The Inflation Reduction Act Explained

The Inflation Reduction Act, or IRA for short: it’s dominated news cycles in the US and around the world, rocked international trade and climate regimes, and has been touted as the largest investment in climate change, simultaneously reviled as a Faustian bargain and betrayal of transatlantic allies. Following lengthy negotiations, the sprawling, 700-page Bill managed to win the support of Congress’ climate advocates, union supporters, and national security hawks alike, and was passed in August 2022. In Europe, the IRA has not been met with nearly as much enthusiasm, though, turning the last few months into a diplomatic dance: the US looking to smooth transatlantic relations while not upsetting the delicate balance at home, while allies abroad seek to win concessions and scramble to put out their own versions of the IRA.

Do you find yourself wondering what this is all about, where we currently stand with the IRA, and why it’s so controversial? We answer some of the most frequently asked questions below.

Section 1: What’s in the Inflation Reduction Act? And what parts have caused such controversy?

In short, the IRA consists of three pillars: investment in clean energy, making health care more affordable, and tax reform to increase collection from top earners.

The IRA can be seen as the third part in Biden’s Build Back Better trilogy, following the Bipartisan Infrastructure Law and the CHIPS & Science Act. These bills seek to improve American economic competitiveness and green infrastructure, together introducing $2 trillion in new federal spending over the next ten years.

More specifically, the IRA contains the following:

Energy, climate, and labor

The IRA provides $391 billion in climate and energy related tax credits, grants, and loan guarantees. Most of this money will flow to, first, clean electricity and transmission infrastructure, e.g. in the form of tax credits and rebates for solar panels, wind turbines, heat pumps, etc; second, to clean transportation, notably including electric vehicle (EV) incentives; and third, to energy efficiency investments, both at home and in manufacturing. Some money also goes to nuclear power as well as carbon capture and storage, which has received mixed reactions among progressives. Some of the less discussed, but all the more important, components of the IRA include $3 billion in block grants to disadvantaged communities to help monitor and clean up pollution and increase resilience to climate change, as well as $3 billion in neighborhood access and equity grants to reconnect neighborhoods through e.g. highway removal or walking and biking trails.

The IRA’s climate provisions are not just remarkable because of the historic investments in green tech they authorize, but also for their commitment to marrying the green with the blue. Energy and climate tax credits for manufacturing are tied to labor requirements: tax credits will increase approximately 5-fold if workers are paid a prevailing wage (minimally the average wage for workers in that sector and area), and a certain percentage of labor hours in the company are filled by qualified apprentices (15% as of the start of 2023). Combined with the jobs the IRA will create through its investments – 9 million over the next decade, according to research by the Political Economy Research Institute – this has led to broad support for the IRA by unions and civil society working on the intersection of labor and climate.

A second requirement, also meant to boost the American economy, has proven to be a good deal more controversial: the domestic content requirement, popularly known as the “Made in America” requirement. It stipulates that the end product as well as key components must be produced and assembled in the US, or in countries the US has a Free Trade Agreement with. This includes Mexico and Canada but excludes allies such as the EU or South Korea. While the requirement helped garner domestic political support, it’s the main cause of concerns and criticism from abroad. More on this in section 5.

Healthcare

Next to the climate and energy provisions, the IRA also contains several important provisions on health care. It expands Affordable Care Act subsidies for Americans buying insurance through state and federal marketplaces. These subsidies, expanded through the 2021 American Rescue Plan, were supposed to sunset at the end of 2022. This would have led to an estimated 3 million Americans losing their ability to afford insurance, and another 10 million paying significantly more for their health insurance. The IRA now extends subsidies for another three years.

Widely celebrated as a huge victory over the pharmaceutical industry, the IRA also gives the federal government the power to negotiate prescription drug prices starting in 2026, and provides a number of other cost-capping mechanisms (see this excellent explainer for the fine details). This means that those on Medicare will see significantly lower drug prices, and the government is expected to save $281 billion over the next decade.

