The authoritative source for independent research on UK-EU relations

07 Mar 2023

Peter Jurkovic unpacks the US Inflation Reduction Act, explaining what it sets out to do, how it will affect the EU and the UK, and how the EU and the UK have responded so far.  

The Inflation Reduction Act (IRA) was signed into law by President Biden in August 2022. The Act aims to spur investment in green technology in the United States by devoting $369bn in subsidies through grants, loans and tax credits to public and private entities.

During Donald Trump’s presidency, both the EU and the UK government were critical of the US for failing to cooperate in global efforts to meet environmental targets. So why has the EU been so critical of an Act that is expected to reduce US net greenhouse gas emissions down to 40% below 2005 levels?

The main objection comes from the fact that the tax credits given out by the IRA to green industries are conditional on production and final assembly being based in the US.

For the US, the advantages of this approach are clear.

“There is a widespread sense among EU and UK politicians and business leaders that the IRA will negatively impact them.”

Firstly, the increase in battery, solar panel, and wind turbine production in America should help create new factories and millions of new green jobs in the country.

Secondly, this should help the US to drag itself away from energy dependence on China, which owns many critical raw materials necessary for the production of new green technology. The legislation will force producers to rework their supply chains away from China due to requirements for a high percentage of components of these green technologies, in particular lithium-ion batteries, to be made in the US or by a country with which the US has signed a free-trade agreement.

Yet there is a widespread sense among EU and UK politicians and business leaders that the IRA will negatively impact them.

How will it affect the EU?

There is significant disagreement over the implications of the IRA for the EU.

Some have described the IRA as an existential threat, as they worry that the incentives offered by the IRA will cause a mass-scale relocation of European businesses in clean hydrogen, carbon capture, and solar industries to the US. EU executives are said to be most concerned about the automotive sector, as only electric vehicles (EVs) with a high proportion of their components sourced and assembled in North America will receive the full subsidy scheme of $7,500 per vehicle for consumers. In September, Tesla decided to pause plans to make battery cells in Germany in order to qualify for US subsidies. Similarly, Northvolt, the Swedish lithium-ion battery producer, now appears unlikely to carry out it plans to build a new factory in Germany in favour of increasing its production in the US.

Electric vehicle battery

For others, the EU is well-equipped to deal with the new policy direction of the US and the main danger lies in a disproportionate response. They argue that green technology is not a zero-sum game; therefore, increased production and investment in EVs and other green industries in the US should not imply less production in Europe. As Martin Sandbu has stressed, there is no fixed supply of green capital since demand and commercial return for green technologies are expected to continue to increase as more countries start to seriously pursue net-zero strategies. So, the challenge is not to prevent European firms from deciding to build wind farms or battery factories in the US but to ensure that at least some firms are willing to start or continue production in the EU.

Indeed, it has even been suggested the IRA may help European electric vehicle firms to gain a competitive advantage over their American counterparts. It is thought that the obligation for companies to dramatically rework their supply chains away from China in order to qualify for tax credits may instead draw some firms to the EU, as this would allow a slower and less dramatic decoupling from China. Furthermore, it is often ignored that the EU also offers significant support to electric vehicle companies through consumer subsidies.

How has the EU responded so far?

The EU response to the IRA has so far taken three forms.

Firstly, the EU has tried to negotiate with the US in an effort to make modifications to the IRA. The economic ministers of France and Germany have held talks in Washington in an attempt to convince the US government to extend subsidies to EU companies working in various green industries. The EU has managed to ensure that imported electric vehicles used for commercial use (i.e. leasing or ride-sharing) will qualify for IRA tax credits, but EVs sold for private use are still excluded. There also seems to be an unwillingness in the US to accommodate EU companies any further than this.

“The UK has already fallen behind the EU and the US with regard to investment in green industries.”

Secondly, some temporary measures have been put in place while more substantial policies are debated. This has included a draft proposal sent by the European Commission to member states, which suggests a further extension to the temporary relaxation of state-aid restrictions (rules designed to prevent member states from subsidising particular businesses or industries), which were first agreed as a means of helping states to support their domestic industries worst hit by the Covid-19 pandemic and later extended to counter the economic impacts of Russia’s war against Ukraine.

Third are the plans for a more substantial and permanent response through a Green Industrial Plan set out by Ursula Von der Leyen, the President of the European Commission. The plan aims to strengthen the EU’s green industrial base and support the transition to net-zero by pursuing four key targets: a predictable and simplified regulatory environment; quicker access to finance; upskilling; and open trade for resilient supply chains. The European Parliament recently agreed to adopt a resolution which establishes a broad commitment to the plan; however, the specific measures will now be debated and voted on.

Inflation Reduction Act

Do EU member states support the Green Industrial Plan?

