The Senate has just passed the Inflation Reduction Act, a major piece of fiscal legislation that’s mostly aimed at boosting energy supply and raising taxes to restrain inflation. Here’s a good NPR summary of what’s in the bill, here’s another from CNN, and here’s a thread from the ever-excellent Jeff Stein of the Washington Post:
I’m going to go through and talk about the specific ways I think this bill will change the U.S. economy, including climate change, energy abundance, monopoly power, and of course inflation itself. But first I’d like to step back a bit and think about what this bill means for the direction of U.S. economic policy in general.
A few weeks ago, I wrote a post about how the initial policy approach that Joe Biden tried to roll out in 2021 had basically floundered. The fundamental reason it floundered was that it was a package designed to fight a depression — providing mass employment in care industries, dishing out welfare via cash benefits — and, much to our surprise, we didn’t find ourselves in a depression at all. Instead, the job market was booming and consumer prices were rising painfully fast. Democrats are very good at fighting depressions — they have a solid playbook inherited from FDR and John Maynard Keynes. But Biden quickly had to retool policy to fight inflation instead. Hence the name of the new bill.
The path toward an anti-inflationary progressive economic paradigm hasn’t fully been charted yet, but the basics are starting to come into view (and, broadly speaking, they’re what I was hoping for). When you want to stop prices from rising, you want to increase supply and decrease demand. Progressive economic policy aims to increase supply via government promotion of investment, and decrease demand via taxes on the rich and powerful. At its core, the Inflation Reduction Act is just that, plus some other measures like drug price negotiation.
But the point here is not just to make prices calm down. Just as the New Deal was ultimately about much more than fighting unemployment (it established social insurance, financial regulation, and large-scale infrastructure programs), the new Bidenomics 2.0 embodied by the Inflation Reduction Act is all about accomplishing progressive goals while also fighting inflation. And the two biggest progressive goals in the bill are:
Fighting climate change while also making energy more abundant, and
Cutting back the excesses of corporate power that have developed in the last two decades.
Kickstarting the Green Vortex
The most important long-term economic challenge facing the U.S. — and the world — is climate change. For a long time we thought stopping climate change was going to require great sacrifice on the part of the U.S. populace — giving up our fast cars, our big houses, our powerful appliances. Many climate activists still embrace this idea, promoting ideas like degrowth, blaming climate change on extravagant lifestyles, and generally telling us that we have to prepare for a long period of belt-tightening if we’re to survive.
This idea has always been politically unpopular, but in recent years it also stopped having the facts on its side. Stunningly rapid advances in green energy technology — especially solar photovoltaic power and lithium-ion batteries, but also various other things — have changed the facts on the ground. At this point, a rapid transition to green energy won’t leave us impoverished — it’ll give us cheaper electricity, faster cars, and a world of greater material abundance in general. Even more crucially, much of the cost decline in renewables has been driven by learning curves — the more renewables we install, the cheaper they get.
These new technological facts — which were the result of decades of dedication and sacrifice by environmentally aware elites — don’t solve the climate crisis all by themselves. But they provide a powerful accelerant to progressive policy, allowing us to push rapid decarbonization through a virtuous cycle. We install more renewables, we get cheaper, demand increases, we install more, they get cheaper. And this cheapness draws in a whole lot of other players — corporations who are fine going green as long as they can save some money, politicians who are happy to push renewables as long as it also lowers their voters’ electricity bills, entrepreneurs who suddenly have a bigger market for their high-tech energy products, and so on. Robinson Meyer calls this the Green Vortex.
The Green Vortex could happen even without a big government push, but it would take longer to get started. Until about a week ago when the Inflation Reduction Act was unveiled, it looked as if this was what we were going to have to do. And we would have done it. But now, it looks as if the government is going to give the Green Vortex a rapid start.
The IRA puts around $370 billion toward clean energy. That’s over a decade, of course, so this is actually not as huge a sum as it sounds — it’s far less than the Green New Deal activists had hoped for — but it’s far from a pittance.
Most of this money is basically just subsidies for companies to adopt green energy. That’s going to disappoint activists who were hoping to tax and regulate dirty energy out of existence — in fact, the bill subsidizes fossil fuels as well. But politically, using subsidies is exactly the right approach, because it focuses on abundance — on making cheap energy cheaper to install. Rhodium Group estimates that the bill will lower household energy costs by about $1,000 per year by 2030, mostly from lower gasoline bills. Lower energy costs mean a richer citizenry. And of course companies will benefit from lower energy costs too, because energy is an important production input; over time, this will increase real incomes.
And I suspect that these estimates are lowballing the benefits, because they’re probably ignoring learning curves. Forecasters consistently underestimate renewables adoption, because they don’t realize that installing more makes the cost go down. My guess is that even the optimistic forecasters are making the same mistake about the IRA. The Democrats’ new bill isn’t just subsidizing energy, it’s subsidizing technological progress in the energy field.
(I’d also like to happily note that the IRA has a tax credit for heat pumps, a low-energy device that functions as both heater and air conditioner. It also includes incentives for electric stoves, which I’ll be writing more about in the coming months. It’s little details like this that will fill in the gaps in our decarbonization policy.)
The Inflation Reduction Act shows how government promotion of investment can leverage positive externalities — in this case, learning curves and technological progress — to fight negative externalities like climate change without requiring great popular sacrifices. It’s a fundamentally progressive approach, in the tradition of FDR’s Tennessee Valley Authority and Eisenhower’s interstate highway system, but it will work just as well in inflationary times as it did in the Depression.
