Two acts passed by the Democrat controlled Congress, the “Chips Act” (late July 2022) and the “Inflation Reduction Act”, (early August 2022) are of concern to fiscal conservatives (especially the “Inflation Reduction Act). The Chips Act is not as problematic as the Inflation Reduction Act, but it does pick winners and losers and I am not in favor of the politicians in Washington DC picking winners and losers. The Chips Act does incentivize the expansion of chip production in the United States, but I am not convinced that the intended effect will be significant because the demand for chips is falling world wide and may stay depressed for the foreseeable future. The long term effect may be more favorable than in the short run and the moving of more production on shore does have some positive security implications. In contrast, the deceivingly titled, poorly vetted Inflation Reduction Act a (hereafter Act) is extremely troublesome in many ways and will be the subject of the remainder of this paper. Without getting heavily into all of the troublesome details of the Act, I have chosen a few basic areas of critical concern.
Looking specifically at the Act, a lot more spending is planned and taxes will be increased. The big losers from the impact of the minimum corporate tax segment of the Act will be employees, wage earners, customers and stockholders, regardless of how the tax increases are being messaged and sold to the public. Corporations unlike individuals do not not accumulate wealth and prosper strictly for their own long term benefit. Successful corporations offer products and/or services that customers want or need at a competitive price. Tax increases like any other cost increase gets passed to to all customers, employees and stockholders. The revenue they generate from products they make or service they provide pays employees and compensates stockholders. As an efficient and successful corporation grows and its income and asset value increases, employees benefit in the form of higher wages and salaries and the value of stockholder holdings grows (including 401K and other employee pension plans).
As noted above any tax increase borne by any corporation doesn’t just vanish in the profit category. It has been well established that a significant portion of the impact of any tax increase falls on labor in the form of stagnant if not lower real wages and salaries, with the remainder of the cost increase being borne by customers in the form of price increases, stockholders in the form of lower return on their investment, and the entire economy in the form of less investment and associated innovation. The big gainers will be big government and agenda driven spending, both in the United States and abroad. Whenever funds are removed from the free market and earmarked for government expansion and government directed spending that picks winners and losers, the economy as a whole takes a hit. What a really bad idea, especially during an economic period that checks all the boxes for stagflation.
Another serious issue associated with the smoke and mirrors “Inflation Reduction Act” is the continued war on fossil fuels in support of the “Green New Deal” in a number of sections of the bill (including the tax on imported oil, additional fees and taxes placed of domestic production, and massive “funding” of EPA activities). The Act earmarks $370B for actions relating to green energy climate objectives including $27B for an EPA managed climate Bank. The incentives relating to electric vehicles will not move the needle significantly from the existing production path because of its restrictive wording. Technology advances will move the needle more and the free market will do it efficiently without any government bureaucratic stupidity. The hundreds of billions of dollars being given to the EPA to expand their activities and the ability of bureaucrats to direct financing in the direction of whatever green products fit into their agenda, paid for by funds being taxed from the free market, will not effectively or significantly improve the domestic or global environment. The Act in its entirety ignores existing infrastructure and technological realities, and through its unbalanced approach to energy hinders the implementation of a truly optimal path toward clean energy. Road blocks in this act will slow down the replacement of high polluting energy sources with cleaner burning natural gas. Virtually all of the tax credits for “climate friendly” cars and home improvements, etc. are totally not affordable for a vast majority of tax payers which renders most of these credits worthless. The net effect of this Act can be expected to increase the cost of oil and gas, over time, in domestic markets, along with its associated inflationary effects, masked in part by the drop in demand for all products as the Fed drives up interest rates and creates demand destruction. Probably the most underplayed, but still concerning aspect of the Act in relation to the EPA is the use of the deceptive terminology “CLIMATE/ENVIRONMENTAL JUSTICE”, with emphasis on “JUSTICE”. This is a format in which logic is replaced by terminology, where all rational unbiased analysis is sidestepped regardless of who is portrayed to benefit and who is not and if anyone will benefit at all other than big government.
