The Inflation Reduction Act is the Walt Whitman of federal legislation: like the great American poet, the bill contradicts itself; it is large and contains multitudes.
It represents the most significant climate investment in U.S. history, but it also paves the way for a massive expansion of oil and gas drilling on federal lands and in federal waters. It includes a new minimum tax designed to ensure that large corporations pay at least 15 percent of their profits to the federal government, but it also showers corporations in tax subsidies that will push many more firms’ tax rates below 15 percent (and in some cases below zero). It is disappointingly modest in its aspirations, but it will arguably be—along with the Affordable Care Act—the most ambitious piece of legislation signed by a Democratic president in more than a half century.
Advocates for climate action and tax fairness should celebrate the bill’s enactment, which will likely occur later this week, after the House votes on the measure. But they should not exaggerate the bill’s accomplishments or sugarcoat the compromises that Democrats made to secure the support of swing senators. Glorifying the Inflation Reduction Act would, moreover, lead Democrats to draw the wrong lessons from the bill’s phoenix-like rise out of the legislative ashes.
The bill succeeded not in spite of its shortcomings, but because of them.
Emissions and Prescriptions
The sprawling legislation—spanning more than 700 pages—is difficult to summarize succinctly, but if one had to choose a three-word phrase to describe the bill, “Inflation Reduction Act” would not be it. Moody’s Analytics, whose estimates are often cited by President Biden, projects that the Consumer Price Index, a key inflation gauge, will be 0.33 percent lower at the end of 2031 on account of the legislation—a reduction in the inflation rate of approximately 0.03 percentage points per year. For comparison’s sake, CPI inflation was 9.1 percent in the twelve months ending in June 2022. So the bill will likely reduce inflation (as advertised), but the effect will be a drop in the bucket—a very small drop in a very large bucket.
A better three-word summary would be “Climate, Medicine, Taxes.” To a first approximation, the bill amounts to a $370 billion climate investment paid for by prescription drug savings and tax changes. The bill’s three baskets can be analyzed separately, but the baskets are so tightly woven together that any normative assessment of the legislation must account for all three.
Let’s start with climate. The bill lays out a smorgasbord of tax credits for clean energy, nuclear power production, electric vehicles, and other technologies that will accelerate the transition to a low-carbon economy. According to estimates from the Rhodium Group, U.S. greenhouse gas emissions in 2030 will be 40 percent below 2005 levels if Congress enacts the bill—compared to 30 percent below 2005 levels if Congress does not act. That’s a meaningful difference. It implies that U.S. emissions will be approximately 14 percent lower in 2030 with the bill than without.
But the claim by Senate Majority Leader Chuck Schumer (D-N.Y.) and Sen. Joe Manchin III (D-W.V.)—repeated by House Speaker Nancy Pelosi (D-Cal.) on Sunday—that the bill will “reduce carbon emissions by roughly 40 percent by 2030” is misleading at best. Three-quarters of that 40 percent reduction has nothing to do with the bill. And the legislation still falls short of fulfilling the United States’ commitment under the Paris Agreement to cut emissions to half of 2005 levels by the end of this decade. In other words, the Inflation Reduction Act is a down payment on our Paris pledge, but a large balance remains due.
Most troublingly, the bill bars the Interior Department from issuing any new right-of-way for wind or solar energy development for a decade unless the department also offers up a total of 20 million acres of land and 600 million acres of ocean area for oil and gas leasing. To put those acreages in perspective, 20 million acres is roughly the size of South Carolina; 600 million acres is more than Alaska and Texas combined. “Drill, baby, drill”—once a slogan of Republican vice presidential candidate Sarah Palin—is about to become official federal policy.
If there is a saving grace, it’s that the giveaway to oil and gas firms is so extravagant that most of the acres offered for leasing won’t attract any bids. Still, the irony of an oil and gas drilling expansion in a bill that aims to reduce U.S. carbon emissions is rich. If this was the price of Manchin’s backing, then it was a price worth paying. But Manchin’s support certainly did not come cheap.
