Details & Analysis of the Senate Inflation Reduction Act Tax Provisions

Last-week’s Democrat-sponsored Inflation Reduction Act (IRA), successor to the House-passed Build Back Better Act of late 2021, has been touted by President Biden to, among other things, help reduce the country’s crippling inflation. Using the Tax Foundation’s General Equilibrium Model, we estimate that the Inflation Reduction Act would reduce long-run economic output by about 0.1 percent and eliminate about 30,000 full-time equivalent jobs in the United States. It would also reduce average after-tax incomes for taxpayers across every income quintile over the long run.

By reducing long-run economic growth, this bill may actually worsen inflation by constraining the productive capacity of the economy.

Our analysis contains estimates of the budgetary, economic, and distributional impacts of the Inflation Reduction Act as specified in bill text provided on July 27.

Using the General Equilibrium Model, we estimate that the tax provisions, IRS enforcement, and drug pricing provisions in the bill would increase federal revenues by about $656 billion over the budget window, before accounting for $352 billion in expanded tax credits for individuals and businesses, resulting in a net revenue increase of about $304 billion from 2022 to 2031.

Excluding the anticipated revenue from increased tax compliance and the drug pricing provisions, the bill would lose about $126 billion in revenue over the budget window.

Major Tax Provisions

The updated draft legislation of the Inflation Reduction Act would include the following major changes, effective beginning after December 31, 2022, unless otherwise noted:

Individual Income Taxes

• Extends the required holding period for carried interest to be taxed as a long-term capital gain from three years to five years for taxpayers with an adjusted gross income equal to or greater than $400,000.

• Extends the expanded health insurance Premium Tax Credits provided in the American Rescue Plan Act (ARPA), including allowing higher-income households to qualify for the credits and boosting the subsidy for lower-income households, through the end of 2025.

Corporate and International Taxes

• Imposes a 15 percent minimum tax on corporate book income for corporations with profits over $1 billion, effective for tax years beginning after December 31, 2022.

Other Modeled Tax Proposals

• Modifies, extends, and creates a variety of tax credits for green energy and other efforts primarily through 2031 or 2033.
• Reinstates the Superfund tax on crude oil and imported petroleum at 16.4 cents per gallon (indexed to inflation) and increases other taxes and fees on the fossil fuel sector.

Significant Tax Proposals Not Modeled

• Expands IRS enforcement funding by about $80 billion over 10 years

• Imposes a 95 percent excise tax penalty on drug manufacturers to lower drug prices

• Increases the research & development tax credit amount that can be claimed against payroll taxes for small businesses by $250,000

Economic Effects

While the latest proposal steers clear of some of the major tax rate increases contained in the House-passed Build Back Better Act, this proposal would raise taxes on work and investment, disincentivizing productive activity. We estimate the Inflation Reduction Act would reduce long-run GDP by about 0.1 percent.

The bill would increase long-run American incomes (as measured by gross national product, or GNP) by less than 0.05 percent, which is entirely driven by the bill’s reduction in the budget deficit over the long run. The bill would reduce the capital stock by about 0.3 percent and wages by about 0.1 percent, while eliminating about 30,000 full-time equivalent jobs.

The proposed 15 percent minimum tax on corporate book income is the most economically damaging provision in the bill, reducing GDP by 0.1 percent and costing about 23,000 jobs. The tax increase on carried interest also eliminates about 5,000 jobs.

For purposes of estimating the bill’s impact on federal budget deficits, interest payments, and resulting changes in GNP, we have estimated about $151 billion of additional spending over the budget window (2022 to 2031) in addition to scored tax provisions.

We estimate that the bill would result in a $178 billion reduction in the deficit (including interest payments) during the first decade and continue to reduce deficits thereafter, leading to a decrease in payments to foreign owners of the national debt and a 0.1 percent increase in long-run GNP. We treat the nontax outlays as transfer payments with no associated impact on the economy in the long run.

The net increase in GNP of less than 0.05 percent is dependent on spending and tax credits expiring as scheduled. For example, if the energy tax credits and health-care subsidies are made permanent, deficits (including interest payments) would increase by $75 billion over the first decade and come down very minimally over the long run, resulting in a near-zero impact of the deficit on GNP and a net decrease in GNP of 0.1 percent in the long run. In this scenario, additional payments are made to foreign owners of the national debt to finance the additional spending, reducing long-run GNP.

