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Does the Inflation Reduction Act Reduce Inflation?

The views expressed are those of the author and do not necessarily reflect the views of ASPA as an organization.

By Bruce J. Carter
September 16, 2022

Politics play a crucial role in the development of policies by the government to support the economic development. Sometimes, the policies are random and popular to appeal to a given constituency. Build Back Better Act, which was later killed in the Senate through continued negotiations, resulted in the passing of the $739 billion Inflation Reduction Act of 2022. The Build Back Better Act is one of the programs aimed at economic regeneration that is shrouded in ambiguity, as was the Affordable Care Act. According to the Committee for a Responsible Federal Budget (2021), rising inflation has created disagreements among experts on the effectiveness of the front-loaded nature of the Inflation Reduction Act and/or Build Back Better policies. The program’s strategies, including tax cuts, increase disposable revenue for direct spending, and consequently, inflation in the short-term. However, some political critics have mentioned that with the high inflation, Congress should not allow the $1.75 trillion in new spending. Furthermore, with supply chain chokepoint, gas and food prices have risen—consumer price inflation rose by 6.8 percent in November 2021, a record never seen in 39-years. No economist can know how the Inflation Reduction Act will impact the already risen inflation. But several economists agree that the effect will be diminutive. Here’s what some economists anticipate:

Two extensive tax reliefs under the Inflation Reduction Act would be applied instantaneously—the earned income tax/expanded child tax credit. In contrast, some of the Inflation Reduction Act tax increases would not take effect until later. Therefore, the federal government would spend more than it takes initially, hence why several economists say a potential modest inflation growth in the short term. Analysts from Tax Policy Center, Committee for a Responsible Federal Budget, the Tax Foundation and Moody’s Analytics agree.

In 2017, President Trump signed into law the Tax Cut and Jobs Act to inject more than $1.8 trillion into the economy. The Department of Treasury predicted that the Act would result in tax cuts amounting to $1.5 trillion. Ideally, policies that boost spending increase demand for goods and tend to create inflation. Tax cuts on corporate and individual earning increases the citizens’ disposable income and hence the demand for goods and services. Due to inflation, sustained economic growth could not be achieved because most of the tax cuts were not committed to investment. According to Horsley (2019), more than 60 percent of the benefits were enjoyed by top the 20 percent of high-income earners. After President Trump’s proposed tax cuts in 2017, there was brief economic growth in 2018, but the rate fell below modest levels in the following year. Although the economy grew significantly over that period, it was a reaction to the increased demand for goods and services by middle and low-income households.       

In addition to tax relief programs, the Inflation Reduction Act is predicted to expand earned income through improved wages and new employment by 0.1 and 0.3 percent in 2040 and 2050 respectively. Increased wages at a given time trigger elevated demand for goods and services. In the short-term, the demand for goods and services may exceed the supply, hence creating inflation. Expanded tax income reduces the government revenue and creates a deficit in the budget. For example, tax cuts implemented by the previous presidential administration created a gradual deficit in the government revenue, which implies that tax cuts are not self-paying. Through expanded tax cuts, the government spends more than it receives. The Congressional Budget Office estimates that by 2020, the cuts implemented by President Trump resulted in a deficit of $1 trillion, which is equivalent to 4.6 percent of the GDP. Although not all deficits create inflation, the ones emanating from the supply side are detrimental to the economy.  

In sum, the Inflation Reduction Act policies would reduce non-interest cumulative deficits by $248 billion over the budget window with no impact on GDP come 2031. In the short term, the Inflation Reduction Act policies may lead to economic growth as producers move to meet the growing demand. Currently, gas and food prices are declining. However, since tax cuts have more benefits for corporates and high-income earners, the expected growth in investment and spending may not be active in the long term. The mixed effects make the Inflation Reduction Act ambiguous and subject to divided opinions among experts. Ideally, the strategy should be dissociated from policies to prevent populist policies that do not have lasting positive implications on the economy.            


Author: Bruce J. Carter has a Ph.D. in Public Policy, and Administration, and he’s co-authored Water Wars: Sharing the Colorado river with Doug Cooper. He received his Executive Certificate from Harvard University in Public Policy: Social, Economic, and Foreign Policies. For Bruce, writing is a form of political engagement. While serving in the U.S Military, Bruce has deployed around the world.  Email: [email protected] Twitter: @BC_bcarter06

 

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