Every country needs an Inflation Reduction Act

MELBOURNE, Nov 25 (Reuters Breakingviews): Lawmakers in South Korea blasted the US Inflation Reduction Act as a betrayal. European Union leaders worried it would leave the bloc's companies at a disadvantage. And big miners like Australia's Fortescue said it left them little choice but to direct a lot of spending to the United States. Yet concerns about market distortion from the policy intended to stimulate investment in the energy transition and signed into law by President Joe Biden in August 2022 are easing. Other countries are realising they need to adapt the blueprint.

The Biden administration's willingness to negotiate on its package of $370 billion of tax breaks and other measures has helped. That has mollified fears among major US allies that the legislation's push to boost manufacturing stateside would shut them out. Seoul lobbied hard with decent success, for example, to allow electric vehicles manufactured in South Korea and sold in the United States to be eligible for the IRA's $7,500 tax credit. Australia struck a deal with Washington in May over critical minerals that paves the way for companies Down Under to gain access to the legislation's financial benefits, while the European Union is still in discussions over those and other issues.

Such progress has allowed the law's real power to shine: its ability to unlock private capital for green products. The IRA contains tax credits to stimulate consumer demand for everything from electric vehicles to heat pumps, and funds to jolt companies into action. In the first 12 months of the act, more than 270 new clean energy projects with some $130 billion-worth of investments were unveiled, per Bank of America.

All in, the IRA could spur $3 trillion in renewable energy technology investment by 2032 - and by 2050 encourage up to $11 trillion of total investment in infrastructure, Goldman Sachs reckons. That means jobs - almost 1.5 million new ones in the US by 2030 - per Labor Energy Partnership estimates.

It's an enticing mix of emissions reductions, more employment and a boost to productivity for politicians around the globe to try to emulate. The trick is finding how to pay for it. Granted, over time the increased economic activity and concomitant tax revenue - not to mention environment-based disasters averted if rising temperatures can be stopped - could cover the initial outlay many times over.

Trouble is, governments also need to show that they will be fiscally responsible stewards of the energy transition in the short term - especially with inflation still a threat and budgets under pressure.

The US national debt, for example, stands at some 120 per cent of GDP, offering no wiggle room even before considering Congress' increasingly frequent battles over funding the government. So the flipside of the IRA's ledger mandated that big companies pay at least a 15 per cent tax on their earnings, regardless of whatever legal ways exist to reduce what they hand over to Uncle Sam. It also introduced a 1 per cent levy on share buybacks and allowed the federal government's health insurance programme, Medicare, to negotiate what it pays for some drugs and cap how much prices increase. On paper at least, that offsets most of the headline cost of the act.

Japan chose a different path for its Green Transformation Act which parliament passed in March. It involves using the proceeds from selling some 20 trillion yen ($135 billion) of government debt to entice 150 trillion yen ($1 trillion) of private capital over the next decade. By one metric, that is a massive stretch: the country's debt to GDP already stands at a whopping 220 per cent or so but with interest rates still negative for now, borrowing costs remain very low. And the plan envisages using revenue from a future carbon levy and an emissions trading scheme to pay off the debt.

Yet while Washington is aiming to catalyse demand for green products made mostly with existing technology, Prime Minister Fumio Kishida's administration has other ideas. It intends to channel more than a third of the cash raised into technologies that are either in the early stages of development, like clean hydrogen and ammonia, or are older but niche like carbon capture and storage. Their success at reducing greenhouse-gas emissions is far from guaranteed and could take a decade or more to be useful at scale, leaving Japan on a slow path to decarbonisation.

The EU is in a tougher spot as it generally does not allow its member countries, with diverse credit ratings and funding costs, to borrow money as a group. So it has suspended some rules prohibiting state aid and is diverting some of its remaining pandemic-era funds into clean energy projects. That is a piecemeal, knee-jerk reaction to IRA concerns. Plus, last week Germany's constitutional court ruled as unconstitutional the government's 2021 decision to divert 60 billion euros of unused debt from to its climate and transformation fund.

One country that is well placed to follow the US' climate funding lead is Australia. Though inflation remains stubborn Down Under, Canberra is running a small budget surplus. Net federal debt is relatively low at just 40 per cent or so of GDP and there's money to be found elsewhere, political will allowing. Options range from capping diesel subsidies, per think tank Climate Energy Finance, to halting some of the inflationary-looking tax cuts due to start next July.

Jim Chalmers, the finance minister, has dropped hints that he may be working on IRA-style incentives, stating at the start of this month that they "can be part of an answer but they're not the whole answer" to sparking the energy transition. The numbers are compelling: A$100 billion ($65 billion) of federal support could bring in around three times that in private investment, research by Climate Energy Finance and the Climate Capital Forum shows.

The government has been pursuing individual policies to date. The latest, expected to be unveiled on Friday, involves more than tripling to 32 gigawatts the amount of renewable power and storage Canberra is willing to help underwrite, local newspaper AFR reported on Wednesday. That will speed up its pledge of having solar, wind and hydropower provide 82 per cent of Australia's electricity by 2030, up from around a third last year.

A broader Aussie plan could offer IRA-style incentives to electrify power supply, cars and homes, but it could also be adapted to leverage the country's strengths. These include a wealth of critical minerals for batteries and grids. There's also some 10,000 times more solar radiation each year than Australia requires, and offshore wind potential that could exceed the capacity of the world's current coal-fired power stations, per Chalmers.

Harnessing all this for processing more minerals onshore, developing green hydrogen and electrifying supply chains could increase the range and economic value of exports and boost manufacturing that's currently stuck at a lowly 6 per cent of GDP, almost half the 2005 level. A well-targeted green stimulus along such lines could yield A$435 billion a year, Deloitte and National Australia Bank estimate.

Done right, it would send a valuable lesson to other countries that climate subsidies aren't just about chasing the United States' tail. And Chalmers is right that financial incentives alone are not enough to foster the shift.

Change requires everything from accommodative policies to developing a trained workforce. The chance to quicken the pace of decarbonisation while powering a long-term economic boost, though, ought to make devising comprehensive, IRA-inspired legislation worth the effort.