The US is quickly assuming the role of global climate leader over the European Union with the passage of the Inflation Reduction Act, which is projected to spur unrivaled investment to the tune of $3 trillion over the next decade while creating a domestic supply chain to ensure the energy transition is not disrupted by turmoil abroad, analysts said.

This unprecedented investment from the Inflation Reduction Act (IRA) will eventually force the EU to consider broadening its policies to match the US under the European Commission's approach to climate regulation, analysts at consulting firm Ernst & Young said Jan. 23. The EU's carbon border adjustment mechanism, which is essentially a tax, went into effect in October 2023.

However, experts said harmonizing the two systems could be a heavy lift as the EU views the IRA as more of a trade threat than a carbon blessing.

Ernst & Young held a Jan. 23 roundtable on the changing clean energy landscape between the US and EU, underscoring the most recent estimates by Goldman Sachs that the IRA would spur more than $3 trillion in investment over 10 years. EY analysts said the "carrot" approach the US has taken, as opposed to the EU's more punitive "stick," has pushed the US into the global limelight as the new climate leader, which the EU will not be able to ignore.

Akshay Honnatti, EY's senior manager on sustainability tax policy, said the US has "leapfrogged" several steps ahead of where the EU and other nations are under the IRA.

The law also places the US in the unique position as the leader in tightening clean energy supply chains by leveraging the IRA's broad approach that focuses both on innovation and scaling up manufacturing, Honnatti said.

Ali Vahdat, EY's tax policy leader for the Americas, said investment firms such as Credit Suisse are bullish about the level of investment coming from the IRA because it does not single out one particular technology or mode of innovation. By comparison, the EU's policies are much more narrowly focused on solar and wind.

Based on the IRA's broad approach, Credit Suisse's IRA spending projections are more than double what is estimated by the Congressional Budget Office, Vahdat said. The investment bank projects between $600 billion and $800 billion will be spent, while the budget office estimates $390 billion. And Goldman Sachs pushes that spending projection up to over $1 trillion, with related private sector investment swelling to over $3 trillion, Vahdat added.

Coordination needed between US, EU

EY global trade and tax sustainability specialist Ilona van den Eijnde said this spending dynamic will eventually force the EU and the US to the table to harmonize their climate and carbon abatement standards.

For now, however, the EU appears to regard the IRA as somewhat of a trade threat in much the same way the US Commerce Department views other countries' government subsidies spurring cheaper imports that push US companies out of the market, Eijnde said in an interview.

The EU has begun talks to protect its companies from the potential dumping of cheaper clean energy products coming from the US.

In spring 2023, the US State Department convened the fourth ministerial meeting of the US-EU Trade and Technology Council in Sweden, launching the Clean Energy Incentives Dialogue to begin sharing information about climate incentives programs.

"It will also allow the United States and the European Union to discuss systemic issues related to the design and effects of incentive programs and also develop a common understanding of market dynamics," the State Department said. "We plan to also undertake joint analyses of non-market policies and practices of third parties to better understand their impact on US and EU."

Eijnde said this is a beginning step but more intense conversations will have to occur on how the EU's carbon border adjustment mechanism (CBAM) will be harmonized with the IRA and other US policies.

Eijnde and Honnatti see the EU adopting a policy more akin to the IRA as the CBAM begins to mature and conversations between the two powers intensify.

The EU's current incentives policy is focused on renewable energy deployment, but there are limits to solar and wind, and new technologies will have to be incorporated along the lines of the IRA, such as carbon capture and other abatement technologies, Eijnde said.

An opportunity for changing EU policy will arise when the CBAM begins collecting revenue in its Nextgen Fund, and the European Commission will have to decide how those funds are used. That could lead to a wider expansion in investment by the EU.

This will also intensify talks between the EU and the US on coordinating the IRA's carbon reductions with the EU's incentives and how US products will be assessed under the CBAM, according to Eijnde.

The CBAM is meant to counter what is known as "carbon leakage," which occurs by substituting EU products with non-EU products with weaker emission reduction and green manufacturing requirements. The idea is to tax the higher-emission imports to incentivize the purchase of low-carbon products.

Currently, the carbon tax only applies to products crossing borders within the EU. This early implementation requires countries to provide product data reports to be eventually used to assess the tax.

Eijnde said the deadline for the first report is Jan. 31, with the tax going into effect for all products in 2026. The CBAM will initially apply to cement, iron and steel, aluminum, fertilizers, electricity and hydrogen.