The Inflation Reduction Act, a broad social spending legislation enacted this summer by President Joe Biden and congressional Democrats, will dramatically increase federal spending on climate and healthcare programs. The law also aims to shift the tax code dramatically, with changes Democrats say will only affect the wealthy.
The Inflation Reduction Act includes nearly $370 million in tax credits and other incentives to encourage people to switch to clean energy sources and lower greenhouse gas emissions. It also extends subsidies to lower the cost of health insurance for those who get it under the Affordable Care Act.
To pay for all of this, lawmakers are relying on two key elements in the law: allowing Medicare to negotiate some prescription drug prices, thus lowering their cost, and a series of new tax measures, largely targeting the wealthy. Combined, the provisions are expected to pay for the law’s climate and healthcare initiatives while cutting the federal deficit by more than $250 billion over the next 10 years.
Experts have given the bill’s tax changes mixed reviews, however, with some arguing it gives the Internal Revenue Service too much power — while others say the changes don’t go far enough. In either case, the law marks a historic change to U.S. climate policy and is set to shift federal tax collection powers significantly for years to come.
“We’re cutting [the] deficit to fight inflation by having the wealthy and big corporations finally begin to pay part of their fair share,” Biden said just before signing the bill. He also promised that “no one — let me emphasize — no one earning less than $400,000 a year will pay a penny more in federal taxes.”
Congressional Republicans unanimously opposed the bill, though, arguing that spending billions in taxpayer money at a time when the country might be in a recession is irresponsible and that the law will, in fact, hike taxes on the less wealthy.
“While Republicans’ pro-growth tax reform in 2017 reduced tax rates for all Americans in a way that increased the progressivity of the tax code and produced historic gains in job and wage growth, the Democrats’ approach to tax reform means increasing taxes on low- and middle-income Americans to fund their partisan Green New Deal,” Idaho Sen. Mike Crapo, the top Republican on the Senate Finance Committee, said in a statement in late July.
Experts say any tax increases on lower- and middle-classes largely come as indirect consequences of higher business taxes. Biden’s pledge “applies only to taxes people pay directly,” according to the left-leaning Tax Policy Center. “Looking at just those direct taxes such as individual income taxes and payroll taxes, the IRA would modestly reduce or not change tax burdens at nearly all income levels in the three years TPC modeled (2023, 2027, and 2031),” John Buhl, a senior communications manager at the center, wrote recently. “Under a broader view of tax incidence, families with incomes below $400,000 would bear some of the burden of corporate tax hikes through lower wages or lower returns to stock ownership, particularly in retirement accounts, even if they don’t pay more in direct taxes.”
The conservative-leaning Tax Foundation argued, however, that the law will “raise taxes on work and investment, disincentivizing productive activity” and “reduce long-run GDP by about 0.2 percent.”
“By reducing long-run economic growth, this bill may actually worsen inflation by constraining the productive capacity of the economy,” the group said.
Nevertheless, higher earners will feel the brunt of the impact, according to the Penn Wharton Budget Model, which offers an independent analysis of public policy. “Most, but not all, of the tax increases fall on higher income households,” the team’s analysts at the University of Pennsylvania wrote recently. “However, future generations, including higher-income households, gain from the improved economy, including a reduction in carbon emissions.
The new law targets corporations with multiple tax increases. The most significant one is a 15% minimum tax on corporations’ book income if that income is more than $1 billion. The measure is expected to generate around $200 billion in government revenue over the next decade, according to the Penn Wharton Budget Model. Similarly, Congress’s nonpartisan Joint Committee on Taxation estimated the measure would increase federal coffers by $222 billion over the same period.
Another component of the law is a new 1% tax on corporations’ stock buybacks, which is expected to bring in nearly $80 billion in government revenue, according to the Penn Wharton Budget Model, or about $74 billion, the congressional Joint Committee on Taxation estimated.
The Tax Foundation argues the law’s new minimum corporate tax is “the most economically damaging provision in the bill, reducing GDP by 0.1 percent and costing about 20,000 jobs” while the “excise tax on stock buybacks […] eliminates about 7,000 jobs.”
