The Inflation Reduction Act: Pro-Growth Climate Policy - Treasury

The Inflation Reduction Act: Pro-Growth Climate Policy | U.S. Department of the Treasury
November 13, 2023

Eric Van Nostrand, Assistant Secretary for Economic Policy (P.D.O.)

Arik Levinson, Deputy Assistant Secretary for Climate & Energy Economics

The Inflation Reduction Act (IRA) is the largest investment in reducing carbon pollution in U.S. history. But along with the Bipartisan Infrastructure Law (BIL) and the CHIPS and Science Act, the IRA also serves as a key investment in our economic growth.

Some skeptics of government climate policy have claimed that initiatives like the IRA will slow U.S. economic growth.

But that old objection does not reflect the economic reality that good climate policy can promote growth. That might sound like the metaphorical free lunch economists dismiss, but it’s not. We describe five ways that climate policies like the IRA can promote growth:

- lessening greenhouse gas emissions which result in costly climate damages;
- adapting to the effects of climate change;
- reducing economic damages from local pollutants often released alongside greenhouse gases;
- supporting innovations that have productivity benefits beyond their direct climate effects; and
- lowering economic reliance on fossil fuels with volatile global market prices.

(1) Mitigating greenhouse gases

Reducing greenhouse gases mitigates the costly damages those emissions would have caused-- the most direct way that climate policy benefits the economy. Some of those economic costs are obvious, like costs due to more frequent and more powerful hurricanes, floods, and fires.

The U.S. Council of Economic Advisers and Office of Management and Budget summarized twelve recent studies assessing the aggregate cost climate damages will impose on the U.S. economy.

The United States accounted for 13 percent of global carbon dioxide (CO2) emissions in 2022, and a quarter of the cumulative global CO2 emissions from fossil fuels burned since pre-industrial times.

That is one reason why President Biden signed the IRA, the largest-ever U.S. federal effort to reduce greenhouse gas pollution. Nine independent analyses reviewed in the journal Science project that the IRA will reduce U.S. emissions in 2035 to an average of 20 percent below what they would be without the IRA.

Even the most ambitious mitigation efforts, however, will be insufficient to avoid damages from the greenhouse gases already causing atmospheric changes. That leads us to a second set of climate policies that also benefit the economy: policies geared towards adaptation.

(2) Adapting to climate change

Adaptation policies include building sea walls and reinforcing buildings, designing new forms of insurance and disaster response, and safeguarding critical infrastructure. Although those steps will be costly, not making adaptation investments would be even more costly. Adaptation investments help ensure that when climate-related weather disasters do happen, they cause less damage.

Economic research has corroborated the value of adaptation expenses. Globally, Hallegatte et al. (2013) calculate that spending $50 billion per year to build higher bridges and move transportation routes inland for 136 coastal cities around the world would reduce expected annual losses from climate change in 2050 by nearly $1 trillion.

Of course, government policies are not always necessary; many adaptations can be undertaken by individuals. People can reinforce and weatherize their homes and upgrade to new energy-efficient heating and cooling systems. But some families cannot afford those adaptations. That is why the IRA includes tax credits to help homeowners afford better doors and windows and energy-efficient temperature control. The credits reduce homeowners’ initial upgrade costs and enable future energy savings.

Moreover, some adaptations like seawalls and road reconstruction are public goods that cannot be left to markets. And that is a reason why President Biden signed the Bipartisan Infrastructure Law. Many parts of the $1.2 trillion law are designed to promote both growth and adaptation to climate change. For example, the law provides $16 billion for upgrading electric power grids.

(3) Reducing local pollution

In addition to improving the economy by mitigating and adapting to climate change, climate policy also benefits the economy by reducing local pollution.

When powerplants burn coal or people drive gasoline-powered cars, that causes greenhouse gas emissions that affect the global climate. Alongside those global pollutants, powerplants and cars also cause local air pollution like sulfur dioxide and particulates. Those local pollutants sicken nearby residents, raise their health care costs, and diminish their productivity, with negative consequences for the whole economy.

Recent economic research provides abundant examples. Air pollution reduces the productivity of factory workers,

The domestic benefits from reduced local air pollution can be significant. The EPA estimates that its proposed new regulation limiting greenhouse gases from electric power plants will provide global benefits of $5.4 billion in 2030 from mitigated future climate damages.

(4) Spurring innovation and spillovers

A fourth way that climate policy can promote growth is by backing innovative research and development (R&D). Without government support, private businesses underinvest in climate-related R&D for two main reasons.

The first is the classic market failure that applies generally to all R&D. Businesses that do invest in new products or production techniques have trouble preventing competitors that do not invest from exploiting their discoveries.

The second reason private businesses underinvest in climate-related R&D arises from the fact that the climate benefits of mitigating climate change accrue globally, not just to the people or businesses doing the mitigation. In economics jargon, mitigation benefits are a public good. As with any public good, leaving climate R&D to market forces has led to underinvestment.

Because the private sector underinvests, for these two reasons, the economic returns to government funding for climate and energy R&D can be especially large. That return on government investment in R&D motivates President Biden’s argument for many aspects of the IRA, as well as the IIJA and especially the CHIPS Act. The policies establish new R&D programs, strengthen existing ones, and advance public-private R&D partnerships, particularly in parts of the country and in academic institutions that have seen underinvestment.

Abundant anecdotes demonstrate the enormous returns on government funding for energy R&D.

More systematic evidence comes from the U.S. National Academies, which found that each patent filed by a DOE grant recipient leads to multiple patent filings by non-recipients.

In recent years, the U.S. share of GDP devoted to energy-related R&D has lagged that of many OECD countries.

(5) Reducing economic vulnerability to international price volatility

Finally, climate policies that promote clean energy may buffer the economy from fluctuations in fossil fuel prices. Just in the past three years, natural gas prices have quadrupled and then fallen by 50 percent,

At the individual level, those price swings are tough on American businesses and households. Retail natural gas prices rise and fall with spot market prices. Oil accounts for more than half the cost of gasoline at the pump, so when oil prices triple gas prices can easily double.

Renewable energy sources like wind and solar are not subject to that type of price uncertainty. Once the solar panels and wind turbines have been installed, the fuel to power them is effectively costless. Businesses and households that heat or cook with electricity powered by renewable energy will not be vulnerable to large price swings. And drivers of electric cars can rest assured that their transportation costs won’t suddenly double.

Economy-wide, international energy price fluctuations have long been blamed for causing or exacerbating recessions.

Conclusion

This post summarizes five mechanisms through which the Inflation Reduction Act and other climate policies can both increase economic output and reduce climate damage. Policies that mitigate greenhouse gases and local pollution, adapt to climate change, spur innovations in energy technologies, and reduce our economic reliance on fuels with internationally set energy prices don’t just make sense for the environment and for the future of the planet. They make good economic sense for Americans today and in the future.

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