In the first of a two-part series, one of the architects of US President Joe Biden’s signature climate legislation reflects on its success and failures a year on, and the lessons for Australia as it crafts its response. By Saul Griffith.
Lessons from the US energy transition
Canada and Europe are literally on fire, heat records are being set globally, the ocean around Florida is warmer than body temperature. Flooding is everywhere. It is now or never on climate and getting the policy right is critical. There are many ways to stimulate the clean energy transition – more and less effective ways to build on private capital, and more and less equal ways that determine who in the socioeconomic order benefits most.
Australia is about to embark on a response to the Biden administration’s signature climate legislation, the oddly named Inflation Reduction Act. In two parts in The Saturday Paper I will first unpack the underlying theory of change in the IRA and what it did and didn’t do well. The second instalment will discuss what Australia can do better or worse in response.
To start let’s consider the climate context. Activists such as Greta Thunberg use the word “emergency”. Behind that word is the fact the “free market” cannot move fast enough to hit either a 1.5 or a 2 degree target for warming. If we continue to slowly shift to electric vehicles, renewable electricity, and electrified homes at current rates we will likely wind up at 2.8 or more degrees of warming. In wartimes, governments can execute emergency powers that enable them to operate outside free market rules. The canonical example is the “Arsenal of Democracy”, the public–private partnership developed in the United States during World War II to produce the war matériel required to triumph. Fossil fuel companies and neoliberal ideologues recoil at the idea of such a step and would like to keep everything on the slow roll. I’m in the emergency camp, as are the vast majority of the world’s scientists.
Was America’s IRA an emergency-style response? Not quite, though it was used to finance some clean energy manufacturing under the Defense Production Act – the very instrument used to finance the Arsenal of Democracy. This component was only US$500 million of the US$369 billion act and was a late addition to the legislation justified as a response to the Russian invasion of Ukraine. These were incentives for American industry to produce the goods required to help Europe transition off Russian oil and gas faster. The IRA was also not Biden’s only legislation to address climate change. The Infrastructure Investment and Jobs Act will deploy another US$110 billion, albeit not all for climate. This act is more akin to the Labor government’s “Rewiring the Nation” investments in energy transmission infrastructure.
Based on the early enthusiasm for electrification reflected in the most recent budget, we have reason to be confident this government grasps the urgency of the challenge and scale of response required. Similarly, Senator Andrew Bragg’s recent moves to establish an inquiry into household electrification augurs well for a more enlightened response from the conservative side of politics.
It looks like Australia’s policy response to the US president’s climate agenda will be in two phases. The first is a narrow trade-based response that will explore subsidies to manufacturing and will likely be announced this year. The second is a not-yet-defined climate and economic response that will be largely shaped by the Australian government’s climate planning process looking at each sector – industry, transport, electricity, et cetera.
The US’s Inflation Reduction Act was conceived very differently. The domestic economic response – stimulus for households and businesses to electrify their appliances and vehicles, and further stimulus to make zero-carbon electricity to power it all – were the guiding pillars of the IRA. Smaller dedications to advanced manufacturing of batteries, heat pumps, electric vehicles and solar and wind technologies were a late addition. The process was more holistic, looking at all sectors of the economy together. This is necessary because of “sector coupling”. Whereas once different fossil fuels were associated with different sectors and considered somewhat separately – oil was the transport sector, coal was the electricity sector, and gas was home and industrial heat – electrification is the principal tool in decarbonisation, and so all sectors must be considered at the same time. Finally one metric being gauged by Senator Chuck Schumer’s office was decarbonisation per dollar spent – keeping an eye on the ultimate goal.
Industry and advocacy groups are lining up for specific subsidies that benefit specific industries, whether it be hydrogen, lithium processing or battery manufacturing. Some media coverage has reinforced this narrow policy agenda and misrepresented the IRA as “a giant sucking sound of international capital”. We need a more considered and less corruptible approach.
I helped to write the IRA, having co-founded a group called Rewiring America (RA) with another energy entrepreneur, Alex Laskey. RA started life as an advocacy group for bold climate action but rolled up its sleeves when Biden came to power to find ways to meet the 50 per cent by 2030 emissions-reduction targets that Biden’s climate team promised on day one. It was all hands on deck for climate policy groups that could do the rigorous modelling, including Jesse Jenkins’ group at Princeton, Rhodium Group, Innovation Endeavours and RA leading the charge.
With much credit to my colleague Dr Leah Stokes, RA hosted the Federal Electrification Policy Coalition (FEPC), which assembled various think tanks, policy organisations, unions, consumer groups, congressional staffers and activists for a weekly call of what should and should not be in an American climate bill.
