The Economic Absurdities of the “Inflation Reduction Act”

By SBE Council at 9 August, 2022, 3:53 pm

by Raymond J. Keating –

If you think that government raising costs, limiting investment and innovation, and doling out more subsidies will somehow reduce inflation, then you should like the “Inflation Reduction Act of 2022” that just passed the U.S. Senate. But if you believe this, that also would mean that a complete review of fundamental economic principles is in order. This is a bill based on and filled with economic absurdities.

The “Inflation Reduction Act” would do absolutely nothing to address the inflation that rages at levels not experienced in over 40 years. In fact, this bill would explicitly work against undertakings that would alleviate inflationary pressures. It is an act that would inflict economic harm at a time when the economy is mired in recession and high inflation, i.e., stagflation.

Our current stagflation ills find their origins in the continuing consequences of the pandemic and related government actions, in particular, ongoing supply-chain challenges and labor force issues; historically unprecedented loose monetary policy; and federal policymaking focused on higher taxes, more regulation, trade protectionism, and increased government spending, which reduce resources, opportunities and incentives for entrepreneurship and investment.

The “Inflation Reduction Act” would not do anything to redress any of these ills, but actually would work to make them worse, while also creating new problems. There are a variety of tax hikes and changes – including taxes that will impact energy consumers and the ability of small businesses to deduct losses – along with questionable spending projects in the package. The Republican Study Committee has prepared a comprehensive overview of the various radical policies in the legislation, and American for Tax Reform lists all the tax increases in a blog post. Here are just a few of the negatives that will have a profound effect on U.S. investment, innovation and the health of the economy:

Negatives of a Corporate Minimum Tax

The imposition of a 15% minimum corporate income tax, as called for in the bill, would be a straight tax increase on corporations. It would limit assorted measures in the tax system that often promote investment. And the fundamental issue is that this tax would drain resources away from corporations at work in the private sector – competing with other U.S. firms and with companies around the world, to ultimately serve consumers – and hand those resources over to politicians to be doled out according to political incentives.

It should be obvious that this tax increase would work against investment, innovation, competitiveness, shoring up supply chains, and economic recovery and expansion.

In addition, while the bill’s minimum tax would apply to corporations earning at least $1 billion in income, the fallout, of course, would be felt beyond just those firms, with the many small businesses that work with and provide goods and services to those corporations, along with their employees, being negatively affected as well. These employees shop and dine at small businesses in local communities.

Negatives of a Stock Buybacks Tax

The Act’s 1% excise tax on stock buybacks would work against efficient allocation of capital, and therefore against economic growth. This tax is based on either a misunderstanding of the economics of stock buybacks, or a wish to score political points, or a political money grab to fuel more government spending, or all of the above. Politicians focused on taxing stock buybacks seem to think that they would be helping investment, but in reality, such a tax would do the exact opposite.

A stock buyback is the result of a company having excess capital, and choosing to return those dollars to shareholders. In turn, company owners who choose to sell their shares obviously have a better idea for how to use those dollars, including making other investments such as in new and/or expanding entrepreneurial ventures. Market decisions to shift resources from less productive undertakings – such as dollars sitting with companies without investment opportunities – to more productive ventures – such as individuals making investments in businesses that are expanding and innovating – are central to driving economic, income and employment growth.

A tax on stock buybacks can have the effect of locking in underperforming investments, and limiting resources available for investing in new and innovative businesses. It effectively raises the costs of more efficiently allocating investments.

Both a corporate minimum tax and a tax on stock buybacks would have negative effects on stock market investments, including the retirement plans, such as 401(k)s, of average Americans, again, including small business owners.

Negatives of Price Controls

Unfortunately, there’s more bad news in the “Inflation Reduction Act.” If passed, it would impose price controls on prescription drugs. Specifically, the bill would allow Medicare to “negotiate,” that is, set, prices for certain drugs. This long has been the first step sought by those who wish to impose price controls on prescription drugs. The signal to entrepreneurs, businesses and investors in the prescription drugs sector would be clear: price controls have arrived.

Price controls, of course, mean limiting potential returns, and therefore, limiting investment in the development of new and improved drugs. The uncertainties, risks and dollar costs of developing prescription drugs are enormous, and the possibility for returns on the few medicines and vaccines, for example, that make it to market is essential. One of the reasons why the U.S. is the global leader in the prescription drug industry is because we don’t impose price controls, unlike most other nations. But by limiting prices, potential returns are limited, and that’s bad news for developing new life-saving medicines.

Also, it is essential to be clear about the make-up of the pharmaceutical industry. While politicians talk incessantly about so-called “Big Pharma,” it is critical to understand that current market leaders were once small startups that gained market share by serving consumers well. And the industry today remains one overwhelmingly populated by smaller businesses.

Consider the breakdown of the pharmaceutical and medicine manufacturing industry by firm size (latest Census Bureau data 2019).

Pharmaceutical and Medicine Manufacturing Employer Firms (2019)

Firm Size by Number of Employees	Percent of Total Employer Firms in Industry
Fewer than 10 employees	49.8%
Fewer than 20 employees	61.2%
Fewer than 100 employees	79.5%
Fewer than 500 employees	91.9%

Data Source: U.S. Census Bureau

Out of 2,111 manufacturers, 1,052 had fewer than 10 employees, 1,291 fewer than 20 employees, 1,679 fewer than 100 employees, and 1,939 fewer than 500 workers.

Add in nonemployer businesses, that is, self-employed with no employees. There were 2,312 in 2019, and therefore, the number and share of small businesses in the pharmaceutical sector jumps even higher.

Undermining the pharmaceutical industry means directly undermining small, entrepreneurial businesses, not to mention inflicting broader harm on patients and the economy.

Negatives of More Government Spending

And of course, the “Inflation Reduction Act” would increase government spending by hundreds of billions of dollars over the coming decade. Again, taking resources from the private sector, which is governed by prices, profits, losses, competition and consumer sovereignty, and handing those dollars over to the government to be spent according to politics, is never a positive for the economy.

And among the dollars being spent, $79.6 billion would go to the IRS to, in part, jack up enforcement. SBE Council Karen Kerrigan summed up the potential implications: “Moreover, super-sizing the IRS to audit more taxpayers means small businesses have a target on their back. Lengthy and time-consuming audits are financially and emotionally taxing, and the message this bill sends to small business taxpayers is that they should be fearful about risk-taking and their chances of being audited.”

A Negative for the Economy and Jobs

Again, to claim that the “Inflation Reduction Act” would actually reduce inflation and/or help fight off a recession would be guilty of perpetuating economic absurdities. This bill is all about an attempted expansion of the size and reach of the federal government, and raising the costs of and diminishing incentives for investment and innovation. As a result, if passed and signed into law, it would constrain economic, income and employment growth, while making the fight to reduce inflation even more difficult.