The Inflation Reduction Act and the price of a made-in-America transition

President Biden signed the Inflation Reduction Act into law at the White House on 16 August[1]. The Act commits 369 billion dollars to energy and climate projects over the decade[1]. It pays for them with a 15 per cent minimum tax on corporations with profits above one billion dollars a year and with savings from Medicare drug price negotiation[2]. Both chambers of Congress passed it on party lines[1]. The President said that "the American people won and the special interests lost"[1]. We examine what the Act does for the climate, what it does to European industry and what the Union should do next.

A climate law written as an industrial law

The Act works through tax credits. The Rhodium Group estimates that it will take United States emissions to between 32 and 42 per cent below 2005 levels by 2030, against 24 to 35 per cent without it[3]. The White House puts the target at 40 per cent[1]. The Union's own target is a net reduction of at least 55 per cent by 2030 against 1990, and the Council agreed on 29 June on a 100 per cent CO2 reduction for new cars and vans by 2035[4]. The two blocs now have comparable ambitions and very different instruments. The Union prices carbon and regulates. The United States subsidises production.

The production credits are the heart of the Act. An advanced manufacturing production credit pays 35 dollars per kilowatt-hour for battery cells made in the United States, 10 dollars per kilowatt-hour for modules and 10 per cent of the production cost of critical minerals, for components sold between 2023 and 2029[5]. A clean hydrogen credit pays up to 3 dollars per kilogram for the cleanest processes[3]. These credits reward output only on American soil. A European battery plant competes against a subsidy that it cannot receive.

The consumer credit is the provision that Europe noticed first. The new clean vehicle credit is worth up to 7,500 dollars[5]. From 17 August the vehicle must undergo final assembly in North America[6]. Half of the credit depends on critical minerals extracted or processed in the United States or in a country with which the United States has a free trade agreement, with the required share rising from 40 per cent to 80 per cent after 2026[5]. The other half depends on battery components manufactured or assembled in North America, with the required share rising from 50 per cent to 100 per cent after 2028[5]. From 2024 a vehicle with battery components from a "foreign entity of concern" loses the credit, and from 2025 the same rule applies to minerals[5]. The Union has no free trade agreement with the United States. A car built in Zwickau or Mulhouse will not qualify, whatever its emissions.

What it means for European industry

The Commission said on 11 August that it was "deeply concerned by this new, potential, trans-Atlantic trade barrier"[7]. Its spokesperson Miriam Garcia Ferrer said that the credit discriminates against foreign producers and that this would make it incompatible with the rules of the World Trade Organization[8]. South Korea's trade ministry raised the same objection and cited its bilateral free trade agreement with the United States[8]. The Union agrees that tax credits help to drive demand for electric vehicles; it objects to the condition attached to them[8].

The objection is sound in law and weak in practice. The national treatment rule of the General Agreement on Tariffs and Trade forbids internal taxes and regulations that favour domestic products over like imported products. A credit that depends on the place of assembly is a textbook case. A dispute at the WTO would take years, and the Appellate Body has not functioned since December 2019. The Act will be applied long before any panel reports.

The deeper problem is the production credits, and no WTO case will remove them. Battery makers, electrolyser builders and solar manufacturers will compare a decade of guaranteed payments in the United States with a European market that offers a carbon price, a regulatory deadline and state aid approved case by case. The Union's Innovation Fund and the Social Climate Fund, capped at 59 billion euro over 2027 to 2032, were designed for a different contest[4]. The investment decisions of 2023 will follow the money.

The timing cuts against Europe. The Union is entering a winter of gas rationing and record electricity prices. An American offer of cheap energy and a ten-year subsidy arrives at the moment when European boards are reviewing where to build the next plant. The Trade and Technology Council agreed in Paris-Saclay in May to avoid a subsidy race on semiconductors[9]. The Act opens one in clean technology three months later.

What our generation should ask for

Our generation will work in the industries that this Act is reshaping. The question is whether the plants of the 2030s stand in Europe or in Ohio. A complaint in Geneva will not settle it, and the Union lacks a federal tax code and a federal budget of that size. It has other tools.

We recommend that the Commission seek, through the Trade and Technology Council, a treatment of Union-assembled vehicles and Union-sourced minerals equivalent to that of free trade agreement partners, and that it set a deadline of the end of 2022 for an answer.

We recommend that the Council and the Parliament accelerate the Fit for 55 files that create demand certainty in Europe, starting with the CO2 standards for cars and the Emissions Trading System revision agreed in general approach on 29 June[4], so that European manufacturers can plan against a date as well as a subsidy.

We recommend that the Commission propose a simplified state aid regime for production of batteries, electrolysers and solar modules, with a single notification and a decision within three months, so that Member States can respond at the speed of the American credits.

We recommend that the Union negotiate with the United States a common definition of "foreign entity of concern" for battery supply chains, because a shared rule on Chinese content serves both sides better than a race that excludes each other's producers.