Understanding the Inflation Reduction Act

President Biden has signed into law the Inflation Reduction Act (IRA). The sprawling bill tackles global warming, lowers health care costs, and tweaks some federal tax policies,

Its success hinged on last-minute cooperation and compromise from Democrats, who, given the lack of Republican support on many of these matters, had little room to lose votes, according to Marc Meredith, a professor of political science in the School of Arts & Sciences. “Their ability to get this through means they were able to unify Democrats in Congress across the ideological spectrum,” he says. “That’s hard, to put it bluntly. It signifies how important getting this done was to the Democratic Party.”

The measure whittled down Biden’s Build Back Better bill, but climate remained a significant focus. That’s instructive, Meredith says, showing that climate change as an issue unifies Democrats across different districts. “A lot of Biden’s original plans were stripped out, probably because there wasn’t the same level of support across the ideological spectrum,” he says.

This bill went through the reconciliation process, which limits Congressional debate time on an issue, essentially cutting off the option to filibuster. But it still required getting all 50 Democratic senators on the same page.

“A lot of these nitty gritty features about Congress that we teach in our classes here at Penn are important for understanding what ended up in the bill and what didn’t,” he says. To that end, three other Penn experts explain the climate, health care, and tax aspects of the legislation.

Climate

Though not referenced in the bill’s name, the provisions to address climate change are some of the legislation’s most noteworthy, totaling nearly $370 billion and representing “the most aggressive climate investment ever taken by Congress,” says climate scientist Michael Mann, who is currently at Penn State University and will join Penn’s faculty next month.

“The most critical provisions incentivize renewable energy: grants, loans, and text incentives for solar panels, wind turbines, and electric vehicles,” he says. “The provisions have the potential to greatly accelerate the clean energy transition and are a primary reason that this bill has the potential to cut U.S. carbon emissions by 40% by the end of the decade.”

Among these incentives are tax credits for consumers who purchase heat pumps, solar panels, and new and used electric vehicles. For companies, the bill includes loan guarantees for clean energy projects and payments for slashing emissions of methane, a greenhouse gas with 80 times the climate-warming power of carbon dioxide.

The bill has its drawbacks when it comes to climate, however. Political concessions to shore up support from Joe Manchin (D-WV) may pave the way for future fossil fuel development. For example, one stipulation requires that federal lands and offshore waters used for renewable-energy development also be opened up for oil and gas development. But Mann says these tradeoffs “do not, in themselves, constitute a major impediment to achieving the promised emissions reductions.”

Clean energy incentives, he says, should give renewable energy enough of a boost in the marketplace to outcompete the fossil fuel alternatives, leaving leases and pipeline permits largely unused and not profitable.

Despite a sense of optimism, Mann says there is more work to do, and he’s looking toward the midterms to continue pushing forward. “It is possible that more aggressive climate legislation that further disincentivizes new fossil fuel infrastructure could be passed if Democrats increase their margins in the upcoming midterm elections,” he says. “Advocates for more aggressive climate action should be turning their attention to organizing and turning out the vote.”

Health care

The IRA contains two main health care provisions, says Rachel Werner, executive director of Penn’s Leonard Davis Institute of Health Economics. “One is related to drug pricing for Medicare. The other has to do with subsidies for insurance premiums for people who buy insurance through the Affordable Care Act marketplaces. The bigger deal is drug pricing.”

Specifically, for the first time, Medicare will have the ability to negotiate with pharmaceutical companies on medication cost. Starting in 2026, this will apply to 10 drugs, a number that will increase to 20 by 2029. “This may sound small, but the drugs they’re targeting are the subset that Medicare spends a lot on, that are older, and that don’t face much competition,” she says. Drug companies that don’t agree to negotiate will incur penalties.

Beyond that, the legislation caps out-of-pocket spending at $2,000 annually for beneficiaries of Medicare Part D, “a very big deal for low-income older adults who are living on fixed incomes,” Werner says. It also streamlines medication costs for these individuals, making what people pay more consistent over the course of the year, and includes a $35 monthly cap on out-of-pocket insulin costs for this patient population, a benefit an earlier draft afforded to not just Medicare beneficiaries but also privately insured patients.

On the insurance subsidies side, the legislation extends through 2025 subsidies targeting households above 400% of the poverty line who purchased insurance under the Affordable Care Act. Such subsidies were first adopted under the American Rescue Plan Act in 2021 and were set to expire at the end of this year. “Without this extension, a couple million people would’ve had very large increases in their premiums,” Werner says. “The result would have been an increase in the rate of uninsured.”

Though certain provisions, like the one limiting insulin price caps to Medicare beneficiaries or another aimed at expanding traditional Medicare coverage to include vision, dental, and hearing didn’t make it into the final bill, Werner says this is the biggest change Americans have seen to health care in some time. “The true effect of drug price negotiations is to be determined,” she adds, “but experts are optimistic that it could have an important impact. It’s at least a step in the right direction.”

Taxes

On the economic side, the IRA makes several key budgetary estimates, according to Kent Smetters, Wharton School professor and Penn Wharton Budget Model faculty director.

First, it creates a new 15% corporate alternative minimum tax for companies that report at least $1 billion in income to their shareholders, what’s called “book income.” This limits the use of some investment credits and other deductions that reduce taxable income. But, because this is novel, it may lead to future investor uncertainty, he says.

Beginning in 2023, the bill also adds a 1% stock buyback fee, which is a tax on the amount of stock a firm buys back from its shareholders. The bill appropriates approximately $80 billion during the next decade for IRS enforcement activities including the hiring and training of new auditors, IT systems modernization, and taxpayer services.

Smetters says these additions and deletions will lead to meaningful financial change in the long term. “While we find a small reduction in gross domestic product (GDP) in the short run, we find that the Act slightly increases GDP over time, especially from carbon and financial debt reduction,” he says. “And the 10-year deficit reduction of $264 billion is slightly larger relative to the original version of the bill, which we scored at $249 billion. The tax on stock repurchases alone adds more than $78 billion to deficit reduction over 10 years.”

The Act will have no meaningful effect on inflation in the near term but would reduce inflation by around 0.1 percentage points by the middle of the first decade after it takes effect, he says. Smetters explains that because these point estimates aren’t statistically different from zero, there’s a low level of confidence that the legislation would ultimately have any measurable impact on inflation.

“Our estimates demonstrate that fiscal policy, including carbon reduction, is possible without adding to inflation,” he says. “At the same time, we estimate essentially no material reduction in inflation.”

Michael Mann is currently a Distinguished Professor of Atmospheric Science at Penn State. In September, he will join the University of Pennsylvania as a Presidential Distinguished Professor in the Department of Earth and Environmental Science in the School of Arts & Sciences, with a secondary appointment in the Annenberg School for Communication.

Marc Meredith is an associate professor in the Political Science Department in the School of Arts & Sciences. He holds a secondary appointment in the Business Economics and Public Policy Department at the Wharton School.

Kent Smetters is the Boettner Professor of Business Economics and Public Policy at the Wharton School and faculty director of the Penn Wharton Budget Model.

Rachel Werner is executive director of Penn’s Leonard Davis Institute of Health Economics. She is also the Robert D. Eilers Professor of Health Care Management and Economics at the Wharton School and a professor of medicine at the Perelman School of Medicine.