As Industrial Policy, the Inflation Reduction Act Will Reshape the Economy

Posted by Harry Godfrey and Tom Lewis on Aug 18, 2022 10:30:00 AM

18-August Blog_IRA 745

On Tuesday, President Biden signed the Inflation Reduction Act (IRA), the most significant legislation ever enacted to advance clean energy, electrify transportation, and combat climate change. That much has been well established. What’s been underappreciated is just how transformational the IRA could be. Akin to the industrial policies of earlier eras, it has the potential to reshape the U.S. economy. Employing tax incentives, grants, loans, and innovative financial tools, the IRA, when combined with the Infrastructure Investment and Jobs Act passed last year, will leverage billions in public capital to catalyze trillions in private investment and total economic impact. In so doing, it is poised to rapidly expand domestic markets for advanced energy and transportation technologies, revitalize American manufacturing, and reshape how we produce and use electricity. In other words, as industrial policy for an advanced energy economy, the whole of IRA is greater than the sum of its parts.

American History, Industrial Policy & the IRA

Broadly defined, industrial policy represents the strategic efforts of government to support specific industries (often manufacturers) that are considered important to the nation’s security and economic health. The IRA may be unique in the annals of climate legislation, but as industrial policy it fits into a continuum that stretches back to the dawn of the Republic. The earliest examples of U.S. industrial policy can be found in the Report on Manufacturers presented to Congress by then Treasury Secretary Alexander Hamilton in 1791.

Over the ensuing centuries, U.S. industrial policy has found a range of manifestations, reshaping America and our economy in the process. The policies of President Lincoln helped build the transcontinental railroad, connecting the Pacific Coast, its industries and resources, with the rest of the country. World War II mobilization, organized by the Roosevelt Administration, made the U.S. into an industrial powerhouse. Construction of the interstate highway system under Eisenhower helped expand markets catalyzed to American car culture. The space program, arguably the most recent industrial policy, has given rise to a variety of technologies we rely upon today, from satellites to solar panels.

In recent decades industrial policy has fallen out of vogue, replaced by free market orthodoxy and deregulation. Long-standing trends, such as widening inequality and the hollowing out of American industry, have revealed some of the risks associated with this shift in economic thinking. But developments of the past few years – China's dominance of strategic sectors, supply chain disruptions caused by COVID-19, escalating oil and natural gas prices from the conflict in Ukraine, and devastating natural disasters exacerbated by climate change – brought the need for a new U.S. industrial policy into sharp focus.

After years of inaction, the first pieces of this new policy clicked into place last year with the Infrastructure Investment and Jobs Act (IIJA). But in scope and scale, the IRA dwarfs IIJA. With almost $370 billion for clean energy and transportation, IRA aims to decarbonize the electric grid, electrify transportation (slashing our linkage with global oil markets), and make American homes and offices cleaner and more affordable through electrification and efficiency. (See our section-by-section summary of IRA’s advanced energy provisions here.) By incentivizing the use of American-made technologies and resources to achieve these goals, the IRA is designed to also revitalize domestic manufacturing – making the U.S. into an arsenal of clean energy and transportation.

If successful, the IRA will shift what America makes, how we produce power, get around, and live. In so doing, it will transform the U.S. economy on a scale that rivals any of the industrial policies introduced since Alexander Hamilton first put pen to paper. To do that, the Act takes a three-pronged approach: (1) supply side “pushes” for domestic advanced energy manufacturing; (2) demand side “pulls” to bring those technologies and materials into the market, and (3) financial innovations to spur additional private investment.  

Supply Push

The IRA provides approximately $60 billion in tax credits, grants, loans and more directly aimed at bolstering domestic manufacturing of advanced energy and transportation, direct industrial support that in size exceeds that of the CHIPS and Science Act to boost R&D and manufacturing in semiconductors and other technologies – itself the biggest piece of overt industrial policy in recent years, signed just a week earlier.

Roughly half of IRA dollars would flow to advanced energy manufacturers and companies in the supply chain through a new manufacturing production tax credit (PTC), section 45X of the tax code. Manufacturers of solar, wind, and battery components, as well as critical minerals producers and refiners, would get a credit for each new unit of an eligible technology or resource produced. As the credit is calculated on mass, watt-capacity, sales price, or production cost and awarded on a per-unit basis, this PTC incentivizes scaling up operations. Because this credit can cascade through the supply chain, it will be critical to making domestically manufactured technologies cost competitive with foreign rivals.

