The biggest sleeper event of the Biden presidency may end up being the laughably misnamed and poorly understood Inflation Reduction Act.
The law that Congress passed on Aug. 12, 2022, and Biden signed four days later was a remnant of Biden’s “Build Back Better (BBB)” plan, which Democrats were unable to pass even though they controlled both houses of Congress at the time. The IRA, as it’s known, includes a mishmash of leftover BBB provisions, including green energy incentives, beefier tax enforcement, a minor business-tax increase, healthcare subsidies, and cheaper drugs for Medicare enrollees. Budget analysts estimated the Inflation Reduction Act would have little to no effect on inflation. Democrats who passed the law with no Republican votes probably named it that so they'd be able to claim credit if high inflation at the time came down, which it has.
Inflation is moderating for other reasons, but a year after its passage, the IRA is shaping up to be immensely consequential anyway. The green energy portion of the bill — the biggest chunk — is the most aggressive effort to decarbonize the US economy ever. But it’s turning out to be even bigger than analysts thought at the time.
Initial estimates ballparked the cost of the bill’s green energy provisions at around $385 billion over 10 years. Those green energy provisions are now likely to cost around $1.2 trillion, according to the latest analysis from Goldman Sachs and the Penn Wharton Budget Model. That’s three times the original cost estimate.
As for the entire bill, Penn Wharton initially thought it would reduce the national debt by about $264 billion over the 10-year budget window. That’s because some provisions cost money while others saved money, with the net effect being a modest savings to taxpayers. But Penn Wharton now thinks the IRA will add about $1 trillion to the debt, for a net swing of nearly $1.3 trillion out of the federal purse.
The soaring cost of the IRA might make it sound like Congressional Democrats who voted for the bill relied on rigged budget math to pass a law that promptly became a lot more expensive than advertised. But the added cost is also a sign of the IRA’s success, because green energy tax incentives are turning out to be way more popular than expected. The cost of the law is rising because there’s a lot more private sector investment in green energy, driven by tax breaks included in the law. Given that the law’s main purpose was to speed green energy adoption, rising costs mean a faster transition away from fossil fuels and a more muscular response to global warming.
Most of the green energy provisions in the IRA aren’t direct spending by the government but tax breaks for private entities that invest in green energy. And most of those tax breaks are uncapped, meaning there’s no dollar limit on the amount of tax breaks the government will allow. In other words, anybody who meets the requirements for various tax breaks will be able to get them, no matter how much the tally adds up to. The “cost” isn’t government spending, it’s foregone tax revenue over the 10-year window.
So initial cost estimates for the IRA relied on some guesswork about the amount of private investment that would qualify for the tax breaks. It’s that private investment that’s turning out to be far stronger than expected a year ago. Those tax breaks increase the return on private sector investments in green energy, and in some cases turn a likely negative return into a positive one. With government subsidies, some private investors who would otherwise take a pass on unproven technology such as biofuels or green hydrogen might decide to give it a shot.
Goldman Sachs expects higher-than-expected private investment in all green energy categories affected by the IRA, but sees the biggest gains in two areas: electric vehicle production and advanced manufacturing.
For EVs, Goldman estimates the federal tax breaks in the IRA will end up costing $393 billion over a decade. The initial estimate, by the Congressional Budget Office (CBO), was just $14 billion. If Goldman turns out to be right, the original CBO estimate would be off by $379 billion—a massive 96% undershoot.
How could the CBO have been so wrong? It’s complicated, but it depends on how many electric vehicles automakers sell in the United States, and where those EVs are built, including major components. To qualify for tax credits that buyers get at the point of purchase, EVs must have a certain amount of domestically produced content, including batteries and battery components. The domestic content requirements rise over time, from 50% of battery components in 2023, as one example, to 100% starting in 2029. There are smaller tax breaks on vehicles with components sourced from nations that have a free trade agreement with the United States, and those requirements increase over time, as well.
Estimating the aggregate amount of future tax breaks on EVs — the cost to Uncle Sam — requires forecasting how many EV sales there will be each year, and also how much of the EV supply chain will be in the United States. That’s turning out to be a huge wild card. Many big automakers have announced new plans to build EVs or battery factories in the United States since Biden signed the IRA, meaning millions of additional EVs may qualify for tax credits. This green energy buildout is a major factor behind a new boom in US factory construction, which is likely to generate a lot of additional manufacturing jobs.
There’s similar logic behind Goldman’s estimate for the total value of another set of tax breaks in the IRA that includes US manufacturing of wind- and solar-power components. CBO estimated those tax breaks would “cost” about $37 billion in lost revenue over 10 years. But Goldman thinks the tab will be more like $190 billion, based on a flurry of new manufacturing plans and announcements based on those incentives.
If you’re a budget hawk who sees no value in transitioning away from fossil fuels and only cares about debt and deficits, this might all sound dastardly. “The Inflation Reduction Act may go down as one of the greatest confidence tricks on taxpayers in history,” the fusty and conservative Wall Street Journal editorial page bemoaned.
As a tool for fighting global warming and climate change, however, the IRA could represent a turning point in governments’ efforts to address a problem that’s causing visible and costly damage all around the world. Nations in Europe and elsewhere are rattled by the possibility that the United States might now capture an outsized portion of the global green energy economy, and some are planning muscular incentives of their own to stimulate home-grown technology. That could create a race to solve the problem, if only to capture the economic benefits.
It’s also not the first time a major infrastructure program has gone over cost, perhaps to the benefit of the nation. The initial cost estimate for the interstate highway system that went up in the 1950s and 1960s was $27 billion, or about $284 billion in today’s dollars. The final cost was five times more, or $129 billion, which would be around $1.4 trillion in today’s dollars. That’s in the ballpark of the latest cost estimates for the IRA. If the new law brings economic benefits similar to those of the US highway system, nobody will be complaining about the cost 50 years from now.