The Inflation Reduction Act: the next big shift on climate action

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At Davos 2023 in January, International Energy Agency Executive Director Faith Birol said that “the Inflation Reduction Act…is the most important climate action after the Paris 2015 agreement”. Six months after the bill was signed by President Biden, this legislation is still on the minds of senior financial figures and policymakers. 

The act includes more than $369 billion in climate and energy spending which could increase to $1 trillion with uncapped tax credits. The policy has sparked debate in the EU, which has begun discussions to implement a similar bill that would potentially include massive subsidies on top of existing green investment programs to persuade green tech to stay in the continent despite its own rules on state aid

Why has this bill in particular so thoroughly shifted the conversation on environmental policymaking? And what lessons should the sustainable finance world take from it?

The Inflation Reduction Act: its effects 

The Inflation Reduction Act is massive in scope – the full text of the act is 274 pages long. The legislation primarily targets the development of US green technology. With a combination of tax breaks, direct subsidies and other financial and legal incentives, it aims to catalyse manufacturing and R&D across a variety of industries and technologies. 

As well as boosting industry on the supply side, the bill also includes tax breaks for businesses and individual consumers to boost their spending on solar panels and electric vehicles, increasing demand for these technologies domestically. 

Crucially, these tax breaks and subsidies are only available  to businesses that produce and supply their products from the United States, excluding nations such as China, which currently dominates the market for manufacturing many green technologies

The effects on climate could be significant according to many projections. According to Energy Innovation the bill is predicted to cut national greenhouse gas emissions by 37%-41% by 2030 compared to peak 2003 levels, potentially putting the US within reach of its Paris Climate Agreement goals. Already, the New York Times has reported that there have been so many new proposals for green energy initiatives that the current energy grid is not prepared to handle it. While this is a notable bottleneck that the US government will have to fix, it also indicates a real momentum towards renewables as a result of the legislation.

For sustainable investors in the US, this bill is a game-changer, according to an analysis by Morningstar Sustainalytics. It goes a long way towards reducing the risk inherent in many green investments by providing direct assistance to green start ups and tax breaks to existing businesses. It also provides direct incentives for businesses to “go green” and create efficiencies within their energy use and supply chains.

In fact, research has shown that companies in the US have sustained or even boosted their sustainability spending in the face of an uncertain economy, underscoring the influence of these subsidies in the business environment.

With a collective $2 trillion in manufacturing spending set in motion across the remainder of President Biden’s current term, it is unsurprising that many businesses are considering moving their production to the US to take advantage of these generous subsidies

Will this be good for sustainable finance?

Where does this leave sustainable finance? Opinion is divided. The transition will need money far beyond the scope that the Inflation Reduction Act provides and was an unavoidable discussion point at COP27. Much of that will need to come from private sources, but governments and policymakers have an important role in directing strategic investments. Government investment can be mutually beneficial with private sources by decreasing risk and bringing down costs for sustainable projects. 

When speaking on the Inflation Reduction Act, the IEA executive director pointed out that ‘There has [hardly been] any game-changing and transformational technologies that have ever been developed in the world that did not at some point have some sort of subsidy.’

Despite obvious benefits to the climate and the green economy, this strategy is not without its critics. Several prominent experts have characterised this bill as ‘climate protectionism’ 

that favours domestic industries over international ones. Europe in particular has protested that these incentives could damage its green tech industry, to the extent that it has caused diplomatic friction between them. The bloc is planning its own investments, though some have argued that competition for subsidies would lead to unhelpful international competition.

Others argue this could create a race to the top that would catalyse capital flows into the low carbon transition. In particular it might reduce the financial risks associated with green technology such as clean hydrogen. We are already seeing some investments in that space, such as our client Border to Coast’s recent €100 million allocation to a Hydrogen infra fund, and the potential for tax and public incentives could inspire further capital.  

In a world where investment in renewables has matched that of fossil fuels for the first time, one cannot help but feel at least a sense of optimism in these developments. Legislation such as this demonstrates that governments are willing to take significant and decisive action to improve the sustainable investment environment. Even before the end of President Biden’s first term, it is clear to see that the Inflation Reduction Act will be a legacy defining action for him that has shifted economic thinking on the climate crisis indelibly. We can only hope that this legacy will be a positive one.  

Elliot Settle, Account Executive

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