Predicting the climate bill’s effects is harder than you might think

The Inflation Reduction Act of 2022, which marks the US's largest-ever investment in climate and clean energy at nearly $400 billion, is a clear environmental victory. But just how far that funding will go in cutting carbon emissions is yet to be seen, and the results are far less certain that some have claimed.

Estimates predict that the bill's mix of tax credits, grants, and loan programs could result in up to a billion tons in annual emissions reductions by 2030. According to several analyses, this would mean the US could reduce greenhouse-gas emissions by up to 40% from their peak levels in 2005.

While models have converged on this 40% reduction as a common estimate, some economists stress that tax credits can have uncertain effects, and predicting the actual future of emissions reductions is tricky.

One reason for the uncertainty is that the bill relies largely on financial incentives rather than regulations or mandates, so its effectiveness depends on consumer choices and business decision-making. Both of those can be unpredictable.

For example, most of the emissions cuts are expected to come from the power industry, as the bill provides generous incentives for companies to build more renewable electricity. But local opposition to new construction, and other barriers to clean-energy projects such as solar and wind farms, could halt progress, discouraging investment and slowing deployment.

Free money

Tax credits are at the heart of the Inflation Reduction Act's strategy for cutting greenhouse-gas emissions.

Some of the tax credits in the bill are for individuals-there's about $35 billion for people looking to upgrade and electrify their homes, as well as a $7,500 credit for purchasing new electric vehicles and a $4,000 credit for used ones. But how many people will decide to buy these cars will likely depend on the health of the economy, how consistent the supply is, and whether they find them appealing.

Other tax credits are for companies and public utilities building clean-energy projects. This is a huge chunk of the bill-roughly $160 billion, including programs designed to keep nuclear power plants running.

These credits come in two forms. Investment tax credits are calculated as a fraction of the initial investment to build a project, starting at 30%; if the plant costs a billion dollars, the builders get a $300 million credit. Production tax credits, on the other hand, are based on a plant's output, paying out a couple of cents for every kilowatt-hour of electricity produced.

A company looking to build a clean-energy project can choose between a production and an investment tax credit. Startups without a tax burden can sell their tax credits to another company that has one, so they can still cash in.

In the power sector, tax credits have been a long-standing strategy-wind and solar projects have qualified for credits for years, and the funding has been credited with helping those technologies succeed, says Karen Palmer, an energy economist at Resources for the Future. The new bill broadens these credits to include other clean-energy technologies.

The logic behind tax credits is simple. If you make clean energy cheaper, people are going to produce more of it," says Nat Keohane, an economist and the president of the Center for Climate and Energy Solutions.

Uncertainties

Economists agree that the new tax credits will reduce emissions-the question is how much. Early estimates come from three major modeling groups: Princeton's REPEAT Project, Rhodium Group, and Energy Innovation. All agree that the new legislation should help get the US to about a 40% reduction in emissions by 2030.

People don't necessarily always do what is, on paper, the most economic."

Robbie Orvis

In the REPEAT group's estimate, almost 40% of the emissions reductions resulting from the bill will come from the power sector, largely driven by the huge tax credit programs for clean energy. An additional 30% will be in transportation, the group predicts, and another 15% in heavy industry.

Not all that expected progress is because of the bill. The US is emitting about 15% less today than it did in 2005, and with policies in place before the bill passed, the country was already on track for reductions of about 25% below 2005 levels by the end of the decade.

And economists are quick to point out that while models can give a broad sense of how policy could shift future emissions, there are plenty of ways that picture could change.

In a report last year, Rhodium Group said the US was on track for emissions reductions of 17 to 30% by 2030. This year, in its June report, that estimate crept up to between 24 and 35%.

The difference in the model results wasn't because of any specific new policy, but largely because of how fossil-fuel prices shot up after Russia invaded Ukraine and how the US government started responding to inflation concerns, says Ben King, associate director for Rhodium Group's climate and energy program. Any factors that shift the price of fossil fuels will likely impact emissions predictions.

Human decision-making can also cause models and reality to misalign. People don't necessarily always do what is, on paper, the most economic," says Robbie Orvis, who leads the energy policy solutions program at Energy Innovation.

This is a common issue for consumer tax credits, like those for electric vehicles or home energy efficiency upgrades. Often people don't have the information or funds needed to take advantage of tax credits.

Likewise, there are no assurances that credits in the power sectors will have the impact that modelers expect. Finding sites for new power projects and getting permits for them can be challenging, potentially derailing progress. Some of this friction is factored into the models, Orvis says. But there's still potential for more challenges than modelers expect.

Not enough

Putting too much stock in results from models can be problematic, says James Bushnell, an economist at the University of California, Davis. For one thing, models could overestimate how much behavior change is because of tax credits. Some of the projects that are claiming tax credits would probably have been built anyway, Bushnell says, especially solar and wind installations, which are already becoming more widespread and cheaper to build.

Still, whether or not the bill meets the expectations of the modelers, it's a step forward in providing climate-friendly incentives, since it replaces solar- and wind-specific credits with broader clean-energy credits that will be more flexible for developers in choosing which technologies to deploy.

Another positive of the legislation is all its long-term investments, whose potential impacts aren't fully captured in the economic models. The bill includes money for research and development of new technologies like direct air capture and clean hydrogen, which are still unproven but could have major impacts on emissions in the coming decades if they prove to be efficient and practical.

Whatever the effectiveness of the Inflation Reduction Act, however, it's clear that more climate action is still needed to meet emissions goals in 2030 and beyond. Indeed, even if the predictions of the modelers are correct, the bill is still not sufficient for the US to meet its stated goals under the Paris agreement of cutting emissions to half of 2005 levels by 2030.

The path ahead for US climate action isn't as certain as some might wish it were. But with the Inflation Reduction Act, the country has taken a big step. Exactly how big is still an open question.