The Inflation Reduction Act (IRA) just signed by President Biden includes more than $200 billion in energy-related tax subsidies over the next decade. It is, as its supporters say, the largest package of incentives aimed at slowing climate change ever enacted by Congress. But it also keeps the US on a relatively inefficient path to cleaner energy.
Broadly, the problem is a familiar one: While most economists prefer a stick—higher taxes— to encourage alternatives by raising the price of fossil fuels, most politicians favor a carrot—tax subsidies—to encourage consumers to buy green energy products. Unfortunately, these subsidies tend to waste money because they often go to people who would consume or produce these products anyway.
But there is another, more specific, problem with some of the subsidies in the IRA. They are inefficient because they try to achieve too many often-conflicting goals at once.
The best example may be the provision to extend and expand a generous tax credit for the purchase of electric vehicles. The goal is simple enough: Get more drivers into ”clean” vehicles by giving EV buyers a tax break.
The problem is Congress, being Congress, had to make multiple concessions to other interests to get the law passed. Instead of maximizing the environmental incentive value of the credit, lawmakers chose to satisfy other demands, each of which will dilute the power of the subsidy.
The credit comes with multiple limitations. Cars that cost more than $55,000 and vans and trucks that sell for more than $80,000 are ineligible. Unmarried buyers making $150,000 or more and married couples filing jointly making $300,000 or more can’t claim the credit. And because it is non-refundable, low-income households can’t fully benefit either.
Another countervailing interest: Buy America (and its top trading partners). The bill ties the credit to a series of conditions: The vehicles and their batteries must be assembled in the US and certain battery components and minerals must come from approved countries. One goal of these requirements is to reduce reliance on China for critical metals used in batteries.
Most of the law’s other green credits also come with labor requirements. The EV subsidies require a certain amount of domestic content and require manufacturers pay a “prevailing wage” to workers and operate apprenticeship programs. Similar labor rules also apply to tax credits for wind turbines and certain solar panels. These rules are common in government contracts and, to many, they serve important goals. But reducing reliance on fossil fuels isn’t one of them.
The EV credit may be the most extreme example of how these labor, commercial, and environmental goals can conflict. The Alliance for Automotive Innovation estimates that 70 percent of EVs made today will not qualify for the credit because they fail to meet these requirements. And these conditions inevitably will raise the price of any EVs that do qualify.
The industry eventually may find acceptable sources for battery materials and build EV assembly plants in the US, but it will take years.
The new law does end one provision of the old credit that limits its value as a tool to fight climate change: It repeals a requirement that automakers can only offer the full credit for the first 200,000 EVs they sell. If you primarily care about reducing greenhouse gas emissions, that’s a good thing. But all these new constraints are likely to overwhelm that change.
Then there is the timing. Currently, consumer demand far outstrips supply of EVs. For example, the well-known shortage of computer chips is severely limiting availability of these vehicles. Many producers say they already have sold out their most popular EVs for the 2022 model year and are building waiting lists for the 2023 models.
Government subsidies to boost demand for products already in short supply never make much sense. But when Congress combines the subsidy with the built-in supply constraints such as production and materials requirements, it won’t accomplish much more than increase those waiting lists, drive up the pre-tax price of whatever vehicles are available, and add to consumer frustration. Not exactly a recipe for reducing greenhouse gas emissions.
By contrast, a carbon tax is designed to achieve only one goal : Raise the price of carbon. There are many ways the tax can be returned to households but in any event the tax still would discourage consumption of carbon-based products by raising their relative prices.
Make no mistake: This Inflation Reduction Act does take important steps towards reducing CO2 emissions in the US. But by choosing the carrot of tax credits, it missed a chance to make even more dramatic reductions.