The Inflation Reduction Act: What to expect

Here's what's in the new law and what it might mean for investors.

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Key takeaways

  • The Inflation Reduction Act aims to combat rising health care costs and climate change.
  • Topline estimates include $737 billion in total revenue raised, $437 billion in total investments, and over $300 billion in total deficit reduction.
  • There are investing implications across sectors, including health care, energy, technology, and more.

The Inflation Reduction Act, which President Biden has signed into law, attempts to combat climate change and rising consumer health care costs, while potentially reducing the deficit. The far-ranging law will also have implications for investors.

Here are the key aspects of the new law and how they might impact companies, consumers, and investors.


Climate

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The new law provides for $369 billion in "energy security and climate change" investments, with the aim of reducing carbon emissions roughly 40% by 2030. Details include clean energy tax credits such as $9 billion in home energy rebate programs and a tax credit up to $7,500 for the purchase of zero-emission vehicles, applying only to vehicles that cost below $80,000. The bill also provides tax credits for fossil fuel companies, as well as permitting reform legislation to be passed before the end of the fiscal year for legacy domestic energy and transmission projects. The intended aim is for these investments to broadly lower costs by building out existing energy and new renewable systems.

There are investing implications in terms of tax credits for both fossil fuel companies as well as the producers of nuclear energy, hydrogen energy from clean sources, biofuels, and carbon capture technology. Producers of residential rooftop solar systems, heat pumps, and small wind energy systems also have incentives in the new law. Additionally, there are incentives for sourcing domestically manufactured steel, iron, and other product components.

Asher Anolic, manager of the Fidelity® Environment and Alternative Energy Fund (FSLEX) thinks this legislation is the first major cohesive US legislative move to invest in solutions to counteract the impacts of climate change.

"The climate section of the bill focuses on making lower and zero carbon sources of energy as well as their use cases more abundant and accessible, and this could result in accelerated uptake of technologies such as electric vehicles and home devices," Anolic states. "I believe that companies that design and produce products or services to fight global warming will see increased demand for their businesses, likely at a greater pace than that of US GDP, from both the public and private sectors."

Health care

The Congressional Budget Office estimates that $288 billion will be saved by allowing Medicare to negotiate for some prescription drug prices and by investing $64 billion to extend the expanded Affordable Care Act program through 2025. The new law caps seniors' out-of-pocket spending for prescription drugs at $2,000 per year beginning in 2025.

The investing implications for drug pricing caps appear to be limited to the makers of 10 high-cost drugs beginning in 2026, ramping up to 20 drugs by 2029. If the drug makers do not negotiate with Medicare, a tax of up to 95% of the sales of the drug can be enforced. Only older drugs are subject to negotiation after a period of 9 years and more complex biologic drugs are subject to negotiation after 13 years.

While the health care legislation may have implications for some consumers over time, it may not create structural changes for investors in this sector. "I think the new law emphasizes the need to invest in innovative companies in the health care sector," says Eddie Yoon, manager of the Fidelity® Select Health Care Portfolio (FSPHX), "that are trying to take costs out of the system without sacrificing access or quality of care."

Taxes

The new law imposes a new alternative minimum 15% corporate tax rate for companies effective for tax years beginning after December 31, 2022. The new tax applies to the adjusted financial statements of income of US corporations with 3-year average adjusted book income over $1 billion and foreign corporations with average US income over $100 million. It also imposes a 1% tax on stock buybacks net of new issuances of stock, effective for repurchases after December 31, 2022. Exempt from the tax are stocks contributed to retirement accounts, pensions, and employee-stock ownership plans (ESOPs). The Congressional Budget Office estimates this will generate $313 billion in tax revenue.

According to the Joint Committee on Taxation, about 150 of the largest US corporations would be subject to the new corporate minimum tax. All companies would be subject to the 1% tax on stock buybacks, beginning on January 1, 2023. As a result, there may be an increase in buyback activity before then to get out ahead of the law. After the proposed law potentially goes into effect, there could be some shift in behavior to distributing capital via dividends compared with buybacks to some extent.

Jurrien Timmer, director of global macro at Fidelity, thinks the new tax on share buybacks may not have much of an investing impact from a shareholder perspective. “We’ll see if the new 1% tax on share buybacks affects corporate behavior. You may see companies returning earnings more as dividends, however, I don’t see the new tax moving the needle that much in terms of valuations," he says.

The bottom line

Jim Febeo, senior vice president at Fidelity Investments, notes that the way the bill was enacted may have ramifications for future bills. "Doing this bill through reconciliation on a party-line vote could impact the appetite for bipartisanship during the remainder of this Congressional session," Febeo notes.

With that said, there will be a range of investing implications. Of course, just as with other policies, passage of the Inflation Reduction Act should not fundamentally alter your investing plan. If you have a plan, stick to it and make any alterations that make sense for your specific objectives.

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