The Inflation Reduction Act (IRA) is a federal law in the United States signed into law by President Joe Biden in 2022 which aims to curb inflation by reducing the deficit, lowering prescription drug prices, and investing into domestic energy production while promoting clean energy. The intent of the IRA is to jump-start investments in manufacturing capacity, R&D and commercialization of cutting-edge (mainly green) technologies within the US, as well as to stimulate the acquisition of critical materials from within the US or from free trade partners.
It is generally accepted that the IRA will have a negative impact on the competitiveness of the EU, although the scale is, as of now, unclear.
Short term effects of the IRA with regards to FDIs are, however, already showing in the:
a) increase of investments made in the US,
b) delaying certain investments in the EU,
c) intense lobbying activity on the part of multinational companies wishing to squeeze more funding from the EU.
Investments will, naturally, not stop in the EU due to the IRA, as investments are not zero sum activities.
However, the EU may find itself in a brutal knife fight with the US to win the largest new investment projects over as well as to keep the companies that have already invested in Europe in the EU, especially in new key clean-tech industries, such as the above mentioned EV battery manufacturing.
There is also evidence that the manufacturing activities are becoming more regionalized (most likely due to the experience of the near-collapse of global supply chains during the COVID-19 pandemic), making the effects of the IRA not the reason but only a new catalyst of this trend.
Why is the IRA important for the European Union?
- Funding for environmental initiatives.
Nearly $400 billion has been set aside for clean energy with the goal of significantly reducing US carbon emissions by 2030. A combination of grants, tax incentives, and loan guarantees will be used to deliver the federal funding. The largest portion is made up of clean electricity and transmission, followed by clean transportation, including incentives for electric vehicles (EVs).
- Private investment incentives.
Tax credits make up the majority of the $394 billion in funding for energy and climate. With estimated tax credits worth $216 billion, corporations receive the most. These are intended to stimulate private investment in manufacturing, transportation, and clean energy. The bill contains a number of direct pay tax incentives, which allow an entity to claim the full amount even if its tax liability is less than the credit.
By lowering the cost of EVs, energy-saving appliances, rooftop solar panels, geothermal heating, and home batteries, an estimated $43 billion in IRA tax credits aims to reduce emissions. From 2023 onward, EVs that qualify will be entitled to tax credits of up to $7,500 for new cars and $4,000 for used cars, respectively. A tax credit of up to 30% of the total cost of qualifying home improvements will be available, with an annual cap of $1,200. The credit for heat pumps is capped at $2,000 annually.
Although the IRA is positioned as a well intentioned climate law, it also provides subsidies that may significantly distort trade, some being even prohibited under WTO rules, triggering worries of protectionism in other countries, mainly in the European Union.
While the green subsidies provided by the IRA are similar in size to those available in the EU, there are several differences:
- incentives provided by the EU are not discriminative in nature, while incentives provided under the IRA may elicit worries of protectionism,
- in general, the incentives provided under the IRA are simpler and pose less of an administrative burden for the beneficiaries,
- innovation is not the main goal of the incentives provided under the IRA, mass deployment and adoption is.
Response of the European Union
In a direct response to the IRA, the EU Commission has adopted a new Temporary Crisis and Transition Framework on 9 March 2023 to foster support measures in sectors which are key for the transition to a net-zero economy, in line with the Green Deal Industrial Plan. Together with the amendment to the General Block Exemption Regulation that the Commission endorsed the same day, the Temporary Crisis and Transition Framework will help speeding up investment and financing for clean tech production in Europe.
