Inflation Reduction Act may have little impact on inflation

WASHINGTON — With inflation raging near its highest level in four decades, the House on Friday gave its final approval to President Joe Biden’s landmark Inflation Reduction Act. The title raises a tantalizing question: Will the measure tame the price spikes that have plagued US households?

Economic analyzes of the proposal suggest the answer is probably no — at least not anytime soon.

The legislation, passed by the Senate earlier this week and now headed to the White House to sign Biden, won’t directly address some of the main drivers of rising prices — from gas and food to rents and restaurant meals.

Still, the law could save some Americans money by lowering the cost of prescription drugs for the elderly, expanding health insurance subsidies and lowering energy prices. It would also deliver a modest reduction in the government deficit, which could bring inflation down slightly towards the end of this decade.

The unbiased Congressional Budget Office concluded last week that the changes would have a “negligible” impact on inflation this year and next. And the Penn Wharton Budget Model from the University of Pennsylvania concluded that over the next decade, “the impact on inflation is statistically indistinguishable.”

Such predictions also undermine arguments some Republicans, such as House Minority Leader Kevin McCarthy, have made that the bill would “cause inflation,” as McCarthy said in a speech on the House floor last month.

Biden himself, when discussing the effect of the legislation on inflation, has cautiously referred to potentially lower prices in individual categories rather than lower inflation as a whole. This week, the president said the bill would “cut the cost of prescription drugs, health insurance premiums and energy costs.”

At the same time, the White House released a letter signed by more than 120 economists, including several novelists and former Treasury ministers, claiming the bill will reduce the government’s budget deficit — by an estimated $300 billion. over the next decade, according to the CBO, would “put downward pressure on inflation.”

In theory, lower deficits could reduce inflation. That’s because lower government spending or higher taxes, which help reduce the deficit, reduce demand in the economy, easing the pressure on companies to raise prices.

Jason Furman, a Harvard economist who served as a top economic adviser to the Obama administration, wrote in an opinion column for The Wall Street Journal: “Deficit reduction almost always lowers inflation.”

Still, Douglas Holtz-Eakin, a top economic adviser to President George W. Bush and later director of the CBO, noted that the lower deficits won’t kick in for five years and won’t be very large over time. next decade given the size of the economy.

“$30 billion a year in a $21 trillion economy isn’t going to move the needle,” Holtz-Eakin said, referring to the estimated amount of deficit reduction spanning 10 years.

He also noted that Congress recently passed other legislation to subsidize semiconductor manufacturing in the US and expand health care for veterans, suggesting that those laws will spend more than the Inflation Reduction Act will save.

In addition, Kent Smetters, director of the Penn Wharton Budget Model, said the law’s health subsidies could drive inflation. The legislation would spend more than a decade expanding $70 billion in tax credits to help 13 million Americans pay for health insurance under the Affordable Care Act.

Those subsidies would free up money for recipients to spend elsewhere, potentially increasing inflation, though Smetters said he thought the effect would likely be very small.

While the law could have the benefit of helping millions of households save more on pharmaceutical and energy costs, it is unlikely to have much of an effect on headline inflation. Prescription drugs represent only 1% of spending in the US consumer price index; expenditure on electricity and natural gas represents only 3.6%.

Beginning in 2025, the law will limit the amount Medicare recipients would pay for their prescription drugs to $2,000 per year. It will empower Medicare to negotiate the cost of some expensive drugs — a long-sought goal President Donald Trump had also suggested. It would also limit Medicare recipients’ out-of-pocket costs for insulin to $35 per month. According to the Kaiser Family Foundation, insulin prescriptions averaged $54 in 2020.

“This is a historic change,” said Leigh Purvis, director of health care costs at the AARP Public Policy Institute. “This allows Medicare to protect beneficiaries from high drug prices in a way that wasn’t there before.”

A Kaiser study found that in 2019, 1.2 million Medicare recipients spent an average of $3,216 on drug prescriptions. Purvis said recipients taking the most expensive drugs could spend as much as $10,000 or $15,000 a year.

The legislation authorizes Medicare to negotiate the prices of 10 expensive drugs starting next year, though the results won’t take effect until 2026. Up to 60 drugs can be negotiated by 2029.

Holtz-Eakin argued that while the provision may lower the cost of some Medicare drugs, it would discourage new drug development or reduce new venture capital investment in drug startup companies.

The energy provisions of the Inflation Act can also yield savings, although the amounts will probably be much smaller.

The bill provides for a $7,500 tax credit for new electric vehicle purchases, though most EVs are ineligible because the law requires them to contain batteries with U.S. material.

And the legislation also significantly expands a tax credit for homeowners who invest in energy-efficient equipment, from a $500 one-time credit to $1,200 that a homeowner could claim each year. Vincent Barnes, senior vice president for policy at the Alliance to Save Energy, said this would enable homeowners to make new energy-efficient investments over several years.

But for all Americans, including those who are not homeowners, the impact will likely be limited. The Rhodium Group estimates that the bill’s amenities will save households an average of up to $112 a year by 2030, as gas and electricity become cheaper as more Americans drive electric and homes become more energy efficient.