Paring back monopoly power
Progressives often focus on economic inequality at the individual level. But in recent decades, a new concern has been added to the list — growing corporate power over the economy. Economists have noted that many of the strange ills that have seemed to plague our economy since the year 2000 — slowing productivity, labor’s falling share of national income, decreasing labor market dynamism, and so on — could be the result of the increasing market power of powerful companies. It’s not for certain, but the evidence has been adding up, and it fits with observed events like an increased pace of mergers and growing concentration in many industries.
The economist Simcha Barkai posits that what we’ve seen in the last two decades is not an increase in capital’s share of income, but rather an increase in pure profits — the kind of inefficient corporate “rents” that signify a lack of robust competition in the economy. This is a direct threat to material abundance — if regular households get less of the corporate pie even as the economy is also producing less because powerful companies are limiting output to jack up prices, it means a poorer nation. So naturally this is something that progressives want to do something about.
The concern over monopoly power has sparked a new antitrust movement. But a number of the Inflation Reduction Act’s provisions are aimed at curbing the power of dominant companies in a more direct fashion. One of the tax hikes in the bill is a 15% corporate minimum tax on companies with $1 billion or more in profits. Targeting tax hikes selectively at more profitable companies will weaken monopoly power, since monopoly power increases profits. There’s also a new tax on stock buybacks — this probably won’t force companies to invest more or raise wages, as some hope, but it will tax more profitable companies, and thus more powerful companies.
The IRA also attacks out-of-control health care prices in a few ways — allowing Medicare to negotiate lower drug prices, a cap on insulin prices for Medicare (though not for the private sector), and a policy that forces drug companies to pay rebates to Medicare if they hike prices faster than the overall rate of inflation.
These policies by themselves will have modest effects — they only focus on drugs rather than procedures writ large, and only on Medicare rather than on the private sector. But they represent the beginning of a progressive strategic shift on health care policy, toward combatting out-of-control prices in the industry. That effort, if successful, will make health care more abundant for Americans.
So by attacking monopoly power, the IRA both furthers progressive priorities — cheap health care and less concentrated corporate power — and has the potential to fight inflation as well.
Together, green energy investment, progressive corporate taxation, and direct government price negotiation represent the core of a progressive approach toward abundance — have the government build stuff, and punish companies that refuse to build stuff in order to extract more profit from the economy. The steps taken in this bill are mostly pretty modest, but if they point the way toward a new progressive policy paradigm, then I’m pretty happy with the result.
So will it actually reduce inflation?
The only remaining question is whether the Inflation Reduction Act will accomplish the purpose stated in its title. The real, honest answer here is “We have no idea.” Economists simply don’t understand inflation very well, and aren’t very good at forecasting the effects of policy.
But we can probably make a few educated guesses here. And the basic answer is that the Inflation Reduction Act will probably not have a big effect on inflation in the short term. The reason is that in the short term, its provisions push on prices in opposite directions.
The revenue increases in the IRA will be disinflationary, because lower deficits and higher taxes reduce aggregate demand. Negotiating and/or forcing lower drug prices will also be disinflationary.
The government investment incentives in the bill, on the other hand, will be inflationary in the short term even if it pushes prices down in the medium term. This is because physical investment requires buying a bunch of stuff — building solar plants and batteries means buying a lot of land, silicon, lithium, and so on, as well as using energy in construction. That increased demand will push up on prices. Additionally, the IRA contains some Obamacare subsidies that will also raise demand and be slightly inflationary.
I don’t really expect any of these effects to be particularly significant even on their own — when we look at the numbers here, it’s at most a few tens of billions of dollars either way in an economy whose size is measured in the tens of trillions. But in addition to the relatively small size, the measures push in opposite directions. Thus, in the short term I expect the bill to do basically nada with respect to the pace of price increases — Fed rate hikes and supply increases in commodity markets are going to be infinitely more important than this bill when it comes to the next three years of inflation.
In the medium term — after, say, 3-5 years or so — the bill’s impact should be disinflationary. Abundant energy will produce a temporary disinflationary effect (temporary because eventually abundance will raise demand and get rid of the disinflationary effect). Curbing monopoly profits should theoretically give powerful companies less of an urge to limit production and jack up prices, which should also be disinflationary. And over time, Medicare price negotiation will limit price rises in the pharma industry.
So I think that we’ll have to wait years to see how much the Inflation Reduction Act reduces inflation. By the time it happens, it’ll be hard to identify, since so much else will have happened to the economy in the meantime. And by then, the Fed and the commodity markets will have already written the story of the Great Inflation of the Early 2020s.
That’s why I think the IRA’s most important effect is on the direction and strategy of progressive economic policy. A few tens of billions here and there won’t make a difference, but if the new focus on abundance and production represents a sea change in the way Democrats approach economics, that’s a big deal.
The IRA will be net deflationary, because the tax increases are larger than the spending by about 300 billion. That said, it's not going to be a detectable effect, just because the package isn't big enough. 30 billion a year is only about 1.5% of the Recovery Act, and that was all delivered in just one year. So maybe a 0.1% decrease in the inflation number.
I agree the green vortex effect is likely to be much bigger. Developing industrial hydrogen could be a HUGE win because the ever-plummeting cost of solar means the energy cost of green hydrogen will get very small soon. If the capital costs of electrolysis can be brought down substantially, green hydrogen could obliterate natural gas and most coal in industrial processes, and there goes another big slice of CO2 emissions.
The unfortunate reality for us is there are few good tools to fight inflation in the short run. The best tool is raising interest rates, and while this effectively reduces demand it tends to push us into recession. We have a few big hammers to fight inflation in the short run. We do have lots of scalpels which can help in the medium term, which is what this bill pulls out.
We shall see how well Jay Powell does, I am hoping he can be a second Paul Volcker (maybe with a softer landing).