Another ominous provision of this bill relates to the massive expansion of the IRS with $80,000,000 additional funding and 87,000 additional auditors. Given the fact that large corporations and billionaires, with teams of tax lawyers and accountants, are already heavily scrutinized by existing IRS oversight, much of the IRS expansion will end up burdening small and medium size businesses with overbearing audits that they cannot afford to fight. Janet Yellen’s statement that the IRS has not been directed to change the audit patterns (%) for the various income categories, other than the very wealthy, is not to be misconstrued. In other words, her promise that audit volume will increase more for the $400,000 and up category than for the $400,000 and down category should not alley any fears because all audits for all categories will still increase. Given the fact that the $200,000 and under category, historically, is by far the most audited income category, middle and low income individuals and small businesses still have a lot to fear in the face of increasing intensive audits. In other words, “buckle your seat belts” small and medium size pass-through S Corps and LLCs, there is a bullseye on your back intended to generate tax income to fund big government spending. Recall Yellen’s promise in 2021 that inflation would be transitory. It makes no sense to attack the drivers of the free market and employers of more than half of the nation’s workforce, especially during a period of stagflation– another bad idea. A small category that has an unusually high audit rate is the earned income category. Although some of that high rate is attributable to fraud, most of the audit issues relate to mistakes made due to the complexity of the claim process and the inability of the claimants to properly fill out the forms. What is needed is a complete rework and simplification of the tax codes (eg. flat tax), not additional complexity with a massive army of IRS bureaucratic auditors. Keep in mind the adage relating to taxes – “complexity creates circumvention”. This does not, however, fit into the American left’s big government playbook. The push to turn the United States into a socialist state takes a lot of funding backed up by the overarching control of the lives of all citizens by the state. A massive IRS with funding enabling them to be intrusive into the everybody lives and to collect lots of money is a good start toward accomplishing that goal given a funding increase of $80,000,000 and an army of auditors.
The deceptively titled Inflation Reduction Act will find more support from mainstream Keynesian economists than earlier version of the “Build Back Better” fiascoes because the long term net effects of the Act on inflation and recession are sufficiently muddled to make precise evaluation an ongoing debate. The effects of increased taxation are clearly negative for all income classes and the economy as a whole. The continued war on fossil fuels will only increase the price of energy for the foreseeable future. For the Keynesian followers the spending aspects of the bill and the minor lip service given to deficit reduction run counter to the negative inflation aspects of the taxation provisions and make the act acceptable. Remember government spending is an acceptable aspect of economic growth in the Keynesian world and there is plenty of spending in both Acts referenced above. Also, most Keynesian economists are also strongly in the “climate change” camp and will endorse spending that picks and chooses winners in the market place that supports their agenda. The Supply-Side economists will always come down hard on non critical government spending especially when it picks winners and losers and backs out free market investment via taxation. Their position that the overall economy is worse off when inefficient big government spending backs out free market activity and expansion, is intuitive and persuasive.
From the timing of this Act it is apparent that the window for this type of big government tax and spend legislation is rapidly closing as the November election approaches. Regardless of the arguments in support of the legislation (which are coming fast and furious as conservative critics point out its troublesome aspects), the Act is agenda driven and not in the interest of the American consumer, American Corporations and the overall health of the free market. Unfortunately, the American economy is not presently in a good state and downward pressure on the economy will only increase as the Federal Reserve raises the federal funds rate to fight inflation. Many stock market analysts believe that inflation has already peaked and hope that the Federal Reserve will pause sooner than planned. Existing inflation data does not necessarily support that belief, but that data is backward looking and economic growth has already been negative for two quarters. Inflation and GDP data in the coming months will be the primary determinants of Federal Reserve rate policy. Having been severely late in reaction to inflation that started in 2021, it is likely if they are going to resist making the same mistake. If the Federal Reserve does pause prematurely then the American economy will have to endure significant inflation for a longer period of time than necessary, which is not a good outcome. We all want to be optimistic that the recession we are in will be a mild one, but that outcome is dependent on the actions of the Federal Reserve, the resilience of the American economy (always good if not regulated to death), and the Biden Administration being constrained from additional fiscal and monetary irresponsibility.