Tax reform

The IRA also contains a number of provisions meant to bolster the IRS’s capacity to collect taxes. An investment of $80 billion in the enforcement agencies of the IRS is expected to yield $203 billion over the same 10-year period. It should be stressed here that the IRA does not raise taxes on the middle class, nor does it send armies of tax collectors to their houses (as has been suggested by some commentators on the far right). These funds will solely be used to go after already owed but to date unpaid taxes of those making over $400,000 a year: so-called “high-end noncompliance.” The U.S. Treasury Department estimates that more than half of total unpaid taxes are concentrated among the top 5% earners, making targeted audits particularly cost-effective.

Moreover, the IRA works to close tax loopholes for large corporations. The current corporate tax rate is 21%, but many of the largest and wealthiest companies, including Amazon and ExxonMobil, pay much less than that. The IRA sets a minimum 15% tax on corporations with profits over $1 billion, to make sure they pay at least this minimum share. This provision is more lenient than originally intended due to concessions to Senator Kyrsten Sinema (D-AZ) to secure her vote. Nevertheless, the new corporate minimum tax is expected to raise approximately $222 billion over the next decade. A 1% excise tax on corporations’ stock buybacks was also added (which currently is not taxed at all), expected to raise $73 billion.

Section 2: Will the IRA, like the name suggests, primarily reduce inflation? Does it have other goals?

The Bill’s overarching framing has been relieving inflation’s pressure on middle and working class families through:

1. Lower healthcare costs;
2. Investments in American energy infrastructure, to ensure jobs and more stable energy prices;
3. Making sure the rich pay their fair share, resulting in lower government budget deficits.

Next to that, it’s been very clear in Democrats’ messaging that this building back of the middle class and country needs to be green and independent (or, at least, not dependent on supply chains abroad for critical materials). Anything else amounts to short-termism, and neither builds a future-proof economy nor climate-change proof infrastructure.

Thus, while the Bill is called the Inflation Reduction Act, it pursues a range of progressive goals. All are at least indirectly related to the budget and inflation, but also stipulate who should pay for and benefit from budget deficit reductions (the rich and big pharma, and the middle class and the climate, respectively), and where the benefits should land (in the US, specifically in manufacturing and poorer regions, not with foreign manufacturers). As such, the Bill connects a number of goals that Biden had set out in his Build Back Better agenda: rebuilding the middle class and tackling climate change, while making the US less dependent on foreign supply chains.

Research from progressive and non-partisan research institutes alike shows that the Bill will generate more revenue than it costs, reduce emissions significantly (by 40% by 2030 compared to 2005 levels, peak emission year; without the IRA, this would have been closer to a 20% cut), and lower health care costs for millions of Americans. Whether the Bill will also reduce inflation is less clear, though, as it has a broad range of micro- and macroeconomic impacts on the economy that partly will only start playing out in the coming years. Overall, though, the Committee for a Responsible Federal Budget estimates that the IRA will very modestly reduce inflation in the near term, and a bit more so in the longer term (explained in detail here).

Section 3: To what extent is the IRA’s content set in stone? Can its content still change, as many allies are hoping for?

Politically, it will not be easy to change the IRA itself – it’s been signed into law August 16, 2022, after no small diplomatic feat: creating sufficient support by marrying the interests of those protecting and advocating for Heartland manufacturers and workers, those worried about dependence on China and advocating more independence, climate advocates, and… Joe Manchin and Kyrsten Sinema. Given that Democrats lost their House majority in the 2022 midterms, passing a bill like this today would not be possible. As such, both senior Democratic lawmakers and the White House have confirmed they do not want to reopen the law.

There are, however, still discussions about the exact implementation of the Bill. The Treasury Department will spend most of the allotted money, and is currently still developing guidance (e.g. on the exact meaning of the domestic content requirements). The EU has already formally requested a general waiver for the implementation of the IRA from the US Treasury Department (which has not been decided upon yet). Smaller changes or accommodations are also a possibility. For example, the Treasury Department in its December 29, 2022 guidelines clarified that consumers leasing an EV are eligible for a $7,500 commercial clean vehicle tax credit - which also includes vehicles not assembled in North America. This is certainly a victory for European carmakers, given the size of the US car market. However, when purchasing an EV, the car and its key components still need to be manufactured in North America to claim a tax credit - something that especially Germany with its large car manufacturing industry would like to see changed.

