Tax Credits Are Expiring for Tesla and GM

The Plug-In Electric Drive Vehicle Credit (EV tax credit)—established by the Energy Improvement and Extension Act of 2008, and further amended by the American Recovery and Reinvestment Act of 2009—provides a tax rebate of up to $7,500 to U.S. purchasers of qualified plug-in electric vehicles. The tax credit is worth its full value until a manufacture sells more than 200,000 vehicles. After this threshold is met, a phase-out period begins. Starting the second quarter following the quarter in which the 200,000^th vehicle is sold, the credit halves to $3,750, and after two quarters at that rate it halves again to $1,875, where it remains for another two quarters before going away entirely.

At present, the only two EV manufacturers to hit this sales threshold are Tesla and General Motors. Tesla began its phase-out period January 1st of this year after hitting the threshold in the 3rd quarter of 2018. On June 30th, the tax credit for Tesla buyers halved again to $1,875, and it will go away entirely in January of 2020. GM is not far behind; its phase-out started on April 1st when the credit for GM buyers was halved. It will halve again to $1,875 at the beginning of October and expire on March 31st of next year.

The expiration of their tax credits will require companies whose sales have been augmented by the electric vehicle tax credit to make their EVs more cost-competitive with internal combustion engine vehicles. The beginnings of this can be seen, as Tesla cut $1,000 off the price of its Model 3 and simplified its offerings by removing the base model option and changing the price scales for the Models X and S after its most recent tax credit reduction. Electric vehicles are growing in popularity, but it’s time to see if they can survive on the market unsubsidized.

Predictably, some automakers are loath to see the credits phase out. Tesla and GM, along with Nissan (whose sales are projected to reach the threshold by 2021) have been engaged in lobbying efforts to extend the credit. They’ve partnered with charging station manufacturers and advocacy groups in the “EV Drive Coalition,” the goal of which is legislation to reform and extend the EV tax credit, although even they acknowledge that the credit must eventually sunset.

In April, Senator Debbie Stabenow (D-MI) introduced S.1094, the “Driving America Forward Act,” to the Senate Finance Committee. The bill, co-sponsored by seven other Senators including two Republicans, Susan Collins (R-ME) and Lamar Alexander (R-TN), would add an additional 400,000 units to each company’s cap, with the value of the additional credits being lowered to $7,000. This increase in the cap would only serve to further entrench the distortion to the market created by the individual manufacturer based phase-out.

Since the EV tax credit began in 2008, the vehicles produced by all major electric vehicle companies have all been eligible for the subsidy. Because the most popular producers will have to learn to live without the tax credit, the EV market will likely start to change. Tesla and GM will need to start innovating more aggressively, cutting prices to make up for tax credit their customers lose, and finding other ways to be profitable that they did not have to concern themselves with while the subsidy was artificially lowering the real price that consumers paid for their vehicles after receiving the tax credit.

The automakers whose tax credit eligibility is phasing out complain that it’s unfair that they, the early adopters who have successfully sold EVs, will no longer have their vehicles eligible for the credit, while other companies’ vehicles will still be able to receive it.

This disparity arises from the 2009 amendment of the law, which established the per-company cap and phase out rather than allowing for one overall number available on a first come-first served basis, regardless of manufacturer. Although this initial structure creates a serious market distortion, plans to extend the credit would not remedy either the overall distortion caused by the credit, or the particular distortion caused when some companies still receive the subsidy as others see their credits phased out after reaching the cap.

Although all government subsidies distort markets, the effect would be far less negative were the program based on a total pool of money or total number of cars irrespective of manufacturer (the first law in 2008 established a total cap of 250,000) after which point the law would sunset. This would have given companies an incentive to compete against competitors to receive the subsidies. As things are, though, the 2009 iteration of the law was structured in such a way as to lead to this eventual interim period where some companies have phased out while others have not yet done so.

As is so often the case with government programs, the reality is a far cry from the ideal hypotheticals drawn up by economists and policy wonks. Suboptimal structures make their way into legislation all the time, and in this case, the structure of the law leaves plenty to be desired.

Now that the distortion has occurred, though, the best path forward is to allow companies to use up their allotments and then enter the real, unsubsidized market. After all, each company gets the same total number of allotments, so although the benefit is going to the latecomers now, while Tesla and GM are phasing out, their arguments of unfairness unravel when its acknowledged that the newcomers will hit the threshold at some point as well. They too will be capped at 200,000.

But, new and less effective manufacturers may continue to crop up, benefiting from the tax credit to their customers, while the companies with more established production methods will no longer benefit from the credit. This could distort the EV market in such a way as to undermine its long-term growth by subsidizing the less productive companies.

It may also cause companies to splinter in otherwise economically impractical ways to gain new tax credit eligibility for their customers. The only phase-out of the law is per manufacturer, so it could conceivably continue in a pattern of propping up inefficient companies, and causing uneconomical allocations for a long time. Overall, the EV tax credit is an example of convoluted policy getting in the way of both the free market, and of its own stated goal.

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