Will the Inflation Reduction Act reduce inflation?

As in the famous case of reports of Mark Twain’s premature demise, the news of the death of climate change legislation several weeks back was clearly exaggerated. Talks between West Virginia’s Joe Manchin and New York’s Charles Schumer had broken down over Manchin’s continued concerns about inflation. Somehow, the climate change legislation received a new lease on life when the two men returned to the bargaining table and agreed upon a new version named the Inflation Reduction Act. Kudos to Sen. Manchin for being concerned about the inflation adversely affecting American pocketbooks, but the question is whether the Inflation Reduction Act will reduce inflation.

Reading through reports of the bill, it appears the primary purpose is to subsidize green energy to address climate change. That means hundreds of billions of dollars aimed at more production of energy from wind, solar, and battery production. The tax credit for electric vehicles will be extended, but it should also be stated the traditional producers have not been left out. There is additional support for oil, gas, coal, and nuclear production.

The bill’s secondary purpose is to deal with healthcare spending in the Medicare program by both the government and consumers. Medicare will be able to negotiate directly with drug companies on some of the drugs that result in the largest spending. It also aims (eventually) to cap the out-of-pocket expense of Medicare participants to $2,000 each year. The government would have to pick up the overages. In addition, the bill would extend subsidies for the Affordable Care Act (also known as Obamacare).

At this point, the reader may be wondering precisely what this climate change and healthcare spending bill has to do with inflation reduction. By and large, the bill is a typical spending measure that would not necessarily curb a raging fire of inflation at all. Subsidies of various kinds are not likely to result in a reduction of inflation. The two most subsidized areas of the economy are probably healthcare and education. Those are the two areas where the most dramatic cost increases have occurred in the past few decades.

To be fair, however, much depends on whether energy subsidies result in legitimate technological advances. If they do, then costs may ultimately decline, but that would depend on the success and the ability of alternative energy to wean itself from government spending. Will we get Silicon Valley (initially subsidized by the Defense Department) or the hucksterism of Solyndra (which took half a billion dollars of federal money with it in a stroke)? The record of such programs is not good.

Enabling Medicare to negotiate with the drug companies is a two-edged sword. On the one hand, it may provide immediate relief to both the government and consumers in terms of prices. On the other, it could inhibit innovation that we hope will yield great advances concerning ailments such as Alzheimer’s disease, diabetes, and a variety of other problems that exact a tremendous toll. Furthermore, it doesn’t come free, and the very taxpayers who welcome the program may end up paying more in taxes than they imagine.

Economists and other experts are being asked whether a large spending bill of this type can curb inflation. Intuitively, we understand that heavy COVID spending has helped create the rapid rise of prices we have been experiencing for months. The Federal Reserve has begun trying to douse inflation in earnest, but it won’t do any good if Washington keeps adding fuel to the fire. Answers that we see coming back are measured.

Over an extended period, the bill should collect more tax revenue than it spends. Assuming the projection is correct, the result would be favorable for controlling inflation. The effect would be modest because the difference is about $300 billion over a term of years in an economy of several trillion dollars annually. But the only way that surplus would impact would be if the government used it to retire debt. For a long time now, we’ve turned any marginal revenue gains directly into greater deficits and a frightening cumulative mound of debt. Furthermore, the effect is likely to come years in the future, if at all.

Will the federal government develop the discipline necessary to turn even its most favorable projections in our favor? The answer is that they must, because financing many trillions of dollars in debt will become substantially more challenging as interest rates continue to rise. But the Inflation Reduction Act is not an answer to that problem.