments is within reach—commitments which would provide a genuine chance at securing a livable planet for future generations if they are kept. At the beginning of August 2022, there was no such path to secure this livable future, but there is now—and that is a mammoth victory.
The IRA was essentially a climate change bill that included extraordinarily important health and tax changes as ride-alongs. If the bill had only included these health and tax policy changes, it would have been eminently worthy of applause. The fact that these changes were essentially side-shows to the IRA’s climate impacts is one clue about how transformative it might turn out to be.
Starting with these opening acts of tax and health policy, the IRA’s key components were:
Health policy: The key health policy changes in the IRA included a substantial increase in the generosity of tax credits to subsidize the purchase of health insurance through the marketplace “exchanges” in the Affordable Care Act (ACA), along with provisions to allow firmer bargaining over the pricing of pharmaceuticals purchased by Medicare. Both of these are big steps forward in U.S. health policy.
The expanded premium tax credits radically increase the affordability of exchange premiums for a wide range of U.S. households. These expanded tax credits expire in 2025—the same time as many provisions of the Trump administration’s Tax Cuts and Jobs Act (TCJA). This sets up a highly salient contrast for what will be more important to Congress in that year—preserving tax cuts mainly aimed at the richest households, or continuing to ensure healthcare affordability for those families who cannot find decent coverage through their employers.
The drug pricing changes both increase affordability to families and are forecast to reduce federal government payments for drugs under Medicare by nearly $240 billion over the next decade. Putting some discipline on the upward march of drug prices in the U.S. has been a key progressive priority for decades. There is still room to limit drug price increases even more, but this is an excellent step forward.
Tax policy: The key tax provisions in the IRA include a minimum tax on corporate income, an excise tax on stock buybacks, and a substantial increase in resources for Internal Revenue Service (IRS) enforcement. Each of these are significant and progressive changes in tax policy. The corporate minimum tax is projected to raise more than $220 billion over the next decade from corporations who have used loopholes to avoid paying their proper share of taxes in the past.
The stock buyback excise tax raises less money, but breaks important new ground in taxing stock returns rather than accounting profits of corporations. Given the rampant abuse of loopholes and financial engineering that allows firms to report deceptively low accounting profits, shifting to a regime of taxing stock returns instead could be transformative.
The expansion of IRS resources could well be the most valuable IRA tax provisions (even given the partial cutback in these resources included in the debt ceiling deal at the beginning of 2023). The nonpayment of taxes legally owed is estimated to be $600 billion annually. The bulk of these unpaid taxes is owed by the richest 5% and even 1% of households. If the full value of the “tax gap” could be collected with better enforcement, this by itself would essentially stabilize the nation’s long-run debt ratio with no other changes needed. While it is unlikely that enforcement alone could collect this much revenue, this clearly shows that enormous sums are available if IRS enforcement can be made more effective. Starving the IRS of enforcement resources and mandates has been a Republican priority for decades, and it constitutes an enormous gift to corporations and rich households who don’t want to pay taxes.
Climate and clean energy provisions: The climate and clean energy provisions of the IRA are its most-known features, and the ones that make it qualify as an “industrial policy” measure. This “industrial policy” label often makes some assume that it is aimed at boosting overall U.S. manufacturing. But unlike industrial policy debates of decades past, the IRA is clear-eyed about its goals—reducing greenhouse gas (GHG) emissions from usage of fossil fuels and transitioning to cleaner sources of energy—and has specific policies well-tailored to meet these goals. Given this narrower (yet still vital) target, it should not be judged by whether it succeeds in boosting manufacturing writ large.
The dominant strategy the IRA employs to lead the clean energy transition is subsidies—paying U.S. businesses, households, and even sub-national governments when they make investments that will lead to reduced GHG emissions. The fiscal support it provides for these investments admirably matches the scale of the decarbonization challenge in front of us. The decision to use subsidies to encourage clean energy investments reflects some hard learning from previous efforts to pass transformative climate bills. These previous efforts—like the American Clean Energy and Security (ACES) Act of 2009—relied on measures to increase the price of carbon emissions rather than subsidies to reduce the cost of clean energy adoption.
In short, unlike past bills, the IRA approach emphasizes carrots rather than sticks. In a perfect world described by introductory economics textbooks, there are reasons to think that a broad-based increase in the price of carbon-emitting activities would be the better way to go. But in the real world where the most important constraint is what could actually be passed into law, creating a coalition of producers who have been incentivized to go all-in on large clean energy investments worked to get IRA passed.
