There is something to be said for the adage "try, try again." In the case of current politics, if you cannot pass the Build Back Better Act, go for a smaller version that is appealing enough to get a slim majority of votes. That is what happened with the Inflation Reduction Act (IRA). The IRA has multiple features, including an extension of Affordable Care Act subsidies, a 15 percent corporate minimum tax, tax credits for zero-carbon energy, more funding for the Internal Revenue Service (IRS), and drug price reforms that will cause more harm. Today, I would like to take a look at the macroeconomic effects of such broad legislation.
Will the Inflation Reduction Act Reduce Inflation?
You would think with a title like the "Inflation Reduction Act," there would be significant reduction in inflation. At the same time, this would not be the first time that the actual impact of the legislation would be the opposite of what the title suggests. No Child Left Behind ended up leaving behind millions of children. The Affordable Care Act made healthcare less affordable. The Defense of Marriage Act did not defend marriage for everyone that wanted to enter into a consenting relationship with another adult. The Inflation Reduction Act is no exception. The name "Inflation Reduction Act" is a reflection of salesmanship and has nothing to do with reducing inflation.
The Congressional Budget Office (CBO), which is considered the gold standard for legislative analysis, does not find that the IRA would have significant impact on inflation. For the CBO, it will have negligible impact in 2022. As for 2023, the estimated range is reducing inflation by 0.1 percent to increasing it by 0.1 percent. Penn State's Wharton Business School, which is quite revered in these sorts of analyses, is not any more flattering. The Wharton Business School found that there was no notable reduction in inflation:
The Act would 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. These point estimates, however, are not statistically significant from zero, indicating a low level of confidence that the legislation would have any measurable impact on inflation.
Corporate Minimum Tax
One of the biggest forms of tax reform in the IRA is on corporate taxes. The IRA imposes a 15 percent book corporate tax on companies that make over $1 billion in profits annually. There are different accounting standards used for reporting income to the government (tax income) versus what is reported to investors (book income). There are instances in which book income is larger than tax income, which means that a corporation very well might pay less in corporate taxes as a result. To quote the Left-leaning Institute on Taxation and Economic Policy (ITEP), "if the total taxes (US and foreign taxes) paid comes to less than 15 percent of those profits, this provision would require them to pay additional tax to raise their effective worldwide tax rate to 15 percent." ITEP calculates that such a provision would generate $223 billion over a decade.
Those on the Left, such as those as ITEP, see this as a step in the right direction because it means addressing corporate tax avoidance. This line of thinking assumes that such a reform would be better for the economy or society. Out of the 0.2 percent decline in the GDP that the Right-leaning Tax Foundation projected, half of that decline is attributable to the corporate tax. As I have brought up before in my analysis of corporate taxes (see here, here, and here), corporate taxes are the least effective form of taxation. The Tax Foundation illustrates how the corporate tax is the most economically damaging way to raise tax revenue.
Using the unconventional way of raising corporate taxes through book income does not make this tax reform any less damaging. In addition to the issues with corporate taxes generally, this alternative minimum tax (AMT) will affect some industries more than others. According to Tax Foundation analysis on this AMT, industries that will feel disproportionate effects are real estate, utilities, mining, and automobiles. The Joint Committee on Taxation concluded that 49.7 percent of this tax incidence would fall on U.S. manufacturers.
Furthermore, as the American Action Forum details, the United States had a brief, but failed experiment with taxing bookable income in the late 1980s called Business Untaxed Reporting Profit (BURP). What ended up happening with the BURP adjustment was a detrimental effect on financial reporting. This would not only incentivize using alternative accounting practices to under-report book income, but the loss of information for investors had negative effects. All Biden's 15 percent corporate tax is going to do is stymie the economy while complicating compliance with tax collection efforts.
Excise Tax on Stock Buybacks
The other major tax reform in the IRA is the 1 percent stock buyback excise tax on U.S. publicly traded corporations. You can read this primer from Congressional Research Service for more information. Essentially, the reason for stock buybacks over paying dividends is the tax preferential treatment. Dividends have a top tax rate of 20 percent, but that is still higher than the zero percent tax for stock buybacks prior to the IRA. Stock buybacks also give stockholders a choice about whether or how to receive distributions. Even so, there is a debate as to whether dividends or buybacks are better for both investors and the company in the long-term.
