U.S. Inflation Reduction Bill: Little Macro but Helping Climate Change Fight
The Inflation Reduction Act 2022 has passed the Senate and is expected to pass the House. What are the macro and climate impacts of the bill?
Bottom line: We see few economic or inflation effects from the U.S. inflation reduction bill, but it should speed up the multiyear reduction in greenhouse gas emissions from the U.S. However, the midterm elections in the U.S. could stop further legislation to fill the remaining shortfall to 2050 net zero trajectory (Figure 1) if the GOP takes the House, and if the GOP wins the 2024 presidential elections, then some slowing of climate action could be seen once again.
Figure 1: Historical and Modeled Net U.S. Greenhouse Gas Emissions (billions metric tonnes CO2 equivalent)
Source: Rapid Energy Policy Evaluation Tool Kit (REPEAT here)
Little Inflation or Macro, More Reducing Climate Emissions
The Inflation Reduction Act of 2022 will likely have little impact on near-term inflation or macro prospects and instead is more multiyear-focused on climate emission reduction. Key points include:
- Tax and spend: Starting from 2023, the 10yr bill includes $374bn of climate change and energy tax credits and expenditure and $64bn of insurance payments for the Affordable Care Act (2023-26). This is funded mainly by a 15% corporate minimum tax rate for companies with at least $100m U.S. or $1bn global income and from extra IRS collections (only meaningful after 2025). Additionally, the bill allows the government to negotiate and reduce drug bills, which will be roughly equal to a budget deficit reduction of $300bn over a 10yr period.
- Little macro and inflation impact near-term: The climate and energy tax credits and expenditure will take a couple of years to fully scale up, which will likely mean that the net fiscal impact in 2023 could be negative (though not contractionary in GDP terms) as the tax increases kick in during 2023. The reduction in drug prices will also not really kick in until the middle of the decade, with little to no impact on near-term inflation and little in the bill to live up to its title. The medium- to long-term impacts are uncertain, though likely to be small. Though the bill involves marginal annual reduction in the deficit, this is offset by the household sector having to pay less for drugs. More importantly, the climate and energy aspects of the bill could stimulate investment in green energy, which could help business investment trends in the U.S. long-term. Overall, the net macro impact will likely be small in the coming years.
- Reducing greenhouse gas emissions: Figure 1 shows the simulations from REPEAT (mainly Princeton academics) of the impact on U.S. greenhouse gas emissions. The new bill is expected to be broadly similar in climate terms to the originally proposed much larger Build Back Better bill and shifts the U.S. closer to the 2050 net zero pathway. The bill's main impact is expected to be on electricity production (mainly solar and wind) and transportation (electric vehicle usage via new and used subsidy). If the REPEAT projections are reinforced by other forecasters, then it would help to increase confidence that the U.S. is reducing greenhouse gas emissions at a reasonable pace. Renewables have been expanding and replacing coal (Figure 2), both due to climate change action in electricity production and as the price of producing solar and wind has become more cost-effective.
Figure 2: U.S. Electricity Production by Source (%)
Source: U.S EIA
- U.S. and COP27 in Egypt: COP27 is scheduled for Nov. 8-20 in Sharm El Sheikh, Egypt. Hopes of a major breakthrough are low, both due to the Ukraine war (where G7 and G20 countries have different views) and as the U.S./China climate cooperation has stopped with last week's Taiwan escalation. Some progress can still be made, as major countries' energy security focus is aligned with a further scale-up of renewable electricity production in the coming decade.
- No U.S. leadership on climate: The U.S. will not be able to provide effective leadership at COP27, however, if the Democrats lose the U.S. House of Representatives at the Nov. 8 midterm election. This is around a 65% probability, though the Democrats have been making up ground recently. This would stop President Joe Biden from enacting any further legislation without GOP agreement, which is unlikely on the climate front. GOP states are already pushing U.S. banks to be less ESG-centric and more balanced to fossil fuels. Any victory for the GOP would also shift the focus to the 2024 presidential election and candidates' climate change policies. Donald Trump, if elected, would likely once again remove the U.S. from the 2015 Paris agreement and probably reverse some of the Biden administration's changes. Ron DeSantis' climate change policies are less clear. While he has favored climate change mitigation in Florida (e.g. protection against coastal flooding), he does not want to do “left-wing stuff”.
In reality, progress on the existing Biden administration greenhouse gas emissions plan may slow as the GOP gains greater power after the midterms, with any actions likely to be a partial reversal of Biden's actions. In the electricity sector, the cheap cost of production for wind will likely remain a driving force for electricity producers switching away from coal and to a lesser degree natural gas. However, the more difficult issues of switching transportation toward electric vehicles and home heating away from natural gas are not being tackled with the same momentum. Indeed, multiyear the swing back to the right politically will likely see the U.S. taking some action on greenhouse gases but also supporting the fossil fuel industry. This happened under President George W. Bush and President Trump. This reflects the influence of the fossil fuel industry on the GOP and also the U.S. desire for energy security (both after the Middle East experience of the past 50 years and also the Ukraine war). This will likely not be fast enough for the U.S. to meet the 2050 net zero target and will also mean that U.S. does not take global leadership on this issue.