But Emily DiVito, a senior manager of the corporate power program at the liberal Roosevelt Institute, lauded the step, saying it “will help rebalance the tax code for smaller businesses and individual taxpayers, who often pay taxes at rates effectively higher than most corporations.” There’s “more to be done” overall, DiVito said, but she also noted the minimum corporate tax “helps with the fair and effective application of existing corporate income tax law.”
“Many corporations maintain two sets of accounting books,” DiVito wrote earlier this month. “One that records the ‘book’ income, or the amount of income that they publicly report on their financial statements. Another contains the tax income that they report on their tax filings. These are often two different figures, allowing corporations to tout their profitability to shareholders, while minimizing their tax liability.”
The new corporate minimum tax “fixes that,” DiVito said. Like Biden, she noted that in 2020, “50 corporations paid $0 in federal corporate income tax — despite recording substantial profits.” She also argued that “to hypothesize about how business investment and productivity may be impacted by only the tax provisions in the IRA is to ignore how the package as a whole will leverage public investment to incentivize private investment, and directly benefit individual consumers and families through cost reductions.”
Moody’s Analytics, which provides economic research, concluded that the tax increases “will weigh on economic growth, all else being equal, but the impact will be small.”
“Though the tax increases being considered are the most meaningful ones since the early 1990s, they are still modest from a historical perspective,” economists at Moody’s wrote this month. “The tax increases on large corporations will also not appreciably hurt economic growth.”
The Penn Wharton Budget Model found that “all income groups would bear some of the additional burden of the 2023 revenue-raising business tax changes,” with those making the least seeing an average tax change of $5, middle-class earners seeing $55, and the very top earners seeing $61,520. “At lower incomes, the tax incidence largely reflects lower wages over time relative to baseline, whereas at high income the tax incidence mostly reflects more immediate changes in the value of financial assets.”
Another major tax change in the legislation is the approximately $80 billion in additional funding for the IRS, which includes $15 million to establish a free e-file tax return system. But more than half of the total funding will go toward enforcement “at a time when the tax gap — the difference between the taxes owed under law and revenue collected — is large and increasing,” Moody’s said.
The funding also comes after years of cuts to the tax-collecting agency. “According to the [Congressional Budget Office], the appropriations for the IRS fell by about 20 percent (adjusted for inflation) between 2010 and 2019,” the Treasury Inspector General for Tax Administration wrote last year. “Approximately 70 percent of the IRS’s overall budget is for labor, and the drop in funding thus resulted in a decline in the number of IRS employees over that period, particularly in enforcement.”
“Employees who work the most complex examination and collection cases experienced especially large declines,” the inspector general added.
As a result of having less enforcement staff, the number of audits fell by 44% between 2015 and 2019, the inspector general said. Nevertheless, the IRS collected $3.6 trillion in revenue in 2019, “which is more tax revenue than any year previously.”
The new funding has been highly criticized by political figures on the Right, who claim that tens of thousands of newly hired auditors will set their sights on middle-class earners.
Treasury Secretary Janet Yellen seemed to fire back at this argument, ordering the IRS not to use newly hired staff “to increase the share of small business or households below the $400,000 threshold that are audited relative to historical levels.”
“This means that, contrary to the misinformation from opponents of this legislation, small business or households earning $400,000 per year or less will not see an increase in the chances that they are audited,” Yellen wrote in a letter to IRS Commissioner Charles Rettig. “Instead, enforcement resources will focus on high-end noncompliance.”
The new enforcement funding will bring in an additional $124 billion in federal revenue over the next decade, Moody’s Analytics found, while the Penn Wharton Budget Model said the figure would be around $147 billion.
In any case, the new IRS funding is “an amazing political achievement,” wrote Janet Holtzblatt, a senior fellow at the Tax Policy Center.
“Let’s face it, the IRS isn’t exactly the Prom King of government agencies,” she said.
