The Biden Administration Managed to Pass the Inflation Reduction Act. But How Will It Work?

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Ishani Srivastava

The Inflation Reduction Act (IRA), the most sweeping piece of climate and energy legislation in U.S. history, was signed into law by President Biden on August 16.

Biden’s original, more ambitious proposal had a long and arduous journey, its wings clipped in efforts to appease conservative West Virginia Senator Joe Manchin, whose support was crucial to pass the bill in the evenly divided Senate. A breakthrough came in late July, and the final version of the bill, nearly 800 pages long, sped through Congress in just under three weeks.

While it’s not enough to halve U.S. emissions by 2030 (the amount pledged by the U.S. in the Paris Agreement), it is a substantial step in the right direction. Committing over $369 billion to energy and climate, the Act targets five levers of climate action—renewable energy, hydrogen, transportation, buildings, and supply chain infrastructure. By and large, the focus is on incentivizing innovation rather than regulation.

The Observer breaks down some of the mechanisms in the Act designed to change the behavior of market actors.

Buildings: The IRA employs a suite of financial incentives (including tax credits and rebates) to direct unprecedented levels of funding towards energy-efficient buildings and appliances.

The approach is to encourage investment rather than mandate changes, so the exact impact of the Act will depend on the market response, and will probably continue to evolve with time. To maximize the IRA’s transformative potential, the market has to be as agile and responsive as possible. These financial incentives must be coupled with a concerted effort to educate and attract consumers and contractors, nurture the necessary skilled workforce to meet the demand of a growing industry, and fold together existing state and utility-level energy efficiency programs.

Transportation: The major policy tools used here are tax credits for buyers and sellers of electric vehicles (EVs), and manufacturers of EV batteries and other components.

The IRA extends the previously existing tax credit for the purchase of new EVs, expands its scope to include pre-owned vehicles, and removes the 200,000-vehicle-per-manufacturer production cap which would have prevented cars made by the four largest EV companies from being eligible. Additionally, the tax credit has been made transferable to the dealer, making it convenient for buyers to avail of it in the form of a discount on upfront cost at the point-of-sale, which is expected to substantially benefit low- and middle-income (LMI) consumers.

A further $1 billion in the Act supports clean heavy-duty vehicles like buses and trucks. These incentives could not come at a better time—heavy-duty vehicles emit a disproportionately high share of greenhouse gas emissions per year, and trucking demand is only expected to continue growing. With the IRA in place, the industry can dramatically decarbonize. The IRA tax credit makes owning an electric truck cheaper than owning a diesel one in most use cases. Trucks can travel 100,000 miles per year, and electrification has the potential to create significant fuel savings. Even many long-haul trucks that are the hardest to electrify could be transformed. Certainly, market actors have a lot of work to do. It’s time for fleets, utilities, manufacturers, and policymakers to step up so that we can have the cleanest, most economic trucks on the road. Fleet operators should start planning for the move to electric trucks. Utilities and regulators must do their part by ensuring that fleets that want e-trucks can buy them. With demand projected to exceed supply, e-truck manufacturers will have to ramp up production significantly.

On the supply side, the Act provides billions of dollars to support domestic sourcing, refining, and recycling of critical minerals for EV batteries, as well as domestic manufacturing and assembly of components. However, the tax credit only applies to vehicles that meet certain strict criteria. Eligibility is contingent on 40 percent of an EV’s battery components (by value) being extracted or processed in the U.S. or in one of 20 free trade partner nations. This requirement begins in 2024 and gradually ratchets up to an eye-watering 80 percent by 2027. These numbers have sent heads spinning across the industry and have drawn special concern from automakers, as today’s global mineral supply chain is based almost entirely outside of the U.S. and its free trade bloc. A rapidly industrializing China has created a near-monopoly on many of these minerals, especially lithium and cobalt. To catch up, American mineral supply chains will require a miniature revolution. The U.S. will need to invest $175 billion in battery production in the next three years. At the same time, it will need to increase its recycling capacity and improve circularity in the battery supply chain. The domestic mining industry will need significant incentives to get there. Fortunately, the IRA’s production tax credit will speed this process along. Critical minerals are only sustainable and affordable if they are a) produced ethically, b) recycled as much as possible, and c) used efficiently. Those three qualities haven’t always been the hallmark of American industry, but there has never been a better time to shift those paradigms.

Electricity: Wind, solar, and related renewables technology for electricity generation already beat fossil fuels on costs. Tax credits in this sector are now designed to spur rapid, nationwide deployment. A “direct pay” provision for states, localities, tribes, rural cooperatives, and nonprofits enables these entities to directly access tax credits and pass on 100 percent of cost savings to customers. The tax credits are guaranteed to extend for at least 10 years, giving renewable developers assurance for long-term clean energy planning.

In addition, $5 billion has also been allocated (plus an amount of $250 billion in the form of a loan guarantee authority) to finance energy infrastructure reinvestment (EIR)—projects that retool, repower, repurpose polluting infrastructure or replace outdated units, such as end-of-life coal plants. Improving the robustness of the credit system is expected to encourage waves of new investment, and lower costs in the long run.

Hydrogen: Clean hydrogen is the key fuel to decarbonize harder-to-abate sectors such as heavy industries, fertilizers, shipping, and aviation.

“Gray hydrogen”, which is manufactured from methane using a highly-polluting process, has long been the cheapest production method. In comparison, clean hydrogen made using renewable energy, or “green hydrogen”, is still struggling to compete on costs. The IRA includes production tax credits (PTCs) for producers of green hydrogen, which have the potential to upend the market completely—making zero-carbon hydrogen the cheapest option can spur a boom in the industry.

Shifting to green hydrogen promises to decarbonize major industrial sources of carbon—such as taking natural gas out of fertilizer production, coking coal out of steel production, and bunker fuel out of shipping.

Critical supply chains: The IRA provides a wide array of credits to support the buildout of fundamental supply chains that underlie all these other sectors—including tax breaks for clean energy generation supply chains, credits for small businesses engaged in research and development (R&D), funding for rural electric co-ops, and an accelerator to fund state and local clean energy distribution programs. These incentives level the playing field for market players, as compared to global competitors.

The IRA uses a slew of financial incentives to push the U.S. economy onto a trajectory of sustained expansion and lower costs for clean energy.