It is done. The Senate passed the Inflation Reduction Act (IRA) with reconciliation procedures. Apart from the political imperative to “get something done”, there is little in the IRA to praise. It will not reduce inflation. As a stand-alone, the health provisions are incoherent. And “historic” investment to combat climate change is part of a larger strategy that never made sense, is chump change compared to the cost of the problem, and has been badly muddled by the administration’s reliance on union efforts. It’s all bad enough.
That includes tax policy – especially the book minimum tax. The basic idea was that a large company (1 billion dollars in financial income) would pay the greater of 21 percent of its taxable income or 15 percent of the income in the financial statements (book income). This was never a good idea.
It was tried in 1986 and eliminated in 1989. It was too complicated to manage and enforce – nothing improved on either front over time. There is an incentive to distort financial reporting for tax purposes; why does the US want to do a U-turn on the progress made on this front after the Enron and Worldcom scandals? It also punished the wrong companies. The only legal way to get the effective rate down is to take advantage of things that Congress itself wrote into the tax code—accelerated depreciation and expensing, research and development tax credits, and so on. Even advocates of the IRA acknowledged that this was not good policy. It was softened to recognize depreciation to lessen the hit on manufacturers and defended on the grounds that it would affect only 100 to 200 companies.
The Senate even tried to make it worse. On Saturday, when the legal text for the tax provisions was finally, and for the first time, made public, it contained a major “gotcha”. Suppose there were four companies, each with $300 million in book income, each of which had as a joint majority investor an investment fund such as a private equity. Under the IRA, these four companies would be considered a single $1.2 billion company, and subject to the 15 percent book tax.
This would have dramatically increased the number of affected companies, perhaps by as much as 15,000 to 20,000. But more importantly, it would have distorted much more economic activity and significantly increased the headwinds to growth. Fortunately, the provision was dropped during the debate, which limited the impact of the book tax.
In summary, the IRA will not reduce inflation, is anti-growth, attacks innovation in the biopharma sector of the economy, and its climate provisions are poorly designed and weak compared to the problem. As the years pass, the IRA will be less and less attractive. It can be celebrated politically, but it is not a political gain.
