The Unintended Consequences of EV Tax Credits

E very tax policy has unintended, and often negative, consequences, and the electric-vehicle (EV) tax credit is no exception.

When lawmakers recently updated the Obama-era EV tax credit in the Inflation Reduction Act (IRA) of 2022, it’s unlikely they anticipated how the new law would hand a massive subsidy to the most successful EV company in the world and create a tax loophole you could drive a fleet of foreign-made EVs through.

Lawmakers made three major changes to the original credit. The first was to focus the credit on incentivizing the domestic production and sourcing of EV materials and batteries. As of April 18, 2023, vehicles that meet both the mineral and battery requirements are eligible for a full $7,500 credit, while those that meet just one of the standards are eligible for a $3,500 credit.

The second was to cap the price of credit-eligible vehicles to cars under $55,000 and SUVs and light trucks under $80,000. Tax-credit eligibility was also limited to single taxpayers earning less than $150,000 and joint filers earning under $300,000.

The last change removed the production limit on auto manufacturers, which had capped the number of credit-eligible EVs to 200,000 units. The cap was likely seen as unnecessary because of the sourcing, pricing, and income rules governing eligibility.

The latest EV sales results for the first half of 2023 suggest things may not be going the way lawmakers planned.

First, EV sales have grown year over year, but the pace of growth is slowing, and dealer inventories are rising. Reuters reports that these trends “could be signals that boosting U.S. EV sales above the current 7% market share level will be more costly and difficult than expected, even with federal and state subsidies.”

Next, Tesla continues to dominate the market by selling almost two out of every three EVs in the U.S. — not far below its share before the IRA was enacted and when its vehicles were ineligible for the tax credit. According to the Kelly Blue Book Q2 EV Sales Report, of the roughly 557,000 EVs sold nationwide in the first half of 2023, Tesla sold 60.5 percent of them, or nearly 337,000. That’s ten times as many EVs as GM, its nearest rival.

Tesla EVs meet the sourcing rules and are eligible for the $7,500 credit. If every buyer was eligible for the credit (many would not be, of course, because of restrictions on the eligibility of higher-income taxpayers for the subsidy), it could amount to more than $5 billion in taxpayer subsidies for Tesla buyers by the end of 2023, a seemingly unnecessary subsidy for EVs that people were willing to buy last year without a tax credit, even if the subsidy (as intended) increases the pool of Tesla buyers.

Another interesting development is the work-around that ineligible automakers have discovered to capture the tax credit: leasing.

Commercial vehicles are not subject to the sourcing or income restrictions, and the IRS ruled that leased vehicles should be considered “commercial.” Any EV automaker can benefit from this leasing loophole, but this has been a particular boon for imported vehicles that typically do not meet the sourcing, manufacturing, or pricing limitations. Leasing can also benefit customers whose income may exceed the cap. Since the automaker (or their leasing company) retains ownership of the vehicle, it is eligible for the $7,500 tax credit, which it may (or may not) pass along to the lessee through a lower price.

USA Today reports that 44 percent of EVs were leased in June 2023, compared with 13 percent in the same period in 2022. For some automakers, the percentages were even higher. In the same month, Kia leased 72 percent of its EV6 vehicles, up from 2 percent a year ago. BMW leased 66 percent of its i4 SUVs, up from 11 percent in June 2022. Hyundai leased 68 percent of its Kona EVs, compared with 18 percent a year ago.

Ford’s Mach-E does not qualify for the full credit because its battery doesn’t meet the IRA sourcing requirements. Yet, the leasing loophole allows customers to get the benefit of the full credit, according to USA Today.

Like many major pieces of legislation, the IRA was crafted to achieve multiple goals, from making EVs more affordable and sparking sales to encouraging onshoring. But if sales from the first half of 2023 are any indication, the law likely has subsidized tens of thousands of buyers who would have purchased an EV anyway and created a leasing work-around that undermines many of the legislation’s key objectives.

As we approach the first anniversary of the Inflation Reduction Act, it’s a good time to question whether the benefits of the EV-tax-credit program outweigh its unintended consequences. The evidence suggests not.