The Inflation Reduction Act (IRA) makes major strides in fulfilling key Democratic campaign promises in the tax, healthcare, and energy issue areas.
The new federal provisions in the IRA will have a limited direct impact on state policy but opens the door for state policymakers to adopt similar legislation.
For questions about the Inflation Reduction Act’s state tax implications, contact Morgan Scarboro (firstname.lastname@example.org).
After several iterations, Congress passed the Inflation Reduction Act (IRA) on August 12, 2022, and President Biden signed the bill on August 16th, 2022. The bill makes big strides toward fulfilling key Democratic campaign promises, including reductions in carbon emissions, the ability to negotiate some drug prices, and extension of the Affordable Care Act. It also raises approximately $739 billion in new federal revenue through targeted tax increases and increases funding for the Internal Revenue Service (IRS). But which, if any, of these policies will have direct impacts on state policy and policymakers? Below we highlight a few major provisions and break down their impact on states.
Corporate Alternative Minimum Tax
What It Does: A key revenue-raising provision in the IRA is the new Corporate Alternative Minimum Tax. Proponents frame it as a way to close tax “loopholes,” and opponents criticize its disparate treatment of different industries and negative impact on investment. Generally, the tax would require companies with at least $1 billion in income to calculate their tax liability in two ways: (1) the traditional accounting method currently in use at the corporate income tax rate of 21 percent, and (2) using book income (technically known as adjusted financial statement income, or AFSI), which is essentially the earnings reported to shareholders, at a rate of 15 percent. Under this system, corporations would pay the higher of the two. There are several adjustments to the calculation of the minimum tax.
State Impact: States are no strangers to Alternative Minimum Taxes (AMT). Prior to the Tax Cuts and Jobs Act (TCJA) in 2017, eight states imposed a corporate AMT: Alaska, California, Florida, Iowa, Kentucky, Maine, Minnesota, and New Hampshire. However, many of these states simply used (or conformed to) the federal government’s AMT (for example, the Alaska AMT was levied at 18 percent of federal AMT liability). So when the federal government repealed the AMT under the Tax Cuts and Jobs Act in 2017, several state AMTs became defunct. However, going forward, because of the way state tax codes are tied to the federal Internal Revenue Code (IRC), some states, including Alaska and Florida, could levy a version of the new minimum tax unless they take proactive action to decouple from the provision. Furthermore, other states may choose to impose their own minimum tax, despite not previously imposing one, if they are looking for new ways to raise revenue.
Reduction of Carbon Emissions
What It Does: The IRA provides for the largest investment in the history of the United States to fight the climate crisis. According to the Committee for a Responsible Federal Budget, the package spends over $386 billion in climate investments, detailed in the table below. The bill is estimated to reduce greenhouse gas emissions by 2030 to 40 percent below 2005 levels, which would help the United States achieve emissions targets set under the Paris Climate Accords.
Clean Electricity Tax Credits
Air Pollution, Hazardous Materials, Transportation, and Infrastructure
Individual Clean Energy Incentives
Clean Fuel and Vehicle Tax Credits
Conservation, Rural Development, and Forestry
Building Efficiency and Electrification
Other Energy and Climate Spending
State Impact: Nearly half of the states and the District of Columbia have greenhouse gas emissions targets. If the clean energy and greenhouse gas reduction incentives contained in the bill prove effective, the IRA will go a long way toward helping those states meet their targets. While the clean energy tax credits and incentives directly benefit qualifying energy producers, most of the IRA’s effects on states’ efforts to reduce carbon emissions won’t be known for some time. The number of eligible electric vehicles manufactured and purchased by consumers, the emissions reduction projects to be built, and the amount of clean energy produced due to the IRA’s incentives will be closely watched by states, however, to see if they may be improved upon or expanded at the state-level.
Additionally, some of the energy tax credits may have an indirect impact on states. States generally do not offer identical tax credits and incentives as the federal government. However, states often enact credits and incentives inspired by federal credits, like certain energy credits, research and development (R&D) credits, and others. It remains to be seen how many states will be inspired to enact their own versions of incentives in the IRA. Alternatively, some legislators may push to reduce state level incentives because of a perception that certain taxpayers are receiving preferential treatment from the federal government.
Medicare Drug Price Negotiation and Caps on Out of Pocket Costs
What It Does: The IRA will, for the first time, require the Secretary of the Department of Health and Human Services to negotiate prices for top selling drugs under Medicare. The legislation also caps out-of-pocket drug spending for Medicare Part D beneficiaries to $2,000 annually, mandates certain vaccinations be provided for free through the elimination of cost-sharing, caps insulin out-of-pocket spending, and requires prescription drug companies to pay rebates if their medication prices rise faster than inflation for drugs used in the Medicare program.
State Impact: The IRA drug pricing provisions are specific to Medicare and exclude state-run Medicaid plans and all private insurance. In 2023 legislative sessions, expect states to consider drug pricing reforms beyond cost transparency in order to extend savings to Medicaid programs and individuals with private insurance. We anticipate lawmakers will introduce legislation across the country capping cost-sharing on frequently used medications, like insulin, and caps on specialty or other high-cost medications. States may also look toward Prescription Drug Affordability Boards, nongovernmental agencies that are tasked with looking for ways to reduce state spending for high-spend medications.