Earlier today, President Biden signed the “Inflation Reduction Act” into law. It’s a huge bill that does a ton of different things. Some of these things will directly benefit farmers and ranchers, through increased funding for USDA conservation programs. I’ll tackle these provisions in my next post, but first I want to discuss what the bill is about overall.
What is the IRA?
The Inflation Reduction Act is essentially a clean energy and health care bill, plus some tax reform to pay for the new spending. It makes a major investment in clean energy technologies, with the hope of lowering energy costs and carbon emissions over the long term. On the health care side, it has provisions to lower the cost of prescription drugs for people on Medicare. It also extends subsidies to prevent big price increases for low- and middle-income households who buy health insurance through the federal marketplace (HealthCare.gov).
So how will it reduce inflation?
It probably won’t. The IRA doesn’t do much for prices in the short term. Like many laws passed by Congress, its name is misleading, since reducing inflation is not really the point of the bill. That said, the health care provisions should reduce out-of-pocket expenses for many people in the next few years. And much of the bill is aimed at developing clean energy alternatives so that in the long term, households and businesses won’t be as vulnerable to fluctuations in the global price of oil, which is currently a big part of what’s driving overall inflation now. But the IRA does nothing to reduce the prices of things like gas, food, and housing in the next few months. (That said, it’s not clear that reducing inflation should be the job of Congress. Most economists think the Federal Reserve has more effective tools to fight inflation.)
Is it going to worsen inflation?
Probably not. The main way Congress can trigger inflation is by increasing the deficit – spending more than the government brings in in taxes – when the economy is already running hot. Over the next decade, the IRA actually reduces the deficit, because it raises more in taxes than it spends. But the amount of deficit reduction is relatively small. Analysts with the Penn Wharton Budget Model say the IRA’s impact on inflation will be “too small to be detectable,” with “no meaningful effect on inflation in the near term.” Basically, if Congress had wanted to laser-focus on reducing inflation, it would have only increased taxes without increasing spending. Instead it did both.
How will it affect taxes then?
The IRA’s tax increases are aimed at a small number of large, publicly-traded corporations that make over $1 billion per year. There is a new corporate minimum tax that could indirectly affect shareholders, workers, and consumers, but there are no new taxes that directly affect households, sole proprietorships, or partnerships. The bill is also expected to raise revenue through increased funding for IRS enforcement. Some people have been concerned that this could mean more audits, but the administration has ordered the IRS to put all new resources toward businesses and households making more than $400,000 per year (whose audit rates have fallen by 86% over the last decade).
What does the bill do on clean energy?
The IRA provides a smorgasbord of tax credits for developing, deploying, and adopting all kinds of clean energy technologies. These include incentives for:
- Consumers, to buy electric vehicles and install heat pumps, rooftop solar panels, and energy-efficient appliances
- Electricity companies, to install more solar and wind generation and battery storage
- Domestic manufacturing, to produce the components and minerals necessary for these technologies
- Companies working on R&D of all kinds of experimental technologies, like biofuels, geothermal, hydrogen, and nuclear fusion
These investments could kick-start a lot of new industries related to clean energy technologies. The idea is that the tax credits can help these sectors get off the ground and mature to a point where they no longer need ongoing support. The IRA is also the largest single step the U.S. government has ever taken to reduce carbon emissions. This is important because if it works, it will slow the heat waves, droughts, and wildfires that have been getting worse lately, and keep Montana livable and productive for a long time to come.
What does the IRA mean for the oil, gas and coal industries?
The IRA represents a major shift in clean energy policy in the US. Policy proposals for addressing climate change used to focus on sticks – making it more expensive to use fossil fuels. That approach hasn’t been very successful in U.S. politics so far. What the IRA does instead is focus on carrots. For the most part, it doesn’t penalize oil, gas, or coal – it’s all about making clean energy cheaper and more abundant.
In fact, the IRA has some provisions aimed at expanding oil and gas production. It requires the federal government to approve certain drilling permits currently under consideration, and to auction federal lands for oil and gas leasing before auctions for renewable energy projects. It also invests in carbon capture and storage technologies, which could make it easier for coal and gas plants to meet future regulatory requirements. The two provisions that could directly hurt oil & gas are an increase in royalty rates, and a new fee for methane emissions. But when considering the net effect of all of these provisions, energy sector models predict that domestic oil and gas production will increase due to the IRA.
Over the long term, many fossil fuel industries are still likely to decline. This transition might be hard for many rural communities. But the good news is that solar and wind production also needs workers and tends to be located in rural areas. A recent study found that a clean energy boom is likely to create new jobs in the same types of places where fossil fuel industries are concentrated now.
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“The IRA is also the largest single step the U.S. government has ever taken to reduce carbon emissions. This is important because if it works, it will slow the heat waves, droughts, and wildfires that have been getting worse lately, and keep Montana livable and productive for a long time to come.”
As an economist how do or did you conclude that this bill will directly affect heat waves, droughts and wildfires? Do you have any analysis that would support this statement or is this just your opinion?
Thanks for your question! There are two parts to this. First is how this bill will affect carbon emissions. Second is how carbon emissions will affect the types of weather patterns I mentioned. Both parts are difficult to predict exactly and have a lot of uncertainty, but I think there’s good scientific support for the general direction of both.
The idea that tax credits and other programs in the IRA will reduce carbon emissions is grounded in both economic theory and research on the past experiences of how tax credits have been able to jump-start new industries and reach “economies of scale”. There are 3 independent teams that have aggregated all this theory and evidence into huge computational models to try to predict the specific effects of this bill: the REPEAT Project, the Rhodium Group, and Energy Innovations. I’ve looked closely at the work of 2 of these teams and believe their scientific standards are high. For these kinds of models, I would definitely take any specific prediction with a large grain of salt, but the fact that the bottom line of these models all more or less agree helps reassure me that their general direction is correct. For an interesting discussion of the nuances and limitations of these models, see this article: https://www.technologyreview.com/2022/08/12/1057675/predicting-climate-bill-effects/
The idea that reducing carbon emissions will slow heat waves, droughts, and wildfires comes from climate science. I’m not a climate scientist myself, but I interface with climate science a lot. These kinds of predictions are based in an integrated understanding of quantum chemistry and thermal physics, historical evidence, and large computational models. To be clear, reducing emissions now is not going to reduce heat waves now. It also doesn’t mean there will be fewer heat waves in the future than there are now. Instead, the idea is that heat waves are going to keep getting worse regardless, but reducing emissions will lead to fewer heat waves *than there would be if we didn’t reduce emissions*. For more on the link between carbon emissions and changing weather patterns, see the Montana Climate Assessment: https://montanaclimate.org/chapter/executive-summary
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