As if that weren’t enough, here’s the kicker: For the first five years, this credit is eligible for “direct pay.” Manufacturers need not have the tax liability, or find a counterparty that does, to realize the value of the credit. They will instead be eligible to receive (essentially) cash payments from the U.S. Treasury! They’ll be able to apply the full value of the credit toward lowering prices for U.S. made solar panels, wind turbines, battery cells, and more.

The IRA likewise provides specific dollars pegged to support the electric vehicle (EV) industry, including $2 billion in grants to help automakers convert conventional manufacturing facilities into assembly lines for EVs, hydrogen fuel cell vehicles, and component parts, and $3 billion for loans – via the Advanced Technology Vehicles Manufacturing (ATVM) program – to firms developing medium- and heavy-duty electric trucks, buses, trains, ships, and planes. Building on President Biden’s announcement in June, the Act also includes $500 million for the Defense Production Act Fund to ramp up production of heat pumps, among other advanced energy technologies. This allocation would more than double the dollars in the fund.

In addition to the creation of a manufacturing PTC and direct support for the EV and efficiency industries, the IRA provides $10 billion to revive the manufacturing investment tax credit (ITC), section 48C. This ITC provides companies a credit for investing in production facilities, helping further drive down the overall cost of domestic manufacturing by cutting capital costs. The IRA also expands the industry segments that are eligible for 48C to include manufacturers of energy storage, grid modernization, energy conservation, and EV charging infrastructure, as well as recycling projects.

To help drive this investment to states and regions impacted by the energy transition, roughly 40% of 48C funds are reserved for “energy communities,” a policy that’s woven into numerous incentives in the bill. From the standpoint of transforming the U.S. economy, this is significant. What policymakers are attempting to do is not only make America an arsenal for clean energy, but also build that manufacturing backbone in communities historically tied to the fossil fuel industry and hollowed out by policies that have shipped jobs abroad. In practical terms, the IRA aims to revitalize manufacturing in places like West Virginia, Ohio, Pennsylvania, Indiana, and Michigan.

Demand Pull

The supply-push provisions in IRA will set the stage for an abundance of American-made advanced energy technologies. But for manufacturers to invest in new factories they need confidence that there will be a market for the goods they'll produce. That is why the demand-pull side of IRA is equally important. IRA invests $250 billion through tax credits, grants, and other direct spending to drive demand for advanced energy technologies. Those programs, along with the goals states across the country have set for clean energy, provide the markets that manufacturers will need to justify their investments in domestic production.

The demand-side drivers of the package are focused on the extension and expansion of clean energy tax credits. If that sounds unexciting – it shouldn’t! Already tax credits have helped establish wind and solar as the fastest growing segment of the electricity market, but now with the market certainty the 10-year extension of the section 45 production tax credit (PTC) and the section 48 investment tax credit (ITC) provides that progress will be supercharged – resulting in an estimated 40% reduction in emissions (from 2005 levels) of the electricity sector by 2030. They do that by further putting a thumb on the scale for clean energy – ensuring that wind, solar, nuclear, hydro, and more outcompete fossil fuels on price.

The extended tax credits also include new features, such as bonus credits for meeting prevailing wage and apprenticeship requirements that raises the ITC from 6% to 30% and the PTC from $0.003/kWh to $0.015/kWh. Additionally, there are 10% adders for utilizing domestic content and for developing projects in the “energy communities” discussed above. The domestic content adder will be particularly important for driving demand for American made technologies. For the first time, nonprofit entities, state and local governments, rural electric coops, and Native American tribal governments will also be eligible for “direct pay,” enabling these non-taxpaying entities to gain the same financial benefit.

There is a lot more here for individual consumers. Expanded residential energy credits – tax sections 25C and 25D – will drive the deployment of rooftop solar and building more efficient homes. The credits provide expanded support for installing everything from the latest heat pump and geothermal technologies to incentivizing the purchases of smart thermostats and induction cooktops.

IRA also provides new incentives to change the way Americans travel. The ongoing EV revolution is the most substantial change in mobility since the automobile itself. Included in IRA are several provisions to speed that transition, including extension of the $7,500 tax credit to purchase a light duty EV and, for the first time, a $4,000 credit for the purchase of a used EV. The credits have several changes in how they will be structured. First, the manufacturer production cap is removed, so EVs made by automakers over the current limit of 200,000 will become eligible again. Secondly, new income caps are applied, limiting the credit to buyers with income up to $150k for single filers and $300k for joint filers. Finally, there is a new restriction for domestic sourcing of batteries and critical minerals. In the near term, many models may be ineligible for credits. But the new requirements will drive demand for domestic production of these materials from automakers who want the competitive advantage that comes with meeting them. There are also expanded credits for purchases of zero-emission commercial vehicles and a new grant program at DOE for replacement of heavy-duty vehicles with zero-emission alternatives.

