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Sep 28, 2022

Inflation Reduction in Name Only, but Still a Big Deal

It is likely no mystery to even the most casual observer of politics how the Inflation Reduction Act got its name. Inflation is high and causing real problems for many households. If only Congress could tame it simply by naming a historic piece of legislation to do the job, even if that legislation was actually designed to tackle entirely different problems…

This is not to say that the package deserves to be dismissed; it is an impressive legislative feat, marking significant advances on healthcare and climate change. On the other hand, the effect it will have on inflation, its raison d’être in name, will be modest at best and occur only over time.

There are three ways the Inflation Reduction Act may still potentially, albeit modestly, live up to its name. First, any legislation that reduces the federal budget deficit would help reduce inflation over time by reducing aggregate demand in the economy. The measure – estimated to cut the deficit by roughly $300 billion over the course of a decade – is therefore a step in the right direction in that it raises much-needed revenue.

Although such a deficit reduction would be helpful to the Federal Reserve’s efforts to combat inflation, it is unlikely to tamp down a soaring inflation rate and bring any immediate relief to households. Indeed, the nonpartisan Congressional Budget Office says the legislation’s effect on inflation will be negligible in 2022 and into 2023.

A large chunk of the additional revenue needed to reduce the deficit comes from a 15% corporate minimum tax, aimed at large corporations that report significant profits but pay little or nothing in income taxes. Higher taxes typically add to costs elsewhere and may lead to higher prices, offsetting any favorable effect that lower budget deficits might have on households’ costs.

The other two ways in which the legislation may help some households see lower costs over time stem from its actual focuses, healthcare and climate. One of the most significant provisions, for example, will allow Medicare to negotiate the price of certain prescription drugs, creating savings for Medicare and driving additional revenue needed to help reduce the deficit. This is a major step in restraining the country’s spiraling healthcare spending and is likely to have the most significant effect on lowering costs for some households through lower drug prices in the medium term (it goes into effect in 2025).

In addition, households will be able to hold onto Affordable Care Act premium subsidies that lower the cost of health insurance through 2024; these subsidies were set to expire and would have contributed to households’ already rising costs.

The law may have its greatest effect on climate, though, through its clean-energy provisions. It includes an array of tax credits, subsidies, loan guarantees and grants to households and businesses to shift into low-carbon purchases and green technologies. In addition, a separate permitting reform bill that was part of the agreement around the package promises to accelerate site permitting and construction of pipelines. Taken together, this marks a bold step toward a full-on clean-energy transformation that could speed emerging technologies and accelerate adoption.

What is harder to assess is whether this emission reduction act will live up to its name in reducing inflation. In the best scenario, subsidies on renewable energy and a greater energy supply through better and more efficient use of infrastructure will help lower energy prices and reduce inflation over time – if they are not offset by higher taxes on foreign oil. It is not clear how much effect households will see in the immediate future. Subsidies on electric vehicles, for example, are too limited to alleviate the accompanying sticker shock and depend on a number of factors, including where the vehicles are assembled.

In the end, however, the most important determinant of inflation is monetary policy, a job that lies with the Federal Reserve rather than Congress. So perhaps it’s not surprising that, though in aggregate some households may see lower costs, the legislation known as the Inflation Reduction Act will not bring immediate price relief to consumers.

This commentary was updated Sept. 28.

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