Impact of the Inflation Reduction Act on Economic Growth in 2023
Written on
Chapter 1: Overview of the Inflation Reduction Act
The Inflation Reduction Act (IRA) is set to take effect on January 1st, and President Biden has stated that it aims to lower healthcare costs for Americans and significantly boost climate change initiatives. However, in an effort to avoid excess demand created by increased government spending, Biden has opted to raise taxes on corporations.
Biden has repeatedly emphasized that corporate America needs to contribute its fair share in taxes, although he has not clearly defined what that entails. He often cites a case where 55 of the largest corporations paid no federal income tax, despite generating billions in profits.
To address this, a 15% minimum tax has been implemented for most corporations, with manufacturing businesses excluded. This change ensures that large corporations cannot evade taxes when they earn profits.
Section 1.1: The Consequences of Tax Increases
Biden has pointed out that the corporate tax rate reduction in 2018 was intended to provide firms with additional capital for investment. However, many companies used that capital to repurchase shares from existing shareholders instead. The IRA introduces an additional excise tax on such stock buybacks.
The unfortunate reality is that these tax hikes are likely to diminish capital formation, slow down economic growth, and increase upward pressure on prices, ultimately worsening inflation.
Section 1.2: Understanding Corporate Tax Avoidance
Why is it that some large corporations manage to pay no taxes? The answer lies primarily in depreciation. For instance, if a company invests $100 million in building a facility, this amount comes from post-tax income. The firm can then recover that investment over time through depreciation.
Consider a scenario where the government permits the company to withdraw $4 million annually for 25 years to recoup the entire $100 million investment. If the company shows a profit of $3 million one year, after accounting for depreciation, the profit would be recorded as a $1 million loss. Consequently, the company would owe no taxes for that year and would have $4 million available for reinvestment, facilitating expansion. Without depreciation and under a 15% minimum tax, capital recovery would be significantly hindered, consequently slowing economic growth in a capital-intensive economy.
Chapter 2: The Impact of Stock Buybacks
In the first video, titled "Jeremy Siegel's 2024 Economy Forecast – Wharton Business Daily Interview," the discussion revolves around current economic forecasts and implications of the IRA.
The excise tax on stock buybacks is also expected to limit capital formation. Biden’s intention is to deter stock buybacks, believing they primarily benefit shareholders. However, this perspective may overlook the broader economic benefits.
When the corporate tax rate was lowered in 2018, the profits after taxes rose, leading to greater retained earnings, which ideally should drive corporate investment. Instead, many corporations chose to repurchase shares from existing stockholders, a move that can stimulate economic growth.
When corporations face limited investment opportunities, stockholders may seek to sell their shares back to the company. This often occurs when those shareholders find better investment avenues that yield higher returns. In such instances, stock buybacks can enhance capital efficiency, fostering increased economic growth.
Section 2.1: Alternatives to Stock Buybacks
The other option for corporations would be to increase dividends for all shareholders. However, many shareholders prefer not to receive these dividends due to the tax liabilities they incur and because they wish for their funds to remain within the corporation. Stock buybacks can elevate stock prices for remaining shareholders without triggering tax obligations.
It's vital for the U.S. economy to generate as much new capital as possible. With the current labor shortage leading to capital replacing labor, increased capital will be necessary moving forward.
The IRA is poised to reduce capital formation, which in turn will decelerate economic growth. This will lead to diminished total supply in an economy where the federal government contributes to excess demand through deficit spending, ultimately resulting in increased prices.
In the second video, titled "Speech by Governor Waller on the economic outlook," insights are provided on the anticipated economic landscape and the potential consequences of the IRA.
In conclusion, the IRA is projected to heighten, rather than alleviate, inflation.
Michael Busler - DDIChat
United States Ph.D. economist with 40 years of experience in economic and business consulting. Can also forecast economic…
app.ddichat.com
Subscribe to DDIntel Here.