Financial Innovation

As we have noted above, the IRA will spur both greater domestic demand and supply of advanced energy and transportation technologies. There is one final piece of the industrial policy equation in IRA: innovative financing.

Included in IRA is $45 billion for loans (along with over $300 billion in new loan authority) for manufacturers, clean energy developers, automakers, and state and local green banks to help finance advanced energy technologies. Also included: $27 billion for creation of a “Greenhouse Gas Reduction Fund,” which will capitalize state and local green banks. Green banks have gained popularity as they catalyze nearly $7 of private capital for every $1 of public money.

This public financing – particularly that from DOE’s Loan Programs Office (LPO) – is structured to spur additional private investment, especially in newer technologies the private sector may see as too risky. Such financial support is particularly important for avoiding the “valley of death” that occurs between the conception and commercialization of technologies, especially in capital-intensive manufacturing.

Beyond dollars, the legislation includes significant new authority for the LPO and ATVM Program. From its inception, LPO was responsible for driving some of the first large-scale investments in utility solar and electric vehicle manufacturing, giving rise to companies like Tesla. Revitalized under the Biden Administration, the LPO has made major new investments in hydrogen and projects across the electric vehicle supply chain.

Finally, it’s worth noting that the additional capital in loan and financing programs under IRA will enable the bill to spend well above the $370 billion that is commonly cited in the legislation. As loans are repaid, additional projects can be funded, increasing the economic multiplier of the legislation. All told, these financial innovations represent a new era in American capitalism, where public funding is not looked at as crowding out private investment, but rather in providing the impetus for additional private investment, producing broader societal benefits.

Getting to Work

The IRA has the potential to revitalize and reshape American manufacturing, transform how we produce energy, power our cars, cook our food, heat and cool our buildings – improving the health and efficiency of the places where we work and live. The work to make that a reality, however, has only just begun.

As industrial policy, the IRA should give rise to a host of new and renewed industries across America, producing solar inverters, offshore wind towers, battery packs, and electric vehicles. In the process the IRA should revitalize Rust Belt towns and former coal communities that have been hollowed out over the past decades. Just where those new factories and facilities arise will be the subject of fierce competition. AEE’s state and federal teams are gearing up to engage with policymakers in a set of target states, revitalizing American manufacturing and building new strength for advanced energy in communities across the country.

Building America’s advanced energy future – producing enough EVs to replace every ICE vehicle, enough solar panels, wind turbines, energy storage facilities, and advanced nuclear power plants to replace coal and natural gas generators – will require a lot of critical minerals, from copper and nickel to lithium, cobalt, and aluminum. In some cases, innovation can produce substitutes and increase efficiency. Over the long term, many of these resources can be recycled, creating closed-loop systems unlike what we’ve seen in energy since the Industrial Revolution. But in the near term, we’re going to need to mine, extract, and refine more material. How and where we do that are critical questions, but time is of the essence. AEE is ready to engage in this urgent policy discussion in Washington and beyond.

Building this future will likewise require deep engagement in the states, addressing permitting challenges, regulatory barriers, and interconnection issues for clean energy projects, distributed energy resources, and EV infrastructure. With a well-established presence in state houses and before regulatory commissions across the country, AEE is prepared and eager to dig in. We’re already engaging with state-level policymakers regarding the advanced energy provisions in IIJA – and will replicate and expand that work around IRA.

So too with transmission. Transporting clean energy, via high-voltage transmission lines, from where it can be produced to where it’s needed has become a critical stumbling block on the path to a decarbonized grid. In the months ahead, AEE will launch a multifaceted campaign to clear this obstacle, tapping our depth of experience and expertise before FERC, regional transmission organizations, and state regulators.

Whether it’s advanced energy manufacturing, permitting, transmission planning, or critical minerals and recycling, the sweeping potential of the IRA creates new challenges and opportunities for the advanced energy industry. At AEE, we’re ready to get to work.

Download 'Economic Impact of IRA and IIJA'

Topics: Federal Policy, Economic Impact, Manufacturing and Infrastructure