US Inflation Reduction Act – what impact on Europe? 

by Roberta Guevska

In August 2022, the US Senate passed its Inflation Reduction Act (IRA) by a narrow majority of 51-50. Although opinions between Republicans and Democrats vary on whether such legislation would be effective in the fight against rising inflation (6.5% as of December 2022, according to U.S. Labor Department data published January, 12), the facts show that the unprecedented federal law would have an impact in three major spheres: economic recovery, energy security, and the fight against climate change. It would also have a major impact on the corporate minimum tax rate. In other words, the IRA seems to build upon the previous US’s Build Back Better Act, which mainly aimed to restore the backbone of the American economy. Nevertheless, while the IRA aims at bringing benefits to the US market and society, transatlantic relations with the EU could get harmed along the way for several reasons.

What’s in it for the EU?

To begin with, the American IRA allegedly poses significant threats to the competitiveness of European companies operating in the US market. While it aims at large to boost the domestic economy by combating inflation, promoting sustainable investment and addressing climate change, the bill tends to cover several broad areas – such as the extension of the Affordable Care Act program, while making prescription drugs more affordable and raising taxes of wealthy corporations.  What is more, US authorities introduced a quite limiting requirement for attribution of subsidies (uncapped, but at least $370 billion) that is directed exclusively towards companies based in the US. 

The exact implications of the IRA on transatlantic relations have yet to be determined, but the bill is, according to many, solely benefitting US-based manufacturers without guaranteeing a level playing field. The situation would be particularly difficult for the automotive industry and manufacturing, as the IRA threatens to introduce discriminatory treatment for EU clean vehicle producers under its Clean Vehicle Credits. This credit is supposed to have a maximum value of $7,500 per purchase and intends to encourage purchasing clean-fuel cars. Moreover, the main challenge is to prevent European companies from relocating their production overseas because of the financial benefits they would profit from. Indeed, the bill allows for the distribution of groundbreaking tax credits for people purchasing electric vehicles, as long as these are produced in the US. 

On the other hand, even if there are a number of preferential prerequisites for the US-based companies, their European counterparts have already well-established supply chains, which makes their relocation less likely. Even if they opt for moving the production across the Atlantic, the process would take at least a couple of years, would be rather costly, and at a high risk. In the long term, all this does not seem to be a sufficient reason to relocate European car production to the US in order to benefit from a few years of subsidies.

EU’s response to IRA 

Yet, while the fears of many European companies could be well reasoned, Heads of State of multiple EU countries and European officials have been working towards guaranteeing that transatlantic relations remain friendly, but not at the cost of harming the European economy itself. In the end, if EU-US negotiations on how to adapt the IRA find themselves at a dead-end, another option for the European authorities could be to bring the case to the WTO. Given the continuing Russian war in Ukraine and the need for unity among Western nations, though, it is the less likely scenario. Finally, during the State of the Union 2022 speech, the President of the European Commission introduced another proposal for coping with the complex situation – the European Sovereignty Fund (ESF) that would benefit the European industry.

While keeping up with the EU’s engagement for sustainable policies, green and digital transition, and promoting competitiveness across Europe, the initiative tends to be a bold step to revamp and develop the EU’s plans for strategic autonomy – including by mobilising the necessary funding. Ultimately, the act would bring back into action and redefine the continent’s independence in production, while taking into account China’s aspirations, the complex situation with Russia’s war in Ukraine, and the sake of transatlantic relations.

On the other hand, the Commission also recently proposed a new approach towards loosening the rules regarding state aid. However, this step is viewed as a threat by numerous member states, as it would allow several wealthy EU countries to subsidise their ‘national champions’. While these objectives seem excessively hard to accomplish, the Sovereignty Fund initiative is the most substantive response to the various challenges presented. In addition to what has already been stated, the ESF would strive to transform the rules for state aid across the Union and add to that complementary EU-level funding. Therefore, the Fund is expected to be financed through innovative means to benefit the European industry and promote the green and just transition that the EU is committed to.

Last but not least, apart from the fact that both the US and the EU are trying to do what is best for their domestic economies without fatally harming each other, what is needed to remedy the current situation is strong collaboration on long-term measures on the climate and trade nexus. Furthermore, the described tensions surrounding the IRA stress the need for a revision of the international trade regulations – something that the EU and US can only accomplish together, alongside other major and emerging economies, so that sustainable and well-reasoned solutions for the challenging months ahead could be found.