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The Inflation Reduction Act: Balancing Economy and Environment

By Ethan Wilson

The 2022 Inflation Reduction Act (IRA) is an ambitious and divisive law conceived to push the USA towards its climate goals and bolster energy security, among other objectives. The choice of adjectives here is deliberate: the IRA constitutes the most significant investment into fighting climate change in the history of the USA, allocating an estimated $370 billion over ten years to energy and climate. In a textbook display of American political polarisation, the IRA was voted on along party lines – Democrats in support and Republicans in opposition.

Let us break down the specifics of the law. Roughly two-thirds of the $370 billion consists of federal tax credits that incentivise clean electricity production and investment in renewable energy manufacturing, renewable fuel production, carbon sequestration, and other clean technologies like hydrogen or direct air capture. The remaining one-third comprises federal government appropriations (bills authorising government spending). These include grants to encourage energy efficiency in housing, funds to support conservation practices that limit forestry and agriculture emissions, and investment in reducing air pollution and supporting vulnerable communities.

Predictions and Realities: The Reasoning behind the Inflation Reduction Act

Climate resilience and innovation-driven energy security are two guiding principles behind the Inflation Reduction Act. A study by the Department of Energy published in August of 2023 – a year after the passing of the legislation – reports that, together with the Bipartisan Infrastructure Law, the Inflation Reduction Act will reduce greenhouse emissions by 1 billion tons by 2030. The IRA is also estimated to have generated upwards of 170,000 jobs in renewable energy already, a figure that is predicted to increase to 912,000 average annual jobs through the next ten years. Third-party estimates report the IRA is set to reduce the deficit by more than $100 billion over the next decade. The suddenly available pool of subsidies has also spurred productivity and private investment in green energy manufacturing.

The data points towards the Biden administration’s intention to prioritise climate change. The IRA should be understood as an aggressive spending policy focused on the environment and a signal of American ambition to lead global climate and energy efforts. The Democrats have clearly demonstrated their will to disassociate from Trump’s policy and rhetoric on climate change by rejoining the Paris Agreement; the IRA is yet another step in the same direction.

Criticisms of the Inflation Reduction Act

Why, then, is there such staunch opposition to this law from Republicans? In some cases, it stems from denial of or disinterest in climate change. In others, it may be a result of party politics. These issues, however, should not constitute the bulk of the discussion. There are criticisms of the IRA that hold substantial weight and should be explored accordingly. The biggest is that the Inflation Reduction Act does not reduce inflation. Admittedly, this sounds counterintuitive, considering inflation (measured by CPI) dropped from 8.3% to 3.2% in the first full year of the IRA. Nevertheless, the Penn Wharton Budget Model concluded the IRA’s impact on inflation is statistically insignificant. Zero, in practical terms. The consensus among economists seems to be that post-pandemic supply chain improvements and Federal Reserve interest rate hikes were responsible for slowing inflation. President Biden regrets naming the bill the Inflation Reduction Act, stating: “I wish I hadn’t called it that because it has less to do with inflation than it does with providing alternatives that generate economic growth”.

Despite some of the optimistic predictions outlined in the previous section, one must note that Democrats passed the IRA amidst a period of recession where inflation was destroying the purchasing power of American families, who were already suffering from extortionate food and gas prices, by an average of $6,800 per two-income household. This came after another massive spending bill the year before, the American Rescue Plan worth $1.9 trillion, significantly contributing to the inflationary environment. The Inflation Reduction Act will be primarily funded by an increase in US debt, already at 121.6% of its GDP. Further, the bill is estimated to increase taxes for the average household by $4,500 over the next decade, though real costs for the American taxpayer could far exceed expected values. Subsidies will only expire once emissions targets are met; failure to do so will simply extend how long these taxes are paid. Conversely, if they are met, studies show the USA could lose out on up to $7.7 trillion in economic growth and an annual average of 1.2 million jobs.

Reflections on the Inflation Reduction Act

Economic policy on the environment must be underpinned by a robust understanding of the economic context within which it will be executed. Reducing the deficit is necessary, though the IRA seems to do so misguidedly. The peak inflation last year was due to demand outpacing supply, yet the decrease in deficit within the IRA comes from raising taxes (reducing supply) instead of lowering expenditure (reducing demand). Also, the bulk of new corporate taxes will be paid by manufacturers, which is conducive to less production or higher costs.

Altogether, the Inflation Reduction Act seemed more about betting on green subsidies than reducing inflation. In a broader context, the IRA reflects the environmental policy challenges of today: striking a balance between environment and economy. Incentivising the production of cheap and clean energy and fighting to reduce greenhouse gas emissions should unequivocally be policy objectives. However, awareness of the economic landscape is imperative for the design of such policies. Perhaps the Biden administration could have slashed spending to lower the deficit while reducing red tape and other barriers to entry. A more gradual plan to prop up the competitiveness of renewables over time while decreasing dependency on fossil fuels could have been devised away from artificial price distortions.

Once again, the point of equilibrium is nearly impossible to find. Policymakers find themselves between a rock and a hard place, challenged to account for the well-being of citizens today and that of the environment tomorrow – a truly strenuous balancing act.

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