This coalition, and the reduced cost of clean energy investments stemming from the investment wave of the next decade, should make future efforts to also raise the price of GHG emissions (through either legislative measures or through direct regulation) a more manageable lift. Further, most of the IRA’s clean energy tax credits are open-ended—so long as investments are made, they will receive the subsidies. This means that arbitrary legislative numerical limits will not constrain the IRA’s contribution to clean energy investments in the coming decade. Even better, these new investments will not rely entirely on private-sector profit-making calculations because of the important “direct pay” provisions in the act.
These direct pay provisions allow parties to receive the subsidies even if they do not have tax liability themselves. This means that non-profit entities and state and local governments (including school districts) that decide to undertake clean energy or efficiency investments will receive incentives. This gives concerned citizens who want to lobby their state and local governments to undertake smart investments a huge potential tool—one that is already being used to great effect.
A number of the subsidies in IRA hinge on the domestic content of investments. For example, the consumer tax credits for the purchase of new electric vehicles (EVs) are only eligible for vehicles assembled in North America and get larger if components of the battery supply chain are also domestically produced. These domestic content requirements have become a source of controversy, but there are plenty of reasons to think they are a net plus. For one, again, the best feature of any prospective climate bill in 2022 was political viability. To the extent that the domestic content requirements boosted political support for the IRA, they are incredibly valuable. For another, the U.S. auto sector has been hamstrung for years (or decades) by a number of policy errors. For example, exchange rates have been misaligned for decades—reducing competitiveness for U.S. producers—while many of our most important trading partners in the auto sector have failed to keep their economies pinned anywhere near full employment, a failure that has reduced demand for U.S. exports. Subsidizing auto production in the U.S. without any comprehensive fix to these larger problems would have resulted in too many of these subsidies leaking abroad relative to the efficient optimum. A comprehensive fix to these larger problems contained within the IRA was obviously far outside the scope of the bill, but imposing domestic content requirements to stem some of the leakage abroad specifically from EVs was not.
Very early data seem to argue that companies are indeed ramping up investment in response to the subsidies. Over the past year, investment in manufacturing structures (i.e., building new factories or expanding existing ones) has risen by a staggering 54%. Crucially, this boost to investment will provide support to the exact economic activities that otherwise may have been depressed by recent Federal Reserve interest rate hikes. If the U.S. economy navigates through 2023 without a recession (which is happily looking more likely all the time), it may well have the trio of industrial policy bills—and particularly the IRA—to thank for this.
Of course, the IRA is far from perfect, and it does not solve all problems in the U.S. economy. For one, it’s an industrial policy bill, and many of the key challenges the U.S. economy faces are not well-suited to industrial policy solutions. And even some opportunities it had to ameliorate some of these more fundamental problems in the U.S. economy were lost along the way.
For example, recent decades have seen ferocious employer opposition to unionization and collective bargaining, and public policy has not maintained a level playing field that protects workers’ organizing rights against this opposition. This means that whenever any kind of economic churn moves jobs out of legacy unionized sectors in the U.S. and into new sectors, the new jobs are far less likely to be unionized. In the case of autos, the churn induced by a large transition out of producing internal combustion engine vehicles and into EVs means that the new EV jobs will—absent some policy support—be less likely to be unionized. Automobile companies are clearly planning for this, and a disproportionate share of new EV investments look to be flowing to so-called “right-to-work” (RTW) states in the South where new organizing is incredibly difficult (though perhaps not impossible, as the recent recognition victory for the United Steelworkers at the Blue Bird electric school bus plant in Georgia highlights).
Early versions of the EV tax credits would have made the credits significantly larger for vehicles made with unionized labor, providing an incentive for auto companies to be more open to allowing workers to bargain collectively. But this union bonus was stripped out of the bill before final passage after heavy lobbying from nonunion auto companies and parts manufacturers (whose production is often located in Southern RTW states), with Senate Republicans and Joe Manchin (D-WV) lining up to oppose it. Currently, there is no policy lever in the IRA that would support strong labor standards in the production of EVs. The IRA does have strong labor standards for lots of investment flows it subsidizes, particularly in the construction of new plants. For example, many of the energy efficiency and renewable energy tax credits get larger if the projects meet prevailing wage and apprenticeship requirements. These strong labor standards for some green investments make the lack of these standards in the production of EVs a noticeable gap.
The IRA’s weaknesses should be addressed going forward by federal, state, and local policymakers. And the huge economic challenges that cannot be addressed optimally by the tools of industrial policy remain. But the IRA provides a path for a livable future for future generations that just was not apparent over a year ago. We need further action to ensure the path is taken, but it’s infinitely better to have it than not.
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