The Biden Administration already hinted at the existence of some flexibility in interpreting and implementing the IRA in a press conference with Macron last December: “there’s tweaks that we can make that can fundamentally make it easier for European countries to participate (…). But that is something that is a matter to be worked out. There is no fundamental – it was never intended, when I wrote the legislation – I never intended to exclude folks who were cooperating with us.”

One important caveat to keep in mind here is the possibility of oversight proceedings on the Treasury Department by Congress. E3G wrote about this worry: “If Members feel the Administration has overreached by granting a waiver to allies like the EU, with whom the US does not have a free trade agreement, Congress could conduct oversight proceedings on the Treasury Department. With Republicans taking over the House of Representatives next year, the Biden Administration is already expecting a slew of oversight hearings on the IRA, which can slow down its implementation. President Biden is unlikely to give a divided Congress any reason for more."

The upcoming 2024 presidential elections further intensify an already delicate political balancing act: the prospect of Congress or the Presidency flipping Republican has Democratic lawmakers anxious to start the IRA’s implementation as soon as possible. The more its provisions and benefits are set in stone, the more difficult it will be politically for a hypothetical Republican majority to undo the IRA – much like the Affordable Care Act’s continued survival through a term with Republican control of Congress and the Presidency. Moreover, the more benefits the IRA brings to the American people before the elections, the less likely this hypothetical situation is to materialize. This high-stakes political calculus is likely to be front and center in the Administration’s mind when shaping the IRA’s implementation, and limits the room for maneuvering to keep transatlantic allies happy.

Section 4: How is the IRA framed in American politics? Is it as controversial as it seems to be outside of the US?

The IRA’s domestic reception could not have been more different from its reception abroad: the Bill was greeted with cheers and celebrated as a historic investment in the fight against climate change. President Biden called the Bill the “largest investment in climate change in all of history,” to which Secretary of the Treasury Janet Yellen added that next to “[putting] President Biden’s climate goals within reach, [it also] creates jobs, saves households money, and strengthens our nation’s energy security.” The climate bill’s clear emphasis on supporting labor and the middle class is historic in its own right: it has managed, after decades of a rather difficult and rocky relationship, to create a blue-green coalition for a just transition. Labor unions and manufacturing companies across the country signed a letter in support of the IRA, and civil society organizations working on the nexus of labor and climate, such as the BlueGreen Alliance, support the Bill fervently.

Concerns about protectionism and a return to America-First policies did not feature in the political discourse at all, quite the opposite: the dominant idea was that the IRA’s provisions would spur green investment around the world and decrease prices for renewable deployment globally. This Bill, Democrats across the board argued, meant that the US could finally go back to climate negotiations with their heads held high. Overall, the main framing of the IRA was one of solidarity and coalition building, domestically between labor and environment, and internationally between nations wanting to invest in green technology. Katherine Tai, the US Trade Representative, framed the IRA as “[promoting] resilience, sustainability, not just for the planet, but also for people and inclusiveness” – a far cry from the European portrayal of a return to the protectionist America First-era.