There seems to be substantial disagreement among EU leaders over two contentious and intertwined EU policy areas. The form that the EU Green Industrial Plan eventually takes will likely depend on how these are settled between the member states.

The first of these is EU rules over state-aid to support key green industries as well as to attract necessary investment. France has called for the EU to respond to the IRA with a ‘Made in Europe’ policy, which would lead to similar subsidies as those in the IRA handed out to domestically-sourced industries. In addition, there are also plans to prevent EU businesses from relocating by allowing member-states to match state-aid offered by bidders from non-EU countries to their own industries (page 9 of the plan).

“Fiscally conservative states such as Germany and the Netherlands are strongly opposed to any additional common EU borrowing.”

However, less economically powerful member states fear that a relaxation of state aid rules would give an unfair advantage to countries like France, Germany and the Netherlands which have the fiscal and technological means to subsidise their industries. These concerns appear justified in light of the extremely imbalanced distribution of subsidies across the EU member states under the Temporary Crisis Framework following Russia’s invasion of Ukraine. Of the €672bn subsidies approved, 77% has been handed out to France and Germany. There are concerns that these proposals could ‘fragment’ the single market by putting member states in competition with one another rather than promoting a coordinated European industrial strategy.

Nevertheless, member states with limited fiscal resources would likely accept relaxations to state-aid rules if they are granted their wishes in a second-policy area: a pooled fund which would allow them to meet their investment needs. This demand is reflected in the ‘Sovereignty Fund’ of Von der Leyen’s Green Industrial Plan which consists of common EU funding to support member states with less fiscal capacity.

Yet, the issue here is that fiscally conservative states such as Germany and the Netherlands are strongly opposed to any additional common EU borrowing. They point to the initial €750bn the Commission has already borrowed for NextGenerationEU and call for the repurposing of unused loans within the Recovery and Resilience Facility to be used to maintain the Single Market’s Level Playing Field.

This is unlikely to satisfy those member states’ concerns about French and German subsidies distorting the single market. Therefore, both state-aid rule relaxations and common borrowing will struggle to find broad approval, which would prevent the Green Industrial Plan from including investment on a similar scale to the IRA.

How will it affect the UK?

The UK has already fallen behind the EU and the US with regard to investment in green industries. The government’s hesitance towards investing in and supporting green technologies was widely criticised after it failed to provide adequate subsidies to avoid the collapse of the start-up Britishvolt, which had planned to build a giant factory to make electric car batteries in Northumberland.

And with the UK now seeming to be caught in the middle of the two blocs’ arms race on industrial policy, there is fear that its green industries will lag further behind.

Electric car manufacturers in the UK have been particularly vocal about how the IRA will make them less competitive. The chief executive of the lobby group, the Society of Motor Manufacturers and Traders has expressed concerns that global investment will likely be drawn to the US due to the tax credits on offer. This point seems to be confirmed by the fact Jaguar Land Rover has not yet committed to carrying out its planned production scale-up in the UK. While, Arrival, a start-up in electric vans has abandoned plans to start production in the UK in favour of a factory in the US.

The IRA may also threaten Britain’s hydrogen industry. The UK has some natural advantages for a flourishing hydrogen industry, however, the London-based green hydrogen fund Hydrogen One Capital has confirmed plans to shift its focus to the US; and many other of the UK’s £1.1bn worth of hydrogen projects may decide to relocate if the government does not match US support.

Inflation Reduction Act Biden

How will the UK respond?

So far, the UK’s response has been limited to negotiations with the US. The UK’s international trade secretary, Kemi Badenoch, has held meetings in Washington and has written to US trade representatives to try and create a loophole which allows UK electric vehicles to benefit from IRA’s subsidies.

The tax credit requires two elements: the final assembly to be in North America, and the critical minerals to be from the US or a country with which it has a free trade agreement. Although there will be no loophole for the UK to be included in the final assembly, there is hope that the vague definition of ‘free-trade agreement’ in the Act could be interpreted to include the UK, which would allow British battery firms to qualify for tax credits.

However, up until this point, the US has given UK businesses little leeway.

Some have proposed that the UK respond with its own Inflation Reduction Act. A benefit of Britain’s exit from the European Union is that the UK is not bound by the EU’s rules over state aid and subsidies to promote green industries.

However, if the EU is able to agree on a Green Industrial Plan, it will be able to draw on much greater resources than the UK to attract investment in these green industries. And in any case, the British government appears to lack the fiscal willingness to engage in expansive industrial policy on the same level as the US. In response to the IRA, Chancellor Jeremy Hunt has said the UK will focus on a regulatory structure which encourages creativity and innovation rather than subsidies.

By Peter Jurkovic, researcher, UK in a Changing Europe.


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