Economic Implications of the Climate Provisions of the Inflation Reduction Act

Abstract

The Inflation Reduction Act (IRA) represents the largest US federal response to climate change to date. We highlight the key climate provisions and assess the act's potential economic impacts. Substantially higher investments in clean energy and electric vehicles imply that fiscal costs may be larger than projected. However, even at the high end, IRA provisions remain cost-effective. The IRA has large impacts on power sector investments and electricity prices, lowering retail electricity rates and resulting in negative prices in some wholesale markets. We find small quantitative macroeconomic effects, including a small decline in headline inflation, but macroeconomic conditions—particularly higher interest rates and materials costs—may have substantial negative effects on clean energy investment. We show that the subsidy approach in the IRA has expansionary supply-side effects relative to a carbon tax but, in a representative-agent dynamic model, is preferable to a carbon tax only in the presence of a strong learning-by-doing externality. We also discuss the economics of the industrial policy aspects of the act as well as the distributional impacts and the possible incidence of the different tax credits in the IRA.