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US Inflation Reduction Act vs Actual Inflation

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The Inflation Reduction Act of 2022, ratified by the US legislature and effective as of August 16 of this year, isn’t quite what its title suggests. Since inflationary pressures are at the forefront of the average American consumer (and voter) right now, the Act – passed into existence through a rather arcane path – doesn’t quite address any measures regarding the same in the present. Rather, it focuses on three primary areas: tax issues (and deficit reduction), energy and healthcare.

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In the Act, $80 billion in new funding has been accorded to the US Internal Revenue Service (IRS), of which $45.6 billion is earmarked for “enforcement-related funds”. IRS Commissioner Charles Rettig stated:

“The resources in the reconciliation package will get us back to historical norms in areas of challenge for the agency — large corporate and global high-net-worth taxpayers — as well as new areas like pass-through entities and multinational taxpayers with international tax issues, where we need sophisticated, specialized teams in place that are able to unpack complex structures and identify noncompliance”

However, the nonpartisan Congressional Joint Committee on Taxation – a US parliamentary body – found that taxes would jump by $16.7 billion on American taxpayers making less than $200,000 in 2023 and another $14.1 billion on taxpayers who make between $200,000 and $500,000. The committee further anticipates that between 78% and 90% of an estimated $200 billion will be collected from small businesses via an additional 87,000 IRS agents being hired under the package. Somewhere between 4% and 9% of the money collected is expected to come from businesses that earn above $500,000 a year.

The tax reform and associated deficit reduction measure is an interesting study. Despite being home to many of the most valued companies in history, personal income tax accounts for nearly 4 times as much revenue as corporate income tax.

Relative to other countries in the 38-nation Organisation for Economic Co-operation and Development (OECD) – comprising primarily of developed nations – corporate income tax as a percentage of tax revenue on average is nearly 60% lower in the US than in the OECD:

The importance of increasing revenues becomes apparent when considering the fact, that government has been running a deficit over the past 20 years. 2001 was the last time the US had a surplus while the deficit has been increasing since 2015, with a nearly $2 trillion jump in the deficit during the pandemic:

The energy aspect is rather interesting in a number of ways and is the largest part of the Act with a total value of $369 billion. While there are incentives for consumers and companies to make clean energy choices, there are several protections made to energy companies in securing public land for increasing domestic production which, as per industry lobbyists and energy companies, has been a problem for securing energy independence for the U.S. since the current administration took office.

There has also been a few interesting adjustments made to the “Qualified Plug-in Electric Drive Motor Vehicle Credit”, which funded the vast majority of the subsidies given for the purchase of new Electric Vehicles (EVs). The tax credit worth up to $7,500 for buyers of new EVs and hybrid plug-ins would be extended through 2032, along with a separate tax credit worth a maximum $4,000 for used versions of these vehicles. However, a new requirement for final assembly in North America has taken effect on August 16, 2022.

For new vehicles, the manufacturer’s suggested retail price (MSRP) for sedans would need to be below $55,000 to be eligible for the tax credit. For SUVs, trucks and vans, that price cap would be $80,000. Additionally, the credit would be unavailable to single tax filers with modified adjusted gross income above $150,000. For married couples filing jointly, that income limit would be $300,000, and for individuals who file as head of household, $225,000. Even used car purchases have similar income limits.

It bears noting that the tax credits are ineligible once a manufacturer reaches 200,000 vehicles sold. Given the sales limit and the MSRP limit, models such as the Hummer EV, Lucid Air, and every existing model by Tesla are ineligible to receive benefits, leaving models by Ford and GM with an advantage currently. Furthermore, tax credit are lowered on new EVs with battery minerals sourced from countries other than the U.S. Given all these factors, there are questions as to exactly how many buyers would benefit from this.

On the healthcare front, the Act enables an extension of the expansion of the Affordable Care Act, which will expand government benefits under Medicare to include the likes of free vaccines and affordable insulin and an expansion of coverage to 10 drugs. The Act will also require drug companies to rebate back price increases that exceed the rate of inflation. Whether there will be a discernible effect on drug prices remains a matter of debate: a lot of turmoil and back-and-forth between the government and pharmaceutical manufacturers can be expected.

In Conclusion

The Penn Wharton Budget Model (PWBM) drafted by the University of Pennsylvania estimates that the Inflation Reduction Act would reduce cumulative deficits by $248 billion over the next decade with no impact on GDP in 2031. However, the anticipated impact on inflation will be “statistically indistinguishable from zero.” On this point, the Congressional Budget Office – another US parliamentary body – is in agreement. The PWBM estimates that the deficit would eventually reduce by $248 billion while the Congressional Budget Office estimates this to be $305 billion.

Thus, it should be clear that the Act, despite its name, is more akin to a deficit reduction measure instead of a inflation reduction plan. In the long run, lower deficits results in lower money supply, which helps lower inflation. The proposed plan to plug corporate tax loopholes, however, will be a tortuous path: Washington is a city of compromises that ensures no single faction can maximize their position and special interest groups will likely ramp up lobbying to blunt the impact of the tax loopholes closing.

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