An Offer that Drug Companies Can’t Refuse
The medical portion of the bill represents a real achievement—though again, it is an achievement that comes with caveats. The bill extends a pandemic program that reduced health insurance premiums for 13 million low- and middle-income Americans, but the extension lasts only three years, after which individuals and families who purchase health insurance through Obamacare exchanges will face another benefits cliff. The bill also facilitates free access to adult vaccines for Medicare and Medicaid beneficiaries, and it imposes a $2,000-per-year cap on out-of-pocket drug costs under Medicare Part D. But even as it makes federally subsidized health insurance more generous to current enrollees, the bill still leaves more than 2 million low-income adults in a “coverage gap”—too poor to claim credits on the Obamacare exchanges, but ineligible for Medicaid under their own state’s laws.
The bill’s medical cost savings come primarily from a provision that requires pharmaceutical and biotechnology companies to accept steep price cuts for a handful of prescription drugs purchased through Medicare. The bill describes this as the “Drug Price Negotiation Program,” but “negotiation” is somewhat of a euphemism. The manufacturer of a drug selected for “negotiation” must accede to Medicare’s proposed price or else pay a 1,900 percent excise tax on all sales of the drug. That’s a negotiation only in the Vito Corleone sense—an offer one can’t refuse.
Drugmakers complain that the Medicare price cuts will discourage investment, resulting in fewer new cures and treatments. That’s about as true as the claim that the Inflation Reduction Act will reduce inflation—it’s probably correct, but the effect is likely to be marginal. The Congressional Budget Office estimates that the number of new drugs approved over the next 30 years will be approximately 1 percent lower as a result of the legislation.
Without trivializing the consequences for patients who would otherwise stand to benefit from those drugs, that’s a cost worth bearing if it makes space in the budget for transformative climate investments.
Tax Changes and an IRS Infusion
The biggest revenue raiser in the bill—according to the Congressional Budget Office’s analysis—is a new 15 percent minimum tax on the “book income” of large corporations. “Book income” refers to the earnings that corporations report to investors under generally accepted accounting principles. If large corporations pay less than 15 percent of their accounting profits under normal tax rules, then the 15 percent minimum tax potentially kicks in.
Manchin told Fox News Sunday that the new 15 percent minimum tax “does not raise taxes.” He added: “I’ve made sure that there are no tax increases in this whatsoever.” That’s an absurd claim. Corporations often pay less than 15 percent of their profits in taxes for entirely legitimate reasons—for example, because the tax code allows writeoffs for depreciation and stock compensation in different years than when those deductions are permitted for accounting purposes. For those corporations, the Inflation Reduction Act certainly does raise taxes—to the tune of $313 billion over 10 years.
The burden of the new corporate minimum tax will be borne in large part by high-income households that own stock. Raising taxes on large corporations and using the revenue to help avert a climate catastrophe is, on balance, a good trade. But President Biden’s claim that the bill “ends” the practice of profitable Fortune 500 companies paying no corporate income tax is just not correct. Carveouts for various business tax credits ensure that many corporations will continue to pay sub-15 percent rates. Indeed, the clean energy credits in the Inflation Reduction Act will likely cause many profitable electric utilities to pay zero or less in federal income tax.
Other tax provisions in the bill are more praiseworthy. A new 1 percent excise tax on corporate stock buybacks marks an important step toward plugging a gap in current law that allows foreign investors—and some U.S. shareholders—to avoid U.S. tax on corporate cash distributions when those payouts take the form of stock repurchases rather than traditional dividends. An $80 billion increase to the budget of the Internal Revenue Service will help to restore an agency that has been starved for cash in recent years, and the expenditure will likely pay for itself several times over. But the bill fails to deliver on Democrats’ larger tax reform ambitions. A last-minute decision to preserve a tax preference for the private equity industry—part of a deal to win over Sen. Kyrsten Sinema (D-Ariz.)—was just the latest way in which Democrats scaled back the bill’s tax components. Ultimately, the Inflation Reduction Act does virtually nothing to curtail the strategies that enable some billionaires to pay near-zero personal income tax rates.
If there is one lesson to be drawn from the Inflation Reduction Act, it’s that passing major legislation through a closely divided Congress will often require self-contradiction. The bill is a devil’s bargain, but if it were ideologically pure, it would also be a dead letter. That’s no justification for making misleading statements about the bill’s contents, as top Democrats unfortunately have. But a clear-eyed view of the bill’s achievements and shortcomings serves to emphasize the fact that here, as elsewhere, the perfect and the good are enemies. Thankfully, the good appears to have won out this time.