We Need a Functional EV Tax Credit System Backed by Sound Policy

Electric vehicle supply and demand has gone from one extreme to the other. A few years ago, EVs were selling for thousands of dollars over sticker price. But the logjam has cleared, and EVs are piling up on dealer lots.

One major cause is a broken EV tax credit system. Credits are nonrefundable, which limit the extent to which lower-income households can take advantage of them to offset vehicle purchase price. And material sourcing requirements drastically limit what vehicles qualify for the credit at all.

The interplay between requirements means people are waiting either for a vehicle they want or can afford to qualify for, or for their own finances to allow them to take advantage of the full credit.

Tweak the EV tax credit regime, move the units, and let’s seize the moment to begin in earnest our shift away from fossil fuels.

EV Credits Remain Nonrefundable

EV credits are offered under Internal Revenue Code Section 30D, and per IRS guidance are for “up to” $7,500 for a “qualified” plug-in EV or fuel cell electric vehicle. The credit is for up to $7,500 because it’s nonrefundable—that is, it’s issuable only to the extent of federal income tax liability for the purchase year. A purchaser who pays less than $7,500 in income tax will only be able to receive a credit for up to the amount they pay in tax.

So, for example, if you make less than about $65,000, you won’t enjoy the entirety of the credit, which can’t be carried forward to future years. The policy rationale is to avoid the potential for fraud and the appearance of engaging in income redistribution.

But the credit needs to be refundable—full stop. We argued for it when the Inflation Reduction Act was being negotiated, and it remains a necessary precondition to opening the EV market to lower-income purchasers. The fact that an individual may not owe income tax of $7,500 has no bearing on the amount required to purchase the vehicle and is of slim comfort when it comes time to cut a check for purchase.

It also focuses on solely federal income tax, ignoring other taxes and fees, such as payroll taxes, that may raise a lower income households outlay well above the threshold in actual dollars paid, while nonetheless not being offset by the credit.

Further, there’s interplay between the credit being nonrefundable and other restrictions. For instance, the credit is only available once every three years.

Rational purchasers will consider whether they can enjoy the credit in full at the time of purchase or, if not, whether they expect to be able to within that time frame. In a nation of self-perceived upwardly mobile individuals, many folks who come in just under the wire likely will wait to receive the full credit.

The Kia EV9 electric vehicle during the 2023 New York International Auto Show in New York on April 5, 2023.

Photographer: Stephanie Keith/Bloomberg via Getty Images

Vehicle Restrictions Are Back

Prior to the EV credit system revamp, there was a manufacturer phase-out for automakers that sold more than 200,000 vehicles. This was problematic, as it effectively limited purchasers interested in receiving the credit to a shrinking list of desirable vehicles.

Thankfully, President Joe Biden and Congress eliminated this requirement. In so doing, however, they introduced a new distortive pressure in the form of critical mineral and battery component sourcing requirements.

The revamped credit regime has a progressive requirement that tops out in requiring in 2027 that 80% of the market value of critical minerals be extracted or processed in the US or a country in which the US has a free trade agreement. Put simply, it mandates that a certain percentage of the metals used to build the vehicle’s battery and hold the electrical charge for use by the vehicle be mined from the earth somewhere in North America.

As of 2023, that percentage stands at 50% and has already excluded from eligibility a vast swath of the most affordable EVs for which batteries, along with the vehicles, are produced overseas. Several of the lowest-cost EVs aren’t even eligible for a credit.

It also has created a cottage industry of battery recyclers, which will become another bottleneck in the supply chain as sourcing requirements ramp up. The pace of adoption is slowing and, as a result, the future market for used and recycled batteries will be depressed.

Absent a policy change, the US will need to become an importer of derelict EVs simply to feed the demand for batteries recycled in North America. If the policy is intended to bolster the domestic recycling industry, there’s reason to believe it won’t be effective.

Chinese firms such as Contemporary Amperex Technology, Co., already dominating the EV battery production market, are trying to expand to North America to meet the burgeoning demand.

The bottom line? We need to decide whether we’re moving forward with electrifying America’s roadways. If we choose to throw our policy weight behind EVs, we should do so without compromise and without attempting to turn every EV credit bill into a jobs bill—because we believe the future of the climate requires the cessation of the fossil fuel industry.

Look for Leahey’s column on Bloomberg Tax, and follow him on Mastodon at @andrew@esq.social.