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The Inflation Reduction Act: Politics and Economics in Climate Policy

By Abir Khan



(Image provided under the Creative Commons License)


In August 2022, the ashes of the Build Back Better Act were scattered across the Senate Floor, a scathing blow to the democrats just months before midterms. Then, seemingly out of nowhere, Senators Manchin & Schumer emerged from secret negotiations with an amendment that lit the pyre ablaze, and in a mantle of gold and flame it was reborn as the Inflation Reduction Act (IRA) spreading its wings as another cornerstone of Biden’s presidential legacy, snatching victory from the jaws of a soberingly partisan 51-50 clash. As opposed to what the act’s name may suggest, the act addresses climate and energy policy. Economists argue that the act will have little impact on inflation, instead it is touted as “the largest investment ever towards climate change”. 

While there was a decrease in inflation from 9% to 3.2%, this was largely due to federal hikes in interest rates, wage hikes in the service economy and recovering supply chains. The IRA was simply not a factor in this, the Congressional Budgeting Office confirming that the bill would have a negligible effect on inflation.

 

Why is it called the Inflation Reduction Act?


            The most compelling argument for the IRA reducing inflation is the bill’s impact on the Deficit. With the revenue from the 15% minimum corporate tax rate, the prescription drug pricing reform, IRS tax enforcement, and closing carried interest loopholes, the bill is projected to reduce the deficit by $300 Billion over the next decade. In a letter to the White House, 120 economists reasoned that this deficit reduction would put downward pressure on inflation. Deficit reduction can lower demand, reducing pressure to hike interest rates to counteract inflation. Economist Jason Furman argues that this is always the case, either through aggregate demand or a theory that lower debt will ensure “policy makers will be less tempted to inflate away future debts”.

It should also be argued that deficit reductions can potentially set firm expectations to efficient levels, which theoretically slows growth, thus counteracting inflation. Though I haven't seen anyone argue this, I believe that the signaling of fiscal restraint could reduce prices when taking into the fact that firms have historically price gouged when inflation has been a hot topic. Reducing expectations of consumer demand would more efficiently prevent these practices rather than lawsuits with tougher burdens of proof.

The issue, however, is the scale to which deficit reduction is being reduced, and whether it will address inflation at a “significant scale”[1] [2] . These deficit reductions will take 5 years to occur, and as Economist Douglas Holtz-Eakin puts it, “$30 billion a year in a $21 trillion economy isn’t going to move the needle”. To be fair, there is a subtler effect of the IRA which could change the game in making deficit reduction more significant to the scale of inflation. Furman makes a very good point that the investment in the IRS could end up yielding more than projected revenue that could shrink our deficit at great enough scales to address inflation. This has yet to be seen, however, so the Inflation Reduction Act seems contentious at best.

            The better explanation for this is agenda politics, plain and simple. The Inflation Reduction Act is the strongest step in US history towards clean energy and meeting environmental goals. The bill is projected to cut annual emissions by 1 billion metric tons annually, getting two-thirds of the way there to the US emissions goal set for 2030. It heavily incentivizes consumers to reduce their own emissions with tax-credits and other subsidies. Democrats have been attempting to consolidate a policy on Climate Change for a long time, but, according to Pew Research, voters have been polling climate change as 11 out of 12 in a list of their priorities – the economy was priority #1. Joe Manchin understood this when he first pulled out of the plan. Aggressive climate policy instead of focus on inflation reduction sends the wrong message to voters. Nearing the midterms – and anticipating a Red Wave – showing accomplishments and concern for the voter base is just good politics. The “Inflation Reduction Act” is easy to run on as a victory.