Of course, concerns about the security of supply chains played a large role in drafting and rallying support for the IRA, too. The US pushes back against the narrative that the IRA with its domestic content requirements aims to decouple the US economy from China, or to retreat from global trade behind a wall of protectionism. Tai: “what we are trying to do is to ensure and to identify where the risks and vulnerabilities are—in the version of globalization that we see right now, [with] global supply chains that were designed for efficiency, chasing the lowest cost, without recognition that concentrations of supply and production create significant risks and vulnerabilities.” These risks became very clear throughout the pandemic, when nations scrambled to secure ventilators and masks, and the supply of semiconductor chips faltered. The US response should be “de-risking”, according to Tai: “It is to build resilience in our supply chains and to create incentives to ensure resilience for our economies. Because whether it is geopolitical, climate-related, or epidemics, there will be more crises that we will encounter. What we need to do to be constructive and productive through this period of time is to figure out how to adapt and prepare the global economy to be able to withstand and cushion future shocks (…) It is really about ensuring that we all have more options.” President Biden and Climate Envoy Kerry have echoed this sentiment in press conferences, with Biden emphasizing that the US needs to become more resilient to supply chain shocks abroad, just like – and he welcomed – Europe will have to, and Kerry encouraging other countries to follow suit and also invest in and subsidize green tech development.

Domestic criticism: not enough climate justice, too much fossil fuel support

Despite a broad support coalition comprising Democrats, labor, and manufacturing representatives, and those advocating for stronger security of supply, there has also been domestic criticism of the IRA. This criticism can broadly be divided into two strands: the first being that the IRA does good things, but does not go far enough. For instance, the IRA does not provide any meaningful funding for public transport or (e-)bikes, and it does not close the carried interest loophole (which primarily benefits the rich) as originally intended, the latter being a concession to Arizona Senator Kyrsten Sinema in exchange for her support.

This concern of ‘good, but by no means enough’ is especially prevalent when it comes to the climate justice provisions in the Bill. It provides $3 billion in block grants to disadvantaged communities to help them monitor and clean up pollution, and build resilience to climate impacts. These predominantly black and brown communities across the US bear the brunt of the impacts of fossil fuel production, as well as that of semi-clean energy production, such as biomass. These climate justice investments thus are vitally important, but in their current state neither large enough nor accessible enough. As co-executive director of the Climate Justice Alliance Ozawa Bineshi Albert explains, the IRA provides for a competitive process for communities to receive a limited number of grants. This pits communities against each other, and given the administrative demands of the grant application, can exclude communities who need this money the most. Varshini Prakash, co-founder of the Sunrise Movement, captures the prevailing sentiment among climate justice activists: “It’s bittersweet (…) this is both a big step forward and (…) not enough. It leaves people out. Many communities will still be left to a status quo of pollution and degradation in the places they live and work.”

The second strand of criticism focuses on some of the things the Bill does provide: drilling permits for fossil fuels, and a technology-agnostic approach. Some commentators speak of a ‘Faustian bargain:’ Great wins for the climate and labor, but at the cost of large concessions to the fossil fuel industry. The IRA ties extra leases for solar and wind projects on federal lands to offering drilling permits for oil and gas. This can lock in additional fossil fuel extraction, perpetuate climate injustice against communities in regions such as the Gulf South and Alaska, and add uncertainty for solar and wind developers. In addition, the IRA is technology-agnostic, meaning that technologies with dubious green credentials, such as nuclear energy and carbon capture and storage (CCS), also benefit from tax rebates.

Section 5: How did the US’s allies react to the IRA? Do they share the same concerns and criticisms, and do they act similarly on these? Or is there a broad spectrum of responses?

Reactions to the plan have been mixed outside of the US, too: while there is widespread appreciation that the US is finally (starting to) pull its weight, the domestic production requirements, which require many key components or end-products for clean energy to be manufactured in North America, have provoked a flurry of criticism and anger. Notable is that the IRA has already spurred countries around the world to launch their own green subsidy schemes, from the EU to India, Canada, and the UK. An excellent overview of individual national reactions around the globe can be found here.

The European Union

Summarizing the concerns, European Internal Market Commissioner Thierry Breton said: “High energy prices in Europe will continue to affect our fellow citizens, but also entire industrial supply chains and [small and medium-sized businesses]. (…) At the same time, China, the U.S. and other countries are trying — not without success — to attract our industrial capacities. Without a strong manufacturing base, Europe’s security of supply, export ability and job creation is at risk.”

