This blog was first published by the European Stability Mechanism (ESM)
A recent report on the future of the European Union (EU) single market highlights some of the advantages of tax credits as an industrial policy tool. Industrial policy has emerged to the forefront of efforts to tackle climate change and strengthen European industry in the face of increased geopolitical uncertainty. This is inherently important for Europe’s resilience. A comparison of recent subsidy schemes in the EU and the United States (US) demonstrates the potential of using tax credits for promoting supply chain resilience, but it also shows that loans and grants can have important advantages when it comes to income distribution and economic stabilisation.
During the Covid-19 pandemic, the Next Generation EU (NGEU) programme was the EU’s initial response to the economic challenges of the pandemic. Later, the two NGEU support facilities responsible for funding investments – the Recovery and Resilience Facility and REPowerEU – became the principal funding sources for the EU instrument set up to aid in the transition to climate neutrality, the Green Deal Industrial Plan.
Similarly, the US Inflation Reduction Act (IRA) provides funds to aid in the decarbonisation of the economy. While both programmes pursue similar goals and have similar financial volumes, they differ in their choice of instruments. Whereas EU support is based on direct government investments in the form of loans and grants, the US approach explicitly focuses on indirect support through tax credits.
Both in Europe and the US, institutional and political constraints rather than cost-benefit analyses have long determined the choice of support instruments. In the EU, the absence of significant EU-wide competencies for tax policy meant that direct support in the form of loans and grants became the instrument of choice. In the US, however, narrow majorities in the US Congress implied that the IRA could only be passed as a budget reconciliation bill, forcing legislators to use revenue measures and leaving tax credits as the preferred support instrument.
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