Sen. Joe Manchin, D-W.Va., speaks to reporters about the agreement he reached with Senate Majority ... [+]
As recently as early last week, it looked like the chances of passage for major Democratic legislation on climate change and taxes this summer were slim. This was due to a failure of Democratic leadership to work out a compromise with West Virginia Senator Joe Manchin, who has shown himself to be a thorn in the side of the progressive wing of the party. That all changed, however, late last week when word came of a potential deal. Now, the Inflation Reduction Act, as it is being called, could be voted on as early as this week.
What’s most interesting about the deal is not the usual pork-barrel spending we’ve come to expect from Congress. The bill has plenty of that, to be sure, but what’s unique here are some “supply-side” reforms worked out as part of the overall package, largely thanks to Manchin, whose support will be vital to ensuring final passage. This might just be a one-off situation to buy Manchin’s support on climate legislation, however it could also signal more openness among Democrats to incorporating economics into their thinking.
The stated goal of the legislation is to reduce inflation. The challenge will be negotiating how to do that without wrecking the economy. There are basically two ways that policymakers can try to keep production going in the economy—or, at least hold it constant—while pursuing other goals like helping the environment.
The first approach is to spend money, and, not surprisingly, this tends to be the go-to default for progressives. The problem with more spending, however, is that the spending has to come from somewhere. Raising taxes is unpopular and even borrowing tends to discourage production elsewhere in the economy. The spending itself can lead to higher prices, which is inconsistent with the goal of lowering inflation.
Alternatively, one can focus on the supply side. Here, through incentive effects, policy can encourage workers and business to produce more intensively or for new workers and new businesses to enter the marketplace. This is usually accomplished by lowering tax rates that discourage work or investment, or by relaxing regulations that prohibit or slow down production. The benefit of supply-side reforms is production goes up and prices tend to fall simultaneously, which is good for the economy and keeps inflation in check at the same time.
Supply-side reforms have gotten a bad name in the past, largely because they tend to be associated with controversial tax cuts during the Reagan Administration and television economists like Art Laffer. But now some progressives are starting to warm up to supply side reforms, albeit slowly.
For example, permitting reforms worked out as part of the deal should speed up National Environmental Policy Act reviews and limit some harmful effects of litigation, both of which tend to slow down development projects or all sorts. Progressives are sometimes leery of these kinds of reforms, but clearing regulatory backlogs speeds up renewable energy projects, along with coal and natural gas ones too.
Manchin also wants to see the Mountain Valley Pipeline completed. It’s been in a bureaucratic holding pattern for months due to opposition from environmentalists, but it may actually be good for carbon emissions as natural gas displaces some coal and heating oil use.
Although there are some good things in this potential deal, there is also a lot not to like. There are handouts for electric car producers and consumers, higher taxes on businesses, and drug pricing reforms that could potentially thwart innovation. Much of this is likely to prove counterproductive for growth, and, potentially even the environment too. So Democrats have not exactly found religion when it comes to marrying their policy goals with sound economics.
Not only that, but here we see tax and spending policies dressed up as something new. In this case, “inflation reduction.” Few seriously believe subsidies for electric vehicles and tax increases on businesses will make a real dent in inflation, especially when the Federal Reserve influences short-term interest rates, and tax increases won’t come for several years down the road. Indeed, the best analysts out there confirm this bill may do a lot of things, but inflation reduction is not one of them.
There are broader lessons here. When constituents demand reforms, the first thing that comes to many legislators’ minds is more spending. But supply-side reforms can have the same intended effects in ways that are less distortionary. These issues don’t need to be partisan either. In theory, everyone should support growing the economy while keeping prices down for consumers.
The Inflation Reduction Act won’t accomplish its stated goal, but what’s interesting is the seed of economic reality that it signals has been planted in the progressive consciousness. This seed could potentially bear fruit in the future in the form of a greater understanding of the benefits of supply-side economics.
It remains to be seen whether this version of the legislation will eventually pass. The permitting reforms could easily be dropped during the final negotiations, for example. But even if progressives learn nothing from this experience, party leadership should not be so dense. Spending isn’t the only way to get things done.