Generally, France and Germany have spearheaded a campaign for relaxing state aid rules so individual EU Member States can match IRA subsidies. At the heart of the proposal: higher and more long-term subsidies for net-zero technologies through the principle of “matching subsidies,” where Member States are allowed to match the subsidy offered to a EU company by a third state. This, of course, is meant to entice the company to stay. However, this has led to fear among smaller Member States that they will not be able to match contributions from larger, wealthier Member States. These worries seem to be taken into account in the drafting of the Green Deal Industrial Plan, based on a leaked Commission Communication on state aid: economically disadvantaged regions may match subsidies to a higher degree than affluent regions in Member States considered economic heavyweights.

Zooming in on individual Member States and their responses, a common theme can be distinguished: strong statements by national governments and warnings by EU-based industry about possibly relocating. Both primarily seem aimed at extracting concessions from the US and EU governments, respectively. At the same time, one can discern more optimistic and active impulses: national leaders speaking of continued cooperation with the US and issuing their own versions of the IRA.

France

In France, the initial reaction to the IRA was decidedly negative, and vocally so, with Macron calling the Bill “super aggressive.” This animosity got better after Macron’s visit to the US and talks with Biden last December. At the joint press conference, Macron said: “President Biden wishes to create more industrial jobs in the long run for his country and to build a strong industry and secure your supplies, and this is very much our approach as well. (…) The circumstances mean that we have no alternative but to work together.” Moreover, France has announced its own bill to boost reshoring of green industries.

Germany

Germany houses much of the industry whose competitiveness the IRA puts most at risk: car manufacturing and large chemical R&D firms such as BASF. VW and BASF have both already voiced their concerns, pointing at the IRA as putting yet another dent in the armor of European competitiveness, already battered by high energy prices, and warned that without appropriate counter measures, they might need to downsize in Europe. 

The German government can hardly be accused of not taking counter measures, though: it has allocated €200 billion on a green support package to industry and households, and will cap gas and electricity prices for industrial consumers. At the EU level, Germany has been at the forefront of mustering a European response to the IRA through relaxation of state aid rules to compete with the IRA’s tax credits. Transatlantically, it has been pushing for concessions by the Biden administration. This has, for example, resulted in a loosening of the domestic content requirements for EV lease cars, allowing European car manufacturers easier access to this sizable US market.

Across the political spectrum, German politicians sound positive about the national and EU-wide response. Christian Lindner of the libertarian Free Democratic Party (FDP) stated that “Europe and Germany can weather this crisis without a collapse in industrial production.” Robert Habeck (Green Party), Germany’s Vice Chancellor, shares this confidence:  “We should be able to build a green bridge across the Atlantic in particular when it comes to industrial policy.”

Global Climate Justice

Amidst individual nations’ scramble to put out their own IRA equivalent and shore up their green economies, it is crucially important that those countries and communities that cannot keep up with this green spending race, particularly in the Global South, aren’t forgotten. The IRA does not contain any funding for international climate finance, and as such must be supplemented by, rather than crowd out, funding for international mitigation, adaptation, and loss and damage. In the IRA’s media coverage – on both sides of the Atlantic – international climate justice has figured disappointingly little, though two excellent analyses can be found here and here.

Section 6: Going forward, what does all this mean, and where do we go from here?

The progressive appraisal of the IRA may be summarized as “imperfect but monumental and transformative”. Yes, many had hoped that the Bill would do more still for the climate, especially also abroad, and in a more progressive manner. Moreover, the Bill strains transatlantic relations with concerns over the local content requirements, especially. On the other hand, though, the Bill has led to an explosion of investment in green technology across the world. The EU, India, and Canada for instance have all published proposals. Going forward, climate diplomacy and dialogue will be key in ensuring that

1. this green investment boom is coordinated and mutually advantageous, not a zero-sum game; and
2. that the Global South is not forgotten in this flurry of national-economy oriented funding.

Want to read more about the IRA? Take a look at our Climate and Finance Director Liane Schalatek’s analysis of the IRA’s achievements and shortcomings.