In any case, one of the main reasons for this excise tax is to increase U.S. tax receipts from foreign investors. A one percent excise tax is still lower in comparison to a 20 percent tax on dividends. Another reason for this tax is to encourage corporations to invest in their business instead of returning excess cash to investors. However, buybacks do not starve firms of cash for investment, according to a 2019 report from the U.K. government. Another study shows that 95 percent of funds from these repurchases are reinvested in other public companies (Booth, 2022).
While projected to accrue $55 billion in tax revenues over the next decade, the Tax Foundation also expressed concern that it might be less if the dividend payouts are largely remitted to tax-preferred retirement accounts. Plus, the call for a tax ignores multiple benefits of buyback (e.g., reduced transaction costs, orderly market trading, lower market volatility). In short, a buyback excise tax could result in an inefficient allocation of capital over the medium-term by trapping capital in stagnant companies.
Will the IRA Raise Your Taxes?
One of Biden's campaign promises was that he would not raise taxes on those making less than $400,000. According to an analysis from the Tax Policy Center, the net effect of the IRA on after-tax income for middle-class households is effectively zero. This makes sense since the two main tax reforms of the IRA are the corporate income tax and excise tax on corporate stock buybacks previously covered. There are no income tax increases whatsoever in the IRA.
This is where the story gets more complicated. When you only look at adjusted gross income as the chart above does, then yes, taxes do not increase. However, the effects of the corporate tax or the buyback excise tax have more indirect, but nevertheless measurable, outcomes. This is why the nonpartisan Joint Committee on Taxation has a more inclusive measure of income in its analysis, which includes such factors as employers' contributions to healthcare, the employer's portion of Social Security taxes, and the implicit value of the insurance that Medicare provides. I will use calendar year 2023 as an example (see JTC CY 2023 figures below). With this more inclusive category, people who make under $10,000 and more than $30,000 will indeed experience an increase in taxation. This makes sense considering that corporate tax increases have multiple secondary effects, including that a significant portion of the corporate tax incidence falls on workers. Even if taxes on adjusted gross income will not increase, the working class will indirectly pay taxes elsewhere.
On the other hand, if you use the JCT's numbers to look further out to the third year and beyond, the net result on tax rates are about as impactful as the projected inflation reduction in the IRA.
Will the IRA help with the deficit? Technically it will, but not by much.
The other thing that irks me is that the Democrats are passing this bill off as fiscally responsible because the IRA is going to reduce the deficit. They are not wrong on that front. According to the bipartisan Committee for a Responsible Federal Budget (CRFB), the IRA is projected to reduce deficits by $300 billion within the first decade. It is the second decade where those savings will increase to the $1.1-1.9 trillion range, largely depending on whether those ACA subsidies remain permanent or not.
The accuracy of budgetary projections two decades out is more tenuous than they are one decade out. Even so, if the IRA ends up saving over a trillion over the next two decades as the CRFB projects, let's first keep in mind that it would be an average of $95 billion per annum. Who knows what spending binge the federal government will go on between now and then? Second, this does not account for the fact that the Biden administration drove up the CBO's projection of the 10-year deficit by $2.4 trillion with the American Rescue Plan and the bipartisan infrastructure bill that was passed. And then we would have to cover the remainder of the $6 trillion in borrowing that Congress did with its pandemic spending. This all ignores the bigger picture about the state of U.S. public debt, including that Medicare, Medicaid, and Social Security are all going to be driving federal debt further. I understand that the Democrats were looking for a legislative win shortly before midterm elections, but it doesn't change the fact that whatever deficit reduction that the IRA is projected to generate is a drop in the bucket in comparison to $30.7 trillion in debt the U.S. government has accrued and what additional debt it is likely to accrue.
Conclusion
What will be the macroeconomic effects of the IRA? In spite of its name, the Inflation Reduction Act will do nothing of significance to reduce inflation. The unintended consequences of the corporate minimum tax and the excise tax are going to cause more problems than they attempt to solve. As for reducing deficit spending, its impact is minuscule when looking at the grand scheme. If you needed more economic effects than those listed above, the Tax Foundation uses its model to project a few other effects. In the next decade, the GDP is going to decrease by 0.2 percent, there will be 29,000 fewer jobs, and there will be a 0.1 percent decrease in wages, and there will be a 0.3 percent decrease in capital stock. It would be nice to see legislation with the net effect of helping out the American people, but it seems that Congress is incapable of completing such a task.
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