The FEPC never talked about industry policy or trade policy. There were two focal points: demand-side electrification (zero-emission vehicles, homes, businesses), and supply-side clean energy (zero-emission electricity). The question was how to achieve energy market transformation, such that the easiest, cheapest and fastest purchasing decision would be to buy the clean, zero-emissions thing. That logic prevailed on the supply and the demand sides. Clean up all the machines, supply them with clean electricity.
The gas industry tried to derail this project, by arguing for similar incentives for gas generators and even gas water heaters. The electrifying climate nerds for the large part prevailed over the gas industry’s weak and self-interested arguments.
The FEPC kept busy with the shifting sands of the political landscape in the US over the 18 months that the bill took shape. A total rethink and rewrite was required multiple times as various political options were ruled out. Anything associated with the Green New Deal legislation proposed by New York Democratic representative Alexandria Ocasio-Cortez in 2019 was largely ignored because those policy proposals had so many social reforms built in that it was politically untenable. The name changed to Biden’s “Build Back Better” and in the dying days of negotiation it became the “Inflation Reduction Act”. Some are now rebranding it as “Bidenomics”.
The revisionist history around the IRA is that it is an industrial policy designed to counter China and restore American manufacturing through reshoring and friendshoring. That narrative has become a useful political talking point, and it was useful in getting a few US senators over the line in the final hours, but it employs a very liberal interpretation of reality. I didn’t hear China or protectionism talked about in the years-long effort. The mantras were “market transformation” and “leverage private capital”.
About 15 per cent of the IRA’s direct incentives were indeed for manufacturing clean things – solar cells, batteries, electric vehicles, wind turbines, electric appliances. But the real spending is in incentivising the buying of these.
At the end of the day, the IRA is a huge tax policy hack and probably should have been called the “Electrify (almost) Everything Tax Act”. It comprises tax incentives for producing the clean electricity, and generous ones for purchasing clean electric machines, including cars, heat pumps, solar panels and induction stoves. These two investments, roughly equal on the supply and the demand side, make up about 80 per cent of the energy-focused investments of the IRA. As for the rest: about 2 per cent went to tax credits for carbon sequestration, 2 per cent to biofuels and “electrofuels”, and about 3 per cent to a production tax credit for hydrogen. About 10 per cent went to direct incentives to manufacture machines that produce or use clean electricity: electric cars, heat pumps, batteries, solar cells.
But the IRA wasn’t all tax incentives; it included US$8.8 billion of directly applied rebates, mostly focused on low- and middle-income household electrification.
Because the IRA is a spending bill without a budget cap, estimates of its total spending can only be approximate. The numbers I quote here are from the official Congressional Budget Office (CBO) data at the time of “scoring” the bill before it was passed.
In retrospect, this all-carrots approach was all that was possible. The spending bill approach had its advantages, however. Everyone drafting pieces of it understood these investments were probably a floor of the ultimate spending in the bill, not a ceiling. Rewiring America estimates that the household-facing incentives alone, scored by CBO at about US$100 billion, could wind up deploying close to US$858 billion. Spending in all categories is ahead of schedule, and Goldman Sachs has recently upped its estimate of the outlay closer to US$1.2 trillion. By any measure, this is a lot of money, and will go a long way to meeting the original goals of those working on the bill – permanent market transformation of the world’s biggest energy economy.
Dr Jesse Jenkins, of Princeton, has estimated the bill will achieve 43-48 per cent emissions reductions. I’m less optimistic, but I’m hoping he is right, or even underestimating. The final delivery of emissions reductions won’t be determined by the policy writing phase as much as by the implementation, or deployment of the capital through various instruments. One of the biggest deployments will be through the Loan Programs Office (LPO), of the Department of Energy, and through the Greenhouse Gas Reduction Fund, which serve similar roles in the energy ecosystem to the Clean Energy Finance Corporation (CEFC) in Australia, though with higher risk tolerance.
Along with market transformation, people drafting the IRA concerned themselves with how to make the federal money do the most work. In his essay in The Monthly this year, Treasurer Jim Chalmers outlined his vision of government investment and programs cleverly designed to crowd in private investment to help deliver social goods, including the clean energy transition. There is reason to believe that Australia can get this right.
An easy example of leveraging private capital is an electric vehicle tax credit of $7500 that draws in $50,000 in private money to buy a $57,500 electric vehicle – a seven-times multiplier of the government incentive capital. The more nuanced type of leverage is how loans, loan guarantees, even loan-bundling can generate even higher ratios of private capital. This is money that will be spent because of the IRA, which is not in the IRA budget.