Revenue Effects

On a conventional basis, the House bill would raise about $304 billion in federal revenue from 2022 to 2031. The bill includes about $656 billion in gross revenue raisers, comprised of about $213 billion in corporate tax increases, $12 billion in individual tax increases, $152 billion net from additional IRS tax enforcement, $278 billion from the drug pricing provisions, and about $1.1 billion in net revenue from items scored by the Joint Committee on Taxation (JCT).

The gross revenue is reduced by about $352 billion in tax credits, resulting in about $304 billion in increased revenue net of tax credits.

We relied on estimates provided by the JCT for tax provisions we did not model. The bill includes about $151 billion in additional spending, and when combined with the $352 billion in tax credits, the bill increases spending by about $503 billion over 10 years.

The largest tax provision is the 15 percent minimum tax on corporate book income for corporations with average annual adjusted financial statement income that exceeds $1 billion for any three consecutive tax years, beginning in 2023. While we estimate that the provision raises $200 billion over the budget window, this may be an upper bound, as it does not account for any behavioral responses—that is, avoidance—since the structure of the tax is unique. Actual revenue could be less if, for instance, companies respond by reducing reported financial income.

A second revenue raiser is a tax increase on carried interest compensation earned by those with incomes over $400,000. We estimate this provision would raise $12 billion over the next decade.

On a dynamic basis—that is, accounting for the reduced size of the economy resulting from the tax increases—we estimate the bill would raise in total about $283 billion in revenue net of tax credits over the next decade.

The revenue table also presents the revenue impact from 2023 to 2032. Over the next 10 years, we estimate that the Inflation Reduction Act will raise about $376 billion in conventional revenue and about $345 billion dynamically after accounting for economic impacts.

Distributional Effects

Over the long run, the Inflation Reduction Act would raise marginal income tax rates faced by higher earners and corporations. The distributional results that follow do not include the impact of drug pricing provisions or IRS enforcement on after-tax incomes.

The proposals would increase the after-tax income of the bottom quintile by about 2.1 percent in 2023 on a conventional basis, largely due to expanded health-care subsidies. The top 1 percent of earners would experience a 0.1 percent increase in after-tax income in 2022, driven by expanded energy tax credits that offset reduced incomes from the corporate book minimum tax and carried interest provisions.

After the expanded health-care subsidies expire in 2026, the bottom 20 percent of filers would see a smaller increase in after-tax incomes, reflecting the remaining expanded credits. The bottom quintile would experience a 0.2 percent increase in after-tax income by 2032 on a conventional basis.

After-tax incomes in 2032 would increase the most at the top of the income distribution due to the rising value of energy tax credits by the end of the budget window. However, increased IRS enforcement and drug pricing provisions not modeled in the distribution would put downward pressure on after-tax incomes in 2032.

On a long-term dynamic basis, the smaller economy reduces after-tax incomes relative to the conventional analysis and most of the expanded tax credits will have expired. On average, tax filers in every quintile would experience a drop in after-tax incomes.

Impact of the Inflation Reduction Act on Inflation

Inflation is driven by expectations regarding the likelihood that the federal government will be able to repay its debt over the long term, which is a function of the expected performance of the economy, tax collections, and spending. By reducing long-run economic growth, the bill worsens inflation by constraining the productive capacity of the economy.

To the extent the revenue raisers are seen as long-lasting sources of revenue, the bill reduces inflation, but projected revenues are not certain and may be less than we are forecasting. For example, the history of the corporate alternative minimum tax indicates the book minimum tax may be a diminishing source of revenue. By increasing spending, the bill worsens inflation, especially in the first two years, as revenue raisers take time to ramp up and the deficit increases. We find that budget deficits would increase from 2023 to 2025, potentially worsening inflation.

To the extent the tax credits and health-care subsidies are expected to be extended on a permanent basis, these policies put upward pressure on inflation.

Lastly, to the extent the durability of the bill’s provisions are in doubt—that is, due to the lack of bipartisan support—it may have little impact on expectations about the fiscal outlook and therefore inflation. On balance, the long-run impact on inflation is particularly uncertain but likely close to zero.

Modeling Notes

We use the Tax Foundation General Equilibrium Tax Model to estimate the impact of tax policies, including recent updates allowing a detailed modeling of U.S. multinational enterprises. The model produces conventional and dynamic revenue and distributional estimates of tax policy. Conventional estimates hold the size of the economy constant and attempt to estimate potential behavioral effects of tax policy. Dynamic revenue estimates consider both behavioral and macroeconomic effects of tax policy on revenue.

The model also produces estimates of how policies impact measures of economic performance such as GDP, GNP, wages, employment, the capital stock, investment, consumption, saving, and the trade deficit.