Published with permission from Knowledge @ Wharton, Wharton's online business journal.
The Inflation Reduction Act of 2022 that President Joe Biden signed into law on August 16 would reduce cumulative deficits by $264 billion over its 10-year budget window, according to a study by the Penn Wharton Budget Model (PWBM), a nonpartisan research initiative that analyzes the fiscal impact of public policy.
PWBM’s estimate on the deficit reduction was lower than the $300-plus billion forecast by the Senate Democrats who sponsored the bill, as it anticipated higher spending on some provisions than Democrats’ projections. The study was produced by PWBM staff, and the report was written by Jon Huntley, senior economist, John Ricco, associate director of policy analysis, and Alexander Arnon, associate director of policy analysis. They analyzed the budgetary, macroeconomic, and distributional effects of the Act.
The study estimated the Act to have minimal impact on inflation, but “in the long run, [it] leads to lower government debt, higher wages, higher total factor productivity and higher GDP.” Those estimates included the impact of debt reduction, carbon reduction, and tax incentives on investments and working hours.
In arriving at its estimates of the distributional tax effects, PWBM assumed that 75% of corporate income taxes are borne by owners of capital, while the remainder is borne by labor. It estimated that higher-income households would bear most of the tax increases. On the other hand, future generations, including higher-income households, will gain from the improved economy, including productivity gains from a reduction in carbon emissions, it stated. ** Financing the Spend, Leaving a Surplus**
According to PWBM estimates, the Inflation Reduction Act will essentially spend $455 billion over the next 10 years to combat climate change and lower health care costs, which would be funded from nearly $720 billion it would raise from new corporate taxes, improved tax collections and savings from prescription drug pricing reforms. The money left over ($264 billion) would go towards lowering the federal deficit.
The bill had showed little traction until Senator Joe Manchin III (D-W. Va.) and Senate Majority leader Charles E. Schumer (D-N.Y.) gave it fresh life on July 27 with a revised package, followed by more changes demanded by Senator Kyrsten Sinema (D-Ariz.), whose support was crucial for the bill.
Sinema had pushed for scrapping a provision that sought to withdraw a tax break on “carried interest income,” or the profits that private equity investors and hedge fund managers make on their investments. Under current law, they pay a lower capital gains tax if they hold their investments for at least three years. The revised bill includes revenue-mobilizers such as a 1% tax on share buybacks by corporations, and a two-year extension of limits on how much business deductions of losses could exceed gross income for noncorporate taxpayers (individuals). Softening those is a new feature that will allow accelerated depreciation of business investment in the new corporate minimum tax.
According to the PWBM study, the biggest investment under the Act will be $385 billion to address climate-change risks and boost clean energy production. That includes tax credits or rebates for purchases of electric vehicles or fuel-cell vehicles, heat pumps, rooftop solar panels, and fuel-efficient appliances, and for weatherizing homes. It also packs tax credits for job creation in projects involving clean energy construction, solar, wind, clean hydrogen, and carbon capture.
“They are hitting the full spectrum in terms of promoting energy alternatives and energy efficiency in the economy,” Arnon said in a recent episode of the Wharton Business Daily radio show that airs on SiriusXM.
The study also estimated that nearly $70 billion will be spent on providing expanded health care subsidies under the Affordable Care Act through 2025; they were earlier set to expire at the end of 2022. Those expanded subsidies, called “premium tax credits,” offer eligibility to households above 400% of the poverty line. “It would keep a lot of people from falling into uninsurance or falling into financial distress,” said Arnon.
A Widening Tax Net
PWBM also estimated the impact of provisions that will “offset those deficit-increasing initiatives.” Fresh taxes will bring in nearly $280 billion, while increased tax collections will net $147 billion; another $230 billion is estimated in savings from reforms in prescription drugs pricing.
Of the new taxes, $200 billion is estimated from a 15% alternative minimum tax (AMT) on corporations that declare at least $1 billion in income in their financial statements, also known as book income. The plan is to target about 200 of the largest corporations that now pay taxes of less than 15% of such book income. Corporations typically report lower taxable income than book income after adjustments such as incentives for investments, which allows them to reduce their tax bills.
“[The minimum alternative tax] is a bit of a Rube Goldberg device,” said Arnon. “It’s a little unpredictable [as to] who it will affect and how it will affect them. You could reduce the tax incentives for investment and accomplish a lot of the same goal. Instead, Congress is approaching it indirectly through the financial statement income.” A recent PWBM webinar discussed the minimum corporate book income tax in detail, including potential issues with implementation.
A 1% tax on share buybacks by corporations is estimated to bring in $78 billion; and $65 billion is sought by extending limits on deductions of excess losses by noncorporate taxpayers. Two other revenue streams are $147 billion from stronger IRS collection drives, made possible by an $80 billion investment in new hires and modernizing the agency’s systems.
Arnon said that while the bill sought to provide “a significant increase in the amount of resources and energy for the IRS to go after potential tax evasion and shady practices, it remains to be seen how this will actually work.” For one, he said “[it would] be tough for the IRS to staff up to the levels consistent with this amount of funding.” At the same time, the proposals would bring about “a sea change in the tax enforcement environment,” he added, noting that the IRS has been under-resourced for a long time.
The reforms in prescription drugs pricing would allow Medicare to negotiate prices of certain prescription drugs; limit Medicare and commercial price growth of certain drugs to inflation; repeal the implementation of a “rebate rule” scheduled to increase drug-related Medicare outlays beginning in 2027; redesign the Medicare Part D benefit formula, and cap out-of-pocket costs for beneficiaries.
“It definitely seems very likely that this will have a meaningful impact on at least the prescription drug prices paid by Medicare and probably the market more broadly,” said Arnon. “The biggest punch for inflation [will come] from those reductions in prescription drug prices.” An earlier PWBM study had estimated the impact of drug pricing reforms.