Can IRA spending really throttle energy inflation?

A casual observer of the Inflation Reduction Act (IRA)’s first year might perceive its spending commitments to be more substantial than its earnings.

The second legislative incarnation of the Biden administration’s Build Back Better program, the act authorized $891 billion in total spending—including $783 billion for energy and climate—over ten years. Still, the act also contains very substantial revenue generating commitments: $738 billion, according to the Joint Committee on Taxation. Nevertheless, the price tag for the IRA’s energy and climate provisions could climb even higher; the more popular the electric vehicle (EV) or home retrofit subsidies prove, the more the US Treasury will have to forego in tax revenue.

Expanding the federal deficit risks exacerbating inflation, regardless of the long-run cost savings wise energy investments could bring. However, the IRA is neither as inflationary nor as expensive as its detractors would suggest.

But nor is there clear proof that the investments in renewables and energy efficiency will reduce the exposure of US households to price fluctuations to the extent that headline inflation is durably reduced.

For now, the budget neutrality argument carries a similar weight to one defending the IRA’s inflation-busting credentials. Shortly after the act became law, the Congressional Budget Office (CBO) published optimistic analysis claiming the IRA would reduce the deficit by $238 billion in the long term. This argument relied on heroic predictions of the positive externalities of IRA-funded investments.

According to the CBO, the IRA’s much publicized allocation of $80 billion for modernizing the Internal Revenue Service (IRS) should pay for itself several times over. Households earning less than $400,000 a year can relax, however—Treasury Secretary Janet Yellen was quick to instruct the IRS to focus its new resources on “high-end noncompliance.”

Some more lucrative changes to the tax code—like the new minimum tax rate on corporates earning above $1 billion—have been in place since early 2023. Others, like the commitment to negotiate lower drug prices for Medicare, will not be fully in place until 2026.

New tax and spending commitments alike can all be changed in upcoming sessions of Congress, though it is noteworthy that the Democrats’ overperformance in the 2022 mid-terms has made such changes unlikely before 2024.

Suffice to say, the fiscal expansion of the Inflation Reduction Act is here to stay, at least for now.

That funding angle is also key to understanding European frustrations with the IRA. The local content requirements nested in the provisions on EV batteries have generated the most headlines, and rightly so. Yet, the European Union (EU)’s struggle to come up with a commensurate response to the IRA—when clichés would otherwise suggest European policymakers are much more experienced in tackling problems through subsidies—requires some explanation.

The EU has managed to re-allocate €225 billion from its post-pandemic Recovery and Resilience Fund (RRF) to REPowerEU, the European Commission’s plan to diversify away from Russian fossil fuels.

However, the €750 billion-strong RRF was designed as a one-off initiative. It cannot simply be expanded or duplicated without triggering acrimonious debates among member states—especially because the terms of borrowing will now be much less attractive, with European Central Bank interest rates at a nearly quarter-century high.

The cost of borrowing for the US government has also been increasing, which could limit the clean energy investment aspirations of the IRA. Few believe the recent downgrade by Fitch of US federal debt from AAA to a still respectable AA+ will exacerbate this, but the event itself should be seen as a warning. Fitch justified their decision by the “steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters” and “repeated debt-limit political standoffs.”

Even if most optimistic projections on the IRA’s fiscal returns are true, the act is not immune from political meddling.

Charles Lichfield is the deputy director and C. Boyden Gray senior fellow of the Atlantic Council GeoEconomics Center

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