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Inflation Reduction Act: What is it and Will it Work?

Tuesday, August 09, 2022 03:10 PM | Neal Farmer
Inflation Reduction Act: What is it and Will it Work?

The seemingly soon-to-pass Inflation Reduction Act proves once again that legislation can have any name slapped onto it for little to no reasoning behind it. The only industry likely to see prices drop as a result are pharmaceuticals as the government will negotiate over drug prices.

However, just because a bill might not live up to its name doesn’t mean it won’t have significant benefits. Mega corporations might finally pay taxes they’ve been avoiding and alternative clean energy sources are being further promoted in a fight against climate change.

Paying Their Dues

The largest regulation in the bill is the minimum 15% levied on corporate profits for firms that earn at least $1 billion per year. Moody’s Analytics expects the tax to raise $313 billion over the next 10 years. The tax will be applied to the “book rate” profits that companies disclose to Wall Street as opposed to the numbers typically shown to the government. The use of book rate profits will (hopefully) mitigate tax loopholes as companies often showed different numbers to Wall Street and government to minimize taxes.

The provision should force big companies to pay taxes that they have been able to avoid in recent years due to loopholes in the tax code. A good cause for sure but one that likely less good for investors as taxes will have the effect of reducing earnings for profitable companies.

Negotiating Drug Prices

The second biggest provision in the new bill is perhaps the ability for the government to negotiate drug prices for Medicare recipients. However, Medicare will only be able to negotiate prices for very few drugs early on with it negotiating on 10 drugs by 2026. Additionally, new medications will not be haggled on until 9 to 13 years after being introduced into the market.

An additional Medicare provision is a $2,000 cap on prescription spending from recipients. Most seniors spend less than that cap already but cancer patients often spend far more, giving a financial cap to cancer patients on Medicare.

Finally, there are extensive tax breaks in the bill including an extension of healthcare insurance subsidies under Obamacare that were increased as a result of the coronavirus pandemic that was set to expire at the end of 2022. Meanwhile, $64 billion is going towards tax credits for those who purchase health insurance on internet exchange markets such as Healthcare.gov.

Again all are admirable efforts but only the negotiating of drug prices would seem to have any positive impact on inflation. Even including that, the effect of negotiating a few drug prices on overall inflation would be extremely minimal albeit very important for those who are currently paying for said drugs. Overall, the Democrats expect the government to save $288 billion over the next 10 years due to these prescription drug pricing changes.

Going Green

One of the last major pushes for this new legislation is a commitment to clean energy in the form of putting $369 billion into renewable energy investments. The goal is to lower carbon emissions by 40% by the year 2030 primarily through wind and solar projects.

The bill will also extend the $7,500 consumer income tax credit for the purchase of new electric vehicles and $4,000 for a used EV. An interesting side note for the tax credit is that the vehicle must be less than $55,000 or less than $80,000 if it's a van or truck. Tesla’s (TSLA) Model 3 is right on cusp of this limit with its Model X and S vehicles surpassing the cap. Additionally, the smaller EV startups such as Lucid (LCID) and Rivian (RIVN) would not be eligible for the tax credits, meaning that the primary winners would be the larger manufacturers that are able to sell EVs at a price below $55,000. In order to be eligible, manufacturers must also have 40% of battery components sourced in the U.S. or free trade agreement partners, measures that bigger companies such as General Motors (GM) have been actively working on.

Additional Measures

Lastly, the Inflation Reduction Act is set to pay for some of these provisions through a 1% tax on all corporate share buybacks in addition to the 15% minimum corporate income tax on firms with over $1 billion in revenue. The Internal Revenue Service (IRS) is also set to receive $80 billion in funding to hire additional agents and new technology to help crackdown on tax evasion. Democrats expect the provision to bring an extra $124 billion in revenue.

Overall, the Inflation Reduction Act is a comprehensive bill that is actually one of the less complicated pieces of legislation at first glance. Any effects on inflation are likely to be minimal but a crackdown on tax loopholes and evasion by the most wealthy isn’t hard to root for. Meanwhile, the ability to negotiate drug prices for Medicare and a cap on recipient spending helps in at least a small way on the major issue of healthcare costs in this country. Finally, a push to cleaner energy sources and cheaper electric vehicles (the people paying for top of the line Tesla’s will be fine without the tax credit) are strong environmental pushes to lower carbon emissions.

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