August has seen both improving inflation numbers and the passage of the Inflation Reduction Act (IRA) of 2022, signed by President Joe Biden. Although this is clearly a case of correlation without causality, it is also worth understanding why the $430 billion IRA is likely to have little success reducing inflation and how other bills signed into law this month may more than offset its limited beneficial impact.
The main way that Congress could help reduce inflation right now would be to lower federal deficits. Less deficit spending would mean the Treasury would issue a smaller volume of debt securities. This, in turn, would reduce the pressure on the Federal Reserve to buy federal debt with newly created money — and it is this newly printed money that is a principal driver of inflation.
Largely to Sen. Joe Manchin’s (D-W.Va) credit, the IRA includes much less new spending than the various incarnations of its predecessor, Build Back Better (BBB), that were pursued by congressional Democrats and President Biden. The version of BBB that passed the House last year would have added $158 billion to the deficit over 10 years, according to the Congressional Budget Office (CBO). Worse, that package contained a lot of temporary provisions that future Congresses likely would’ve felt obligated to extend or make permanent, such as universal pre-school and refundable child tax credits. The CBO also estimated that if all provisions in BBB were made permanent, the proposal’s true fiscal impact on taxpayers would have been closer to $3 trillion.
The last time CBO looked at the Inflation Reduction Act before it passed the Senate, it estimated a net deficit reduction of $294 billion (the final number will be slightly different). But notably, the deficit relief is backloaded. Through the end of Fiscal Year 2026, the bill’s net deficit reduction was only $18 billion, CBO found, with all the rest coming between 2027 and 2031, which is why skeptics understandably wonder if the deficit reduction will actually materialize.
With all the federal deficit spending anticipated in the coming years, it’s also true that $18 billion in deficit reduction is a rounding error by federal budget standards. The CBO’s latest baseline forecast projects aggregate federal budget deficits of $5.76 trillion during fiscal years 2022-2026. The IRA promises to reduce this incremental red ink by about 0.3 percent.
Also, the bill’s deficit impact is highly dependent on how effective additional Internal Revenue Service personnel will be in raising more tax revenue. The CBO estimates that a beefed-up IRS will collect an additional $43 billion through FY 2026 and an additional $161 billion in FY 2027-2031. Since a large ramp-up of IRS enforcement resources does not have any recent precedents, revenue estimates are necessarily speculative.
CBO offered multiple caveats in a Sept. 2021 blog post, in which it explained how it derived its enhanced tax collection revenue estimate. Most notably, CBO offered the following caution:
“The IRS intends to hire mid- and senior-level people with private-sector experience who will not require a great deal of training to become productive. But it might not be able to hire its desired mix of candidates. If it hired less experienced candidates, it would have to spend more resources training them. Not only would they take longer to become productive, but current staff members would have to devote more time to training them. A related source of uncertainty in CBO’s estimate is attrition: If it proved higher than expected, personnel would have fewer years at full productivity.”
Since the CBO made its estimate, the labor market has tightened, and the so-called “Great Resignation” — the wave of people quitting traditional jobs in search of greater meaning or flexibility — has continued. As a result, it may be more difficult for the IRS to recruit and retain experienced staff than expected.
Finally, when the bill is taken together with this month’s other two major new laws, the fiscal benefits are more than fully offset. The Honoring our PACT Act of 2022 (S.3373), which provides health care benefits to veterans exposed to toxic substances during their service, includes $667 billion of new spending and no offsetting revenue through 2031, according to the latest CBO estimate.
And the Chips and Science Act of 2022 includes $280 billion in new spending on semiconductor production and scientific research. This measure also has no new federal revenues or offsets, and thus its costs will result in additional deficit spending.
In summary, the three major bills signed this month are projected to add $653 billion to the federal deficits over the next 10 years. While this is much less additional red ink than taxpayers saw the federal government run up during the pandemic, it incrementally adds to the supply of Treasury securities at a time when they are abundant.
If Congress really wants credit for tackling inflation, it must make sure that all new spending measures are paid for while it tackles the fundamental fiscal imbalance that is driving trillion-dollar annual deficits over the long-term.
Marc Joffe is a policy analyst at Reason Foundation, former senior director at Moody’s Analytics, and author of the new study “Unfinished Business: Despite Dodd-Frank, Credit Rating Agencies Remain the Financial System’s Weakest Link.”