The political economy and worldwide implications of the Inflation Reduction Act in the US


In May last year I
about a

by Eric Lonergan and Corinne Sawers called Supercharge Me. The book
argued, in essence, that economists should stop thinking about carbon
taxes as
to tackle climate change, what we could call the big stick, and
instead think about carrots in the form of subsidies and public
investment designed to get green industries to a scale where their
rapid growth would be inevitable.

Inflation Reduction Act (IRA) is essentially a climate bill passed in
the US that does exactly that. It is full of carrots, sometimes open
ended carrots, designed to promote greener industries, financed not
with carbon taxes but higher corporate taxes and lower drug prices
for medicare. As I largely agreed with the central idea behind
Supercharge Me, I thought it would be interesting to see how that
strategy had proved successful in one of the most difficult countries
to convince to go green.

IRA started as
Back Better
which was a massive programme of infrastructure spending with a large
green component and welfare spending. Some of that was diverted into
the Infrastructure Investment and Jobs Act, which was passed into law
in November 2021, but the climate part became stuck because one
Democratic Senator, Joe Manchin from the Coal and Gas state of West
Virginia, refused to support it. (The Republican party was of course
united in opposition.)

looked as if once again the US Congress would block effective green
action in the US. But then, to the surprise of many and with a name
change the IRA was passed in August 2022. So why did Manchin change
his mind, and what was lost as a result? What follows leans very
heavily on
excellent talk and discussion
so if you want to know more than I can write here have a look.

key idea from Supercharge Me is to use the story of solar power as a
model for how to green large parts (not all) of the economy. Solar
power started off as a relatively expensive form of energy that also
required large capital costs to install. However, partly as a result
of what the book calls Extreme Positive Incentives, costs came down,
more solar power was installed which allowed costs to come down even
further, until now solar is one of the cheapest forms of energy.

Vehicles (EVs) are another example of where strong incentives or
regulations could produce similar effects. In the UK at the moment
not many people buy EVs because they cost more to buy and the
charging network is far from ideal. However if the government
provides incentives for people to buy EVs their costs will fall, and
if they ensure the charging network is substantially improved more
people will want to buy them. The IRA includes incentives to buy EVs
(which are
heat pumps and a lot more besides.

what made Senator Manchin decide to finally support this bill? The
answer is complex, and there are certainly some changes in the bill
that he insisted on which are far from progressive. One example is
that green incentives no longer require union labour. No one is
suggesting the IRA is everything those supporting a Green New Deal
would want. But something is better than nothing, so it is
interesting to see why Manchin changed his mind, and why Big Oil did
not fight against the IRA.

answer is the invasion of Ukraine. As I have already noted, green
energy is now cheap energy, and that is intensified when the price of
carbon based energy suddenly shoots up. That is one reason for the
change of name to IRA. But perhaps more importantly, with US energy
producers getting huge profits and exporting large amounts of gas to
Europe, green energy seemed less of an existential threat to Big Oil.
Republicans pleaded with oil companies to fight the IRA, and they

are some signs that the IRA may also be robust enough to survive a
Republican Congress. There is a new ‘battery belt’ in the US in a
similar position to the old bible belt: southern red states which
will be reluctant to give up the subsidies the IRA has created.

other factor that helped get the IRA passed in the Senate was China.
Once you see Green Energy as at least part of the future, then most
politicians will want their own country to be part of that. As with
IT, there was a common concern that China was becoming too successful
in providing key parts of the green revolution, and so the IRA is
actually a very protectionist measure. Trump’s Make America Great
Again has become an insistence that green goods should be Made in
America. Again this aspect of the IRA may be far from ideal, but the
link between greening the US and protection is not one I would have
guessed beforehand. It has also

for the EU in how to respond.

the Ukraine war
also accelerate

the global move towards renewable energy. For any significant
movement in the UK
will have to wait

for a Labour government, which has pledged a substantial programme of
green investment,
a publicly owned renewable energy company. The main threat to this
happening on the scale required to avoid harmful global warming, both
in the UK and elsewhere, is an obsession with the government’s
deficit and public debt.

IRA is fully financed by higher taxes, and that was the only
political option Biden had. But whether we are talking about
conventional public investment, or incentives to encourage private
investment in green energy, using borrowing rather than taxes makes a
lot more sense from an economic and political point of view. This is,
after all, temporary government spending to spur investment with
future benefits, so its costs should be spread over generations.
There are strong economic arguments for higher carbon taxes because
the polluter should pay, but the political constraints on achieving
this seem high. In the UK at least there is a strong argument that
permanent revenue from higher taxes should be used to fund permanent
increases in current public spending to allow our public sector to
recover from 15 years of Conservative governance.

how do we avoid deficit targets slowing down the transition to a
green economy? Once again I need to stress that in an ideal world
this would not be a problem. I have argued many times that targets
for the total deficit or for falling debt to GDP make no sense,
because public investment should not be constrained by fiscal rules.
If public investment yields a good social return then it should
happen, whatever the implications are for public debt. But
unfortunately we are not in that ideal world, and so we need to start
thinking about more imaginative ways to get around the obsession with
public debt.

of these has recently been proposed in an interesting article by
Peter Bofinger. He
the case

for funding public missions through increases in public debt, which
is a kind of ‘project based golden rule’. (This idea of missions for government has recently been championed by Mariana Mazzucato, but
it goes back
than this
In the UK context this would allow the debt to GDP ratio to increase
only to the extent that it represented spending to undertake a
mission, in this case to green the economy. This generalises an idea
I put forward in my post on Supercharge Me, which was to create a
‘green account’ that was outside normal fiscal rules. As I noted
there, it would also require monitoring by the OBR to ensure mission
spending was clearly defined.

the IRA illustrates, the obstacles to fighting climate change can
with compromise and imagination be overcome. It is a mistake to
prevent such compromise when the ideal is not politically possible.
Providing incentives for greener energy is politically easier than
making the polluter pay. While in an ideal world fiscal rules would
not get in the way of such incentives, we live in a world that is
obsessed by public debt. This too requires imagination and compromise
to ensure this obsession does not get in the way of tackling climate

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