Recycling the Muni Exemption Debate.

• Author: Marlowe, Justin
• Position: PERSPECTIVE

With a bit of late summer, pre-midterm election legislative maneuvering,

Congress passed the Inflation Reduction Act of 2022 [IRA], Critics and defenders of the law both seem to agree that its name doesn't describe its main objective. In fact, the IRA is really a climate bill. It calls for $737 billion in new spending over the next decade, most of it for climate-focused investments like energy security, climate adaptation, and drought resiliency.

As is often the case with major pieces of federal legislation, IRA's unintended consequences could far outweigh its intentions. That's especially true for state and local finance. If IRA works as intended, we'll see a lot more wind farms, solar panels, recycling facilities, and electric vehicles. But this legislation might also inadvertently reopen a longstanding and acrimonious debate about the federal government's role in the municipal bond market.

IRA doubles down on many of the Biden Administration's core principles around climate adaptation. One of those principles is "carrots before sticks." President Biden and many Congressional leaders have said they'd much prefer to encourage businesses and individuals to invest in clean energy than to discourage fossil fuel use through a carbon tax or other "sticks." The challenge with this approach is that the federal government's main tool--in many ways its only tool--to that end is tax subsidies that encourage investment by reducing an individual's or business's federal tax liability. We know from decades of research that tax preferences of that sort are a decidedly imperfect way to encourage investment. But despite those imperfections, IRA includes more than $200 billion for energy-related tax subsidies over the next decade.

Tucked into IRA's arcane details are two subtle but enormous shifts that chart a new course for these types of energy tax subsidies. One is that IRA allows a business that's received many of these credits to sell or transfer those credits to "unrelated parties." This is similar to affordable housing tax credits, where developers that seek to build or rehabilitate affordable housing receive the credits and sell them to investors. That upfront capital from investors is often what makes a project profitable. Before IRA, most energy-related tax credits were not transferable. Now they are.

But IRA doesn't stop there on transferability. It goes a monumental extra step by defining "unrelated parties" for some credits to include...