Inflation Reduction Act Pt. 2: Windmills and Windfalls
The recently passed Inflation Reduction Act of 2022 has received plenty of attention in the past several weeks for its provisions on key Democratic priorities. In particular, major steps have been taken in the fields of healthcare (we dig into this in part one of our series) and climate change. This week’s article will focus on the latter area, which has–alongside healthcare–been the subject of intense debate in US politics, especially in the past decade. How does the Inflation Reduction Act combat manmade climate change, and what does it mean for the US economy–and for you?
The modern-day political debate over climate change largely began in the 1980s, when scientific concerns on the subject grew, culminating in the formation of the Intergovernmental Panel on Climate Change (IPCC) in 1988. Its task: to generate a comprehensive analysis of climate change–and offer recommendations to the world’s governments. Its first report in 1990 singled out something called the greenhouse effect, wherein certain gasses–particularly carbon dioxide–trap heat within earth’s atmosphere.
In moderation, this phenomenon retains enough heat on Earth for the planet to sustain life. With the onset of the Industrial Revolution, however, humans have increased carbon concentrations beyond historically precedented levels. These emissions largely stem from the burning of fossil fuels like coal, oil and gas. The subsequent rise in average global temperatures has resulted in more severe hurricanes, wildfires, and heatwaves. Increased carbon concentrations in the ocean have contributed to the bleaching of coral reefs. The melting of the polar ice caps has put nations like the Marshall Islands at risk of disappearing beneath rising sea levels. And these problems are but the tip of the iceberg; as concentrations of atmospheric carbon continue to increase, even more adverse effects are likely to play out. So with stakes this high, finding a solution should be easy, right?
Well, putting aside political and social conflicts about climate change, the key issue in economic terms is that carbon emissions are externalities: costs or benefits generated by a transaction borne by uninvolved parties. Practicing flute in the morning, for example, creates a negative externality for your neighbor: being woken up at an unreasonable hour. On the other hand, getting vaccinated is a positive externality; doing so also prevents other people from being infected. The problem with externalities is that because their full costs and benefits are not accounted for, too much of a negative externality and not enough of a positive externality are produced. In the context of climate action, too many emission-heavy processes are carried out by businesses and not enough clean energy solutions are made.
Because the US is so dependent on the use of fossil fuels–it is the world’s second largest emitter of carbon–summoning the political will to address this environmental challenge has been difficult, to say the least. The Kyoto Protocol, an international emissions reduction plan, was effectively torpedoed when the United States under then-President George W. Bush backed out in 2001. In 2009, President Obama proposed a plan for a carbon cap-and-trade system; under such an arrangement, the total level of carbon emissions would be limited and permits to pollute would be traded. The goal of such a plan is to use market mechanisms to economically phase out socially harmful activities. President George H.W. Bush actually passed a similar measure in the 1990s to limit acid rain. Sadly for Obama’s plan, the US Senate stopped its passage. In light of these experiences, some concessions were made in the Inflation Reduction Act to win the support of Senator Joe Manchin (D-WV), who had opposed previous renditions of the bill on the grounds that they were too expensive. Additionally, Manchin’s state of West Virginia produces a large amount of coal; thus, several provisions friendly to oil and gas drilling were also included in the final draft of the Inflation Reduction Act.
The Inflation Reduction Act’s carbon reduction provisions hark back to the measures proposed by Arthur Cecil Pigou, who first outlined the concept of externalities. He proposed that negative externalities be taxed; the additional cost of paying the tax will disincentivize people from the negative externality-generating activity and decrease supply. The new price of the good will thus more accurately reflect the social cost of the externality. Conversely, positive externalities can be subsidized to account for the additional benefits the action brings; with additional money to produce the good or service generating the positive externality, its supply and the social benefits it brings will increase. In a nutshell, the Inflation Reduction Act seeks to do exactly these things; it offers tax credits and subsidies for investing in clean energy and buying electric vehicles while also instituting a minimum fee for oil and gas extraction on public lands.
These climate provisions are projected to lower emissions by 40% by 2030 relative to 2005 levels, according to some estimates. The White House’s Office of Management and Budget also estimates that $1.9 trillion worth of social and economic damages by climate change will be averted by the Act. While the political debate over the bill will likely continue for some time, there are already some individual implications. The subsidies in the Inflation Reduction Act might make clean energy investment an even better idea–although oil and gas are likely not going away anytime soon. The tax credit on electric vehicles has also been expanded, so maybe you can finally get that Tesla you have been eyeing. Be forewarned, there are some strings attached; cars above a certain price level and individuals with more than a certain income are not eligible, and there are requirements on where the car is manufactured. But perhaps the largest benefits of these climate provisions are intangible; Earth’s ecosystem provides a multitude of economic services whose value economists have only recently tried to quantify.
Ultimately, the ethos of the Inflation Reduction Act is that economic growth can only be sustained by responsible use of the planet’s resources. As with the rest of its provisions, whether or not this goal plays out will only be decided with time.