There are many in Australia, including in the press, who conflate these investments. Much of the investment related to the IRA is money spent by private industry because the policy has transformed the market. The LPO isn’t designed to make or lose money, but through its various mechanisms, including taking risks – with financing successes such as Tesla and famous failures like Solyndra – it helps inject investor and corporate confidence into nascent industries. The LPO gets to set the dials on its risk-taking, and currently loses about 3.1 per cent over the investments in its portfolio. This is by design and means success. It means that the DOE gets the private sector to spend roughly US$30 billion for every US$1 billion it spends. By these measures the IRA is likely to deploy private and public money amounting to well in excess of US$2 trillion. If we include the induced spending of households and small businesses using the incentives to buy electric vehicles and appliances, it will be tens of trillions, in an enormous public–private partnership.
If you stimulate the demand and supply sides of the energy economy, you create a much larger base for the manufacture of the machines that service those two sides of the energy economy. By design, the IRA was about spending a small amount of money that would get households and businesses to spend a truly staggering amount of money. As was the case with the original incentives for rooftop solar in Australia, which have now made solar the cheapest electricity in Australia – the market is transformed. The US IRA aims to do the same for vehicles, batteries, utility scale renewables, and cooking and heating appliances.
Let’s consider what the IRA didn’t do. The IRA had very little for small businesses and the commercial sector, so they are under-represented in the spending.
Because the IRA has a huge number of tax incentives, it is regressive. Almost by definition, half of the population pays tax and the other half receives net tax benefits, so not everyone pays enough tax to qualify for IRA help. Australia would do well to avoid this problem with a more progressive set of policies that help everyone to join this cleaner and lower-energy-cost future. Encouragingly, the government has directed the CEFC to target low-income households in the billion dollars allocated in this year’s budget for household upgrades.
The IRA also provides no sticks. There are no sunsetting periods for internal combustion engines or moratoriums on gas connections. These things are left up to the states.
In summary, the IRA was notionally budget-neutral, balancing the spending on climate and energy with increased tax revenue from a beefed-up Internal Revenue Service. The notional (spending side) budget effect of the IRA was originally estimated at US$369 billion – that figure may very well become US$1 trillion because it is an uncapped spending bill with a 10-year time line. However, that US$1 trillion will very likely be leveraged five or 10 times by households and businesses, to deliver as much as US$10 trillion. This in turn delivers market certainty, giving manufacturers and investors the confidence to invest trillions more in manufacturing facilities – and approximately US$100 billion in the first year of the IRA alone.
Australia should take three lessons from the IRA. First, invest roughly equally in the supply and the demand sides of the energy economy, because both must be transformed at the same time and at the same rate. Second, induce huge amounts of spending and finance from the private sector and households to make the money go further. And third, user demand for clean electric machines induces demand for supply-side clean energy generation, which in turn induces investment in manufacturing the necessary machines – creating far greater market certainty about how the future will look.
And then there is the political benefit. One driving principle behind the household-facing sections of the IRA was that they must be good retail politics. Policy that gets embedded in the tax code as a middle-class incentive will be resistant to political changes in the future. Or, as the Republican president Dwight Eisenhower conceded in a letter to a friend about his predecessor Roosevelt’s New Deal, “Should any political party attempt to abolish social security and unemployment insurance and eliminate labor laws and farm programs you would not hear of that party again in our political history.”
We modelled out potential energy savings for American households at around US$1000–$1500 a year after total electrification. The prospects are even better in Australia – yet another reason we should go harder and faster – because it will save households $3000 to $5000 a year, a figure broadly accepted by the likes of CSIRO and the Grattan Institute. Retail electrification is good politically if you sell the advantages to the electorate.
People wrongly believe the IRA is a huge government dollar giveaway that only the US can afford because it runs such huge deficits and manages the global default currency.
The US Congressional Budget Office does the work of estimating the net cost of policy writing. As is the case in Australia, the tendency is to want to make programs “revenue neutral”. That is how the IRA was specifically designed, with additional financing of the US tax office to improve tax compliance sufficient to pay for the tax concessions.
Australia wouldn’t even need to look that far or hard.
Australian governments hand out $10 billion in tax subsidies to fossil fuels, the largest of them about $7.5 billion in fuel tax credits. With a 10-year forward-looking budget, similar to the US IRA, that annual amount would look like $75 billion more for Australia than our pro-rate of the IRA CBO estimate – sufficient to fully fund an even more ambitious climate policy than the one in the US.
In a country with sunshine and wind as prolific and cheap as ours, where the return on investment in electric vehicles is very short, it is absurd that we are subsidising foreign oil for large corporations. As economic rationalists like to say, “The money has to come from somewhere.” Well, here it is. Let’s take it back for the people and make sure our IRA response works not for a select few manufacturers but for all Australians.
Next week: How to shape Australia’s response.
This article was first published in the print edition of The Saturday Paper on September 9, 2023 as "Lessons from the US energy transition".
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