Will the Inflation Reduction Act Reduce Inflation?  How to Take Advantage of the New Law

The Inflation Reduction Act (IRA) just passed in both the House and Senate and is expected to reach President Biden’s desk for final ratification this week.  The description of the bill from the democrats in the Senate is:

“The Inflation Reduction Act of 2022 will make a historic down payment on deficit reduction to fight inflation, invest in domestic energy production and manufacturing, and reduce carbon emissions by roughly 40 percent by 2030.”

Let’s dig into the soon-to-be law and discuss whether it will reduce inflation, and then highlight the tax breaks and benefits ordinary people like us can take advantage of from this bill.

Will It Reduce Inflation?

Short-Term

The cause of inflation comes down to simple economics – too much demand in the face of limited supply will increase prices.  And the process of bringing down inflation is often painful since it can mean reducing consumption.  The government can reduce overall consumption by increasing taxes, cutting government spending, or raising interest rates.  The government can help increase supply by removing frictions in production, easing regulations, and making investments in infrastructure (this helps in the long-term). 

We believe the Inflation Reduction Act could slightly add to inflationary pressures over the near-term, as the provisions to put more money in consumers’ pockets could increase overall demand in the economy and make it easier for corporations to pass down increased taxes to end-consumers.

Long-Term

Long-term, the bill allocates $369 billion to energy security, clean energy infrastructure, and climate change initiatives.  Included are a slew of personal and business tax-credits for clean energy related purchases.  This could be expected to reduce our dependence on fossil fuels over the long-term, which should shield the economy from inflationary pressures due to fossil fuel prices.  Short-term, however, these tax credits may modestly stimulate inflation, as there is a lag between the purchase date (and when tax credit is received), production date, and installation date (when the clean energy benefit is received) of the specific clean energy facility or vehicle.

Tax Credits & Goodies for Ordinary People

Regardless the bill’s potential impact on inflation, there’s lots of tax credits and other new benefits in this soon-to-be law.  Let’s cover a few.

Lower Health Insurance Marketplace & Medicare Drug Costs

If you buy your health insurance from Healthcare.gov, the increased subsidies available from the 2021 American Rescue Plan will continue to be available through 2025.  This extension limits healthcare costs to 8.5% of income, with no specific income-level cutoff.  Prior to 2021, there was a “benefit cliff” where earning just one cent over specified income level cutoffs (around $50,000 per individual) could more than double one’s healthcare costs.

Another healthcare benefit is a new $4,000 (and dropping to $2,000 in 2025) annual out-of-pocket maximum for prescription drugs for those on Medicare and a limit on how much Medicare part D premiums can increase each year.  Medicare will also be able to negotiate the price of prescription drugs which should lead to lower costs for participants.  Finally, the income limit to participate in Medicare’s Low-Income Subsidy program will be increased from 135% of the federal poverty level to 150%.

Tax Credits for Home Improvement & Electric Vehicles

The IRA extends and increases the Residential Energy Tax Credit (it expired at the end of 2021) to individuals for various clean-energy home improvement projects.  This credit previously allowed up to 10% ($500 lifetime maximum) of a project’s cost to be claimed as a tax credit.  The IRA will increase this credit to 30% of a project’s cost with $1,200 lifetime maximum credit amount.  One project that I’m hoping to claim this credit on is replacing my old, inefficient, single-pane windows with energy-star rated hurricane windows.  Additionally, if you live in Florida, hurricane windows just became sales-tax exempt in July and will stay exempt for the next two years.  Energy efficient appliances, water heaters, insulation, and doors also qualify for this credit.

The Electric Vehicle (EV) Tax Credit will also be extended for new cars, and the first ever used EV tax credit will be introduced to consumers.  The tax credit is up to 30% of an electric vehicle’s cost, up to a maximum of $7,500 for new cars and $4,000 for used cars.  Please note the credit for used EV is subject to lower income limits than the new EV credit ($75,000 for an individual, $150,000 for a couple filing their taxes jointly).

Other Goodies & Final Thoughts

Many of the other energy-related tax goodies in the bill are narrower in scope and apply to either low-income individuals or owners of larger businesses.  My overall thoughts are that they won’t materially impact inflation over the short-term, but a lower reliance on fossil fuels could protect consumers and the economy from flinching in future years due to oil price spikes.

As for the tax credits available to most individuals, I expect many of them to be retroactive to the beginning of this year.  Therefore, if you bought a new appliance in January, you may still be able to claim the credit once Biden signs the bill into law.  Lastly, many of these credits are expected to last close to a decade, meaning that if you’re just starting to save up for that new furnace or electric vehicle, you have plenty of time to do so and still receive the credit.