The European Backlash to the Inflation Reduction Act, Explained

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Last August, after months of stalled negotiations and setbacks, the US Senate agreed to a deal that transformed what was originally known as President Biden’s Build Back Better agenda into the Inflation Reduction Act (IRA), a massive climate, health, and social spending operation. The law’s marquee provision is a $369 billion subsidy scheme that is meant to encourage private investment into green technologies. Notably, some have characterized the bill as the largest climate investment in American history. As a result, the bill is undoubtedly a win for the environment, with some analysts predicting that it will reduce American carbon emissions by 40% with respect to 2005 levels.

However, because the IRA’s subsidies favor investments that are made in America, some European leaders are concerned that companies will relocate their industrial capacity from Europe to the United States in order to take advantage of the generous tax benefits that the IRA offers. Importantly, even if Europe’s existing industrial base is not at risk, companies may choose to focus their new investments in the United States rather than in Europe. This poses an important risk to Europe’s ability to insert itself into the growth opportunities that the green transition offers. As a result, this significant incentive to invest in America has generated calls from European business leaders for Europe to respond to the Inflation Reduction Act and match America’s green subsidies in order to prevent a wave of deindustrialization in Europe.

In particular, European economic officials have expressed anxiety over the tax breaks that the IRA offers to individuals who purchase electric cars as those credits only apply to cars that are made in North America. As a result, consumers will be incentivized to narrow their options of potential electric car purchases to car companies whose industrial base is located in North America. From Canada’s perspective, the inclusion of Canada in this “buy North America” scheme was a victory for officials who feared that they might be subjected to the same fate as Europe. In fact, Canada may stand to benefit significantly from the IRA because its prominent mining industry will be tapped to address the growing demand for lithium, a critical mineral necessary for the production of electric cars. Europe was not as lucky as Canada. Germany in particular, a nation that is heavily dependent on its car industry, has voiced concerns with the IRA by calling its subsidies “discriminatory.” Its officials have called upon the United States to include Germany and other EU states in the IRA’s subsidy scheme, just as Germany claims the United States has already done for others.

As tensions have grown over the potential effects of the IRA, commentators have become worried that Europe may escalate this brewing trade conflict by proposing a subsidy package of its own. Worryingly, that may trigger an intensifying, tit-for-tat economic competition over the investment decisions of a few powerful industrial sectors. This situation has raised concerns among high-level European officials over the possibility that global markets will become flooded with subsidies, a state of affairs that would discourage competition and instead encourage companies to engage in a bidding war with governments. 

Whether or not a full trade war is on the horizon, Europe has already begun to respond to the IRA with plans to loosen state regulations on tax credits and redirect some Covid-19 relief funds. More specifically, the EU plans to allow individual member states to offer more extensive tax credits to companies who might be weighing the potential trade-offs of investing in either the United States or Europe. EU officials also argue that these tax breaks will make it easier for European businesses to compete in the context of much lower energy prices in the United States. This line of argument could be interpreted as a deflection of the allegation that these actions are a direct response to the IRA and that Europe is not planning to match the actions of the United States. Either way, it remains to be seen whether the United States will capitulate and extend the IRA’s benefits to Europe or if it will stay the course and create a new era of climate-related trade wars. 

However, from the perspective of climate activists, the news of a green tech-related subsidy war is surely positive. If governments can help in the green transition by lowering the costs of investment, production, and innovation, breakthroughs in technology and in decarbonization will become more likely. Regardless of a trade war, analysts have noted that the IRA will boost the production of wind farms, solar panels, and alternative energy storage technology. Because the IRA provides incentives to both businesses and consumers, the new investments that companies make will be more accessible to the public for consumption. If Europe does respond to the United States, environmentalists should be hopeful that a new 21st century green tech Space Race has possibly begun.