2022 Inflation Reduction Act 

The U.S. Senate passes the Inflation Reduction Act, clearing a path for a final vote by the House of Representatives

• The U.S. Senate passed a climate, healthcare, and tax bill yesterday afternoon referred to as the Inflation Reduction Act (IRA). The bill aims to spend $433B on climate and healthcare initiatives over the next decade and is estimated to more than offset those expenditures with $739B of proposed revenue. The bill passed through the Senate by a vote of 51 to 50 – with voting split along party lines. Vice President Kamala Harris casted the deciding vote. The legislation is now off to the House of Representatives to vote this coming Friday and is anticipated to pass. 
• A disproportionate amount of the appropriated expenditures ($369B or just over 85%) will be directed towards climate initiatives. The funds will be dispersed in the form of investments, grants and loans, aimed at supporting the development and adoption of clean energy technology and decarbonization activities across a variety of sectors. Perhaps most noteworthy is the approximately $80 billion in new rebates allocated to eligible households for electric vehicles and to help decarbonize residential buildings. This includes $9 billion in home energy rebate programs focused on low-income households and a 10-year consumer tax credit for other households to electrify home appliances and perform additional energy efficiency retrofits. In terms of more specifics on climate initiates: 
  • A key element of the bill is an extension of the existing tax credit for new electric vehicle purchases. The existing $7,500 rebate was subject to a 200,000-unit sales cap per OEM that major manufacturers like Tesla and GM were continuously butting into and limiting the adoption of electric vehicles. The new measure maintains the level of the tax credit but converts it to a point-of-sale rebate and eliminates the sales cap entirely. A new federal tax credit is also introduced for used EVs of up to $4,000. However, in both cases, the full credit is only available for individuals reporting adjusted gross incomes of $150,000 or less and joint filers of $300,000 or less. Limits will also be placed on the MSRP of the vehicles to further target the incentive towards middle and lower-income households. 
  • An estimated $270 billion in tax credits, grants, and loans focusing on on-shoring clean energy manufacturing, decarbonizing the power sector, and building a clean energy supply chain. These include an extension and expansion of both investments and production tax credits to decarbonize the power sector. This includes building renewable and zero-emissions electricity generation and energy storage, $30 billion in grants and loans to states and electric utilities to transition to clean electricity, $40 billion in investment and production tax credits to build and produce EVs, wind turbines, solar panels, batteries, and for critical minerals processing, and $22 billion in grants and loans to build new clean vehicle manufacturing facilities and to retool existing auto manufacturing facilities to manufacture clean vehicles.
  • However, chief among these provisions are an extension and expansion of the investment and production tax credits for renewable electricity generation that have been largely responsible for buildup of renewable capacity the U.S. has seen thus far. While solar and wind are naturally receiving the most focus, an expanded ITC/PTC is also available for nuclear generation and energy storage facilities are being included for the first time.
  • The bill also includes a new methane charge targeted at oil & gas production of $900 per tonne of emissions starting in 2024, rising to $1,500 per tonne by 2026. New methane regulations were expected to be passed by the EPA that would have forced broad-based reductions in methane emissions, but the new bill accelerates the timeline given that EPA regulations are yet to be released and will likely have a longer timeline. 
• On the healthcare side, the IRA extends the Affordable Care Act insurance subsides until 2025. These subsidies were originally part of last year's 2021 American Rescue Plan and were estimated to have lowered insurance premiums to $10-per month for over 13 million Americans. The bill also puts a cap of $2,000 on out-of-pocket prescription drug costs for individuals on Medicare, effective in 2025. Other healthcare reforms include making prescription drugs more affordable by allowing the federal health secretary to negotiate the price of certain expensive drugs each year for Medicare. However, there are several caveats. Not every prescription drug or patient will be impacted, and there's a sizeable lead time before the lower prices will kick-in. Negotiations will take effect for 10 drugs covered by Medicare in 2026, increasing to 20 drugs by 2029. 
• On the revenue side of the ledger, there are several noteworthy items: 
  • A new 15% minimum corporate tax imposed on all corporations making over $1 billion. It is estimated that this alone will bring in more than $300B in revenue over the next decade. 
    
  • Prescription drug pricing reform is also estimated to save the government nearly $300B over the same time period. 
  • The carried interest provision – which gave preferential treatment to private equity and hedge fund profits – was dropped at the eleventh hour of negotiations, but Democrats were able to negotiate a 1% excise tax on stock buybacks and dividends. On the surface, the excise tax could bring in more revenue than closing the carried interest loophole, however, it won't take effect until next year – suggesting corporations are likely to pull-forward any share buybacks before the measure takes effect. 
  • Enhancements in IRS Tax Reform are expected to result in nearly $125 billion of net new revenue.

