The Inflation Reduction Act was never about reducing inflation

OPINION:

Treasury Secretary Janet Yellen took to the pages of the Wall Street Journal to trumpet the accomplishments of the Inflation Reduction Act (IRA) of 2022. In her article “A Prosperous Year for the Inflation Reduction Act,” Ms. Yellen claims that the IRA has improved productivity, which in turn will reduce energy prices and spur economic growth.

Unfortunately, Secretary Yellen’s article exhibits unfounded optimism as to how government spending affects prices, productivity, and the economy.

First, let’s be clear: The IRA did not reduce inflation.

Some have argued that post-pandemic inflation was caused by supply-side problems, including President Biden, who dubbed it “Putin’s Price Hike.” In fact, the widespread, persistent inflation during the pandemic recovery was mostly caused by poor monetary policy by the Federal Reserve. The Fed’s belated tightening eventually brought inflation down, not Mr. Biden or the IRA.

If the IRA did not reduce inflation, then what did it do? Primarily, it funneled money to so-called “green” energy projects and Democratic party constituents.

The IRA was never about reducing inflation. The bill’s title was simply a selling point to gain favor with voters. More than half of the $737 billion in spending was allocated to climate-related grants, subsidies, and tax breaks, plus expansions of Affordable Care Act subsidies and special provisions for union workers, who tend to vote Democrat.

Mr. Biden himself refers to the IRA as targeting the climate rather than inflation. “Let me be clear,” the president said, “The Inflation Reduction Act of 2022 would be the most significant legislation in history to tackle the climate crisis and improve our energy security.”

Secretary Yellen agrees. She describes the IRA as “the boldest climate action in the nation’s history.” Although her article touts the IRA as “spurring economic growth and helping the U.S. reach its climate goals,” not once does she argue that the Act has reduced inflation.

Inflation and climate aside, is Ms. Yellen right that the IRA will improve productivity and spur economic growth? The evidence says No.

Ms. Yellen credits the IRA with “a boom in U.S. factory construction spending” and “investments in clean energy and manufacturing.” She claims that under the IRA, “taxpayer resources are spent more productively, and the benefits to the overall economy are magnified.”

Economic research, however, finds that government spending does not make the economy more efficient. A review of the literature finds that, in most cases, an increase of one dollar in government spending leads to an increase of only 60 to 80 cents in total spending in the economy. Even considering the cumulative effects over time, each additional dollar of spending has a long-run effect on the economy of only about 66 cents.

Why doesn’t more spending improve the economy? Because government spending is wasteful. Politicians spend money on projects that benefit themselves and their constituencies at the expense of average Americans.

For each dollar spent, the federal government must take a dollar out of the economy, either from consumers by raising taxes or from the financial system by issuing bonds. That money would be better spent by consumers and businesses. As Milton Friedman famously said, “Very few people spend other people’s money as carefully as they spend their own.”

Government spending is effective neither at reducing inflation in the short run nor at improving productivity in the long run. The evidence says the IRA is unlikely to improve productivity or economic growth. It is also unlikely that the IRA reduced inflation because that was never actually the goal.

The Inflation Reduction Act has not, as Ms. Yellen claims, made America more prosperous. That’s simply preposterous.

• Thomas L. Hogan is a senior research faculty member at the American Institute for Economic Research (AIER). He was formerly the chief economist for the U.S. Senate Committee on Banking, Housing, and Urban Affairs.