           

Economics Policy in an Era of Climate Change


            Climate change policy – especially when it’s also within the realm of economic policy – is not difficult for experts to reach consensus.What is difficult, unfortunately, is getting such economic policy into the hearts of Americans and onto the president’s desk. The prices of gas & goods have the potential to outweigh our long term climate goals in terms of political capital. Take for example, Carbon Pricing. The IPCC reports with high confidence that carbon pricing is “necessary in models to achieve cost-effective 1.5°C pathways”. According to a profile on US Climate Scientists 85.36% of Climate Scientists support carbon taxes on industries, while 71.18% support carbon taxes on individuals. Economists are heavily inclined to agree. And yet, the policy seems politically dead. This goes to show that the greatest challenge politicians face in fixing the climate is not finding a solution, but selling that solution to their voters. The Inflation Reduction act is named in a way that cloaks what the bill actually represents. Biden himself admits it, “It has nothing to do with inflation…It has to do with the $368 billion, the single-largest investment in climate change anywhere in the world, anywhere. No one has ever, ever spent that. And it’s beginning to take hold.” The president was unafraid to state that “I wish I hadn’t called it that because it has less to do with reducing inflation than it has to do with providing alternatives that generate economic growth”, yet calling it that was politically pragmatic, and making this statement afterwards wouldn’t change that the bill was passed.

Could this be a sign that Washington is catching on? In times of extreme weather, rising climate anxieties may have a greater impact on voting patterns soon, but as of now, branding climate policy in this way could be the wisest decision. [3] It’s not as if politicians have to give up directly advocating on climate action either, hence Biden proudly touting it as one of the largest climate investments in the world. Alternatively, though it dissolved in January of 2023, the house Special Committee on the Climate crisis provided a framework for such advocacy.


Works Cited:

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Albrizio, Silvia, and John Bluedorn. “How Managing Inflation Expectations Can Help Economies Achieve a Softer Landing.” IMF, 4 Oct. 2023, www.imf.org/en/Blogs/Articles/2023/10/04/how-managing-inflation-expectations-can-help-economies-achieve-a-softer-landing.


Berman, Noah, and Sabine Baumgartner. “The Weather of Summer 2023 Was the Most Extreme Yet.” Council on Foreign Relations, Council on Foreign Relations, 18 Sept. 2023, www.cfr.org/article/weather-summer-2023-was-most-extreme-yet.


Bivens, Josh. “The Inflation Reduction Act Finally Gave the U.S. a Real Climate Change Policy.” Economic Policy Institute, 14 Aug. 2023, www.epi.org/blog/the-inflation-reduction-act-finally-gave-the-u-s-a-real-climate-change-policy/.


Burgess, M. G., et al. Climate Change Opinion and Recent Presidential Elections. Zenodo, 17 Jan. 2024, doi:10.5281/zenodo.10494414.


Cochrane, Emily, and Lisa Friedman. “Manchin Pulls Plug on Climate and Tax Talks, Shrinking Domestic Plan.” The New York Times, The New York Times, 18 July 2022, www.nytimes.com/2022/07/14/us/politics/manchin-climate-taxes.html.


DeBoer, Larry. “Capital Comments: Supply Chain Pressure Is Easing, and so Is Inflation.” Extension, 24 Aug. 2023, www.extension.purdue.edu/news/2023/08/supply-chain-pressure-is-easing-and-so-is-funding.html.


Fichera, Angelo. “Inflation Reduction Act Can’t Take Much Credit for Drop in Inflation Rate, Experts Say.” AP News, AP News, 21 Aug. 2023, www.apnews.com/article/fact-check-inflation-reduction-act-impact-one-year-950550722320.


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Jenkins, J.D., Mayfield, E.N., Farbes, J., Jones, R., Patankar, N., Xu, Q., Schivley, G., “Preliminary Report: The Climate and Energy Impacts of the Inflation Reduction Act of 2022 ,” REPEAT Project, Princeton, NJ, August 2022.https://doi.org/10.5281/zenodo.7106218  


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Segers, Grace. “Manchin and Schumer Surprised Everyone with the Inflation Reduction Act-Even Democrats Themselves.” The New Republic, 28 July 2022, www.newrepublic.com/article/167213/manchin-schumer-suprise-inflation-reduction-act-democrat-reactions.


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Wiseman, Paul. “From Eggs to Electronics to Used Cars, Consumer Inflation Eased Its Grip on US Households in July.” AP News, AP News, 10 Aug. 2023, www.apnews.com/article/inflation-prices-interest-rates-economy-federal-reserve-9ca16040f3824b498a7129e47b65f363.


Yglesias, Matthew. “How the Green New Deal Became the Inflation Reduction Act.” How the Green New Deal Became the Inflation Reduction Act, Slow Boring, 2 Aug. 2022, www.slowboring.com/p/how-the-green-new-deal-became-the.

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