Key Implications

• Despite being a significantly pared down version of the originally proposed $1.7 trillion "Build Back Better" bill, the IRA is without question a big win for both the Biden Administration and proponents of policies that address climate change.  
• This bill represents a significant leap forward for climate policy and puts the U.S. a major step closer to its interim greenhouse gas emissions reduction target of between 50-52% from 2005 levels by 2030, set by President Biden last Spring. Early optimism surrounding the bill's ability to successfully reduce emissions emanates from the bill's focus on the transportation and power sectors in which decarbonization is comparatively achievable and account for 52% of the U.S.' GHG emissions. According to the Rhodium Group, early modelling suggests reductions of between 31-44% by 2030 are more feasible rather than the higher goal previously laid out, which still moves the dial, but perhaps not as much as initially touted. Without any additional climate action, estimates are for emissions reductions of between 24-35% by 2030. 
• Power generation represented 25% of emissions in 2020, but those have fallen by 40.3% since 2007. Pre-existing policies around state-level renewable portfolio standards (RPS) and federal investment and production tax credits have already resulted in a dramatic surge in renewable generation across the country. According to the Energy Information Administration (EIA), 76% of new capacity additions came from solar and wind in 2020 due to a significant reduction in the levelized cost of electricity (LCOE) over time from those sources. The concern about continued reductions in emissions in the sector stemmed from the expiry of the ITC and PTC for both solar and wind this year and the recent Supreme Court ruling that prevented the EPA from setting emissions standards for fossil-fuel generation. However, even with expiry of the credits, the EIA projects that the LCOEs for solar wind would remain advantageous relative to combined-cycle natural gas and that 57% of new capacity additions through 2050 would be in renewables. The IRA changes the calculus on that projection even further by extending the ITC and PTC for another decade, while also raising the tax credit available for nuclear and making energy storage eligible for the ITC for the first time. These actions are likely to cement renewables as the go-to source for new generation. 
• On the transportation side, which represented 27% of GHG emissions in 2020, the IRA should have a significant impact on EV adoption. The existing consumer rebate sales unit cap was an oft-cited barrier by OEMs and lifting that entirely should help with the relatively low share of EV sales, currently at ~5%. Recall that the Biden Administration also committed $7.5 billion in last year's Bipartisan Infrastructure Bill to build out the EV charging network across the country. The IRA also includes a new rebate for medium and heavy-duty vehicles and chargers specific to freight.
• All said, the battle for emissions reductions through 2030 are likely to be in the above two sectors, but key to the IRA's long-term economic impact is the significant funding towards building out the clean energy supply chain within the U.S. and alongside its strategic trading partners in North America. The shift from "Made in America" to "Made in North America" is significant relative to previous iterations of the climate policy discourse. Shifting production of critical minerals and clean tech manufacturing away from Asia is a natural outcome of rising geopolitical tensions, but the dominance of China in the supply chain cannot be understated at this point. The IRA, along with the previous legislation and actions among key partner countries like Canada, are important first steps in ensuring the sustainability of the energy transition itself.
• Based on a scoring done by the Congressional Budget Office on a previous iteration of the bill released on July 27th, preliminary estimates suggest the IRA will reduce the deficit by approximately $300B over the next decade. From an economic growth perspective, this implies either a negligible or very small net drag over the next decade. Despite its name, the IRA will also do little to impact current inflationary pressures, with some early estimates by the Penn Wharton Budget Model suggesting a very small disinflationary impact in latter half of the decade.

Disclaimer

This report is provided by TD Economics. It is for informational and educational purposes only as of the date of writing, and may not be appropriate for other purposes. The views and opinions expressed may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The report does not provide material information about the business and affairs of TD Bank Group and the members of TD Economics are not spokespersons for TD Bank Group with respect to its business and affairs. The information contained in this report has been drawn from sources believed to be reliable, but is not guaranteed to be accurate or complete. This report contains economic analysis and views, including about future economic and financial markets performance. These are based on certain assumptions and other factors, and are subject to inherent risks and uncertainties. The actual outcome may be materially different. The Toronto-Dominion Bank and its affiliates and related entities that comprise the TD Bank Group are not liable for any errors or omissions in the information, analysis or views contained in this report, or for any loss or damage suffered.