Cheap Electric Cars Won’t Happen in America Until We Fix the Federal Tax Credit
Sure, batteries are expensive. But a lot more could be done to bring down EV costs.
"I feel pretty confident we can get to a compelling sub-$30,000 car in five years," crackled a voice on Boston's NPR station WBUR. That was Elon Musk in a radio interview back in 2009. Twelve years later, Tesla has yet to sustain production of an electric vehicle deliverable for under $40,000. In fact, no automaker has yet turned their invested billions into the electric car's Model T moment. Even this new generation of non-Tesla EVs aimed at the mass market—think the Volkswagen ID.4 that starts at $39,995 and others—are hardly cheap.
Many blame the price of lithium-ion batteries for keeping EVs out of the budget of most Americans, and they're not wrong. But it's far from the only obstacle slowing EV adoption in the United States. Looming behind the battery supply hurdle is another, equally large barrier, one America must contend with if it's to democratize the electric car: The well-meaning, but utterly borked $7,500 federal tax credit for EVs.
The EV We Need
First, let's back up and turn "the electric car's Model T moment" into something less abstract. This hypothetical vehicle has to be both something median-income Americans—$78,500 for families last year—can afford and are willing to buy, meaning it must satisfy our high standards for comfort, and more importantly, our regular driving needs. General consensus dictates this means it needs 200 to 300 miles of range. Arbitrary figures, but not disagreeable given Americans' commutes average under 50 miles, per a 2018 study by Answer Financial. As for price, cars toward the bottom of our market like the Nissan Versa or Honda Civic, maybe $15,000 to the low-$20,000 range, seem like fair benchmarks.
It's true that, especially in the mid-2010s, automakers did offer an assortment of smaller EVs like the Honda Fit EV and Ford Focus Electric. But as this 2014 Car and Driver comparison test notes, that arrangement was a deeply flawed one. Those cars generally only existed in California specifically to meet that state's EV mandates, many of them were lease-only, and they still often came in well over $30,000. They were derided as "compliance cars," built and sold only to comply with state regulations, and they felt like the afterthoughts they were. They were a dead end for our electric future. (Late Fiat Chrysler CEO Sergio Marchionne once even begged people not to buy the Fiat 500e, because his company was losing so much money on them. That's not a path to success.)
So why, despite China's best efforts, does a truly affordable electric car not exist on the American market? Like everything in a capitalist economy, this boils down to the business case; the outwardly boring abstracts of opportunity cost, supply, and demand. In short, whether it'll turn someone a buck.
"There's a risk to producing a high-volume, new technology-type vehicle," Edmunds' Executive Director of Insights Jessica Caldwell pointed out. "You get a recall, or something goes wrong, that's a lot of money to fix it. Rolling it out in a slower manner is something fairly traditional in the auto space."
It's Not a Technology Problem
Caldwell's observation is supported by the decades-long trend of new technologies like in-car entertainment systems first debuting in low-volume luxury cars, before years of refinement permits their democratization in economy cars. The technological gulf between a decently equipped compact car and a "luxury" car is far less wide than it was in the 1980s. But while the technology to produce an electric car adequate for the vast majority of Americans' commutes has been around for decades, an EV for the people hasn't yet arrived stateside. We offer nothing like SAIC's $5,000 Wuling Hong Guang Mini EV, which is selling like crazy in China.
Carmakers are struggling to source rare minerals used in some batteries and motors without causing environmental and financial problems—never mind ethical—and even if they weren't, they'd still face the challenge of turning a buck on economy EVs; a segment that has always relied on volume for profit. And in America, that volume is supposedly subsidized by the government in the form of the famous $7,500 tax credit.
How the Federal EV Tax Credit Works...
Before we go any further, we have to understand what the federal EV tax credit is and how it works. It awards up to $7,500 in non-refundable tax credits to the first 200,000 buyers of eligible electrified vehicles per manufacturer. As a non-refundable credit, this money amounts to a discount on your federal taxes, and if you don't owe the amount of credit you qualify for, you don't keep the extra. In other words, if you only owe the federal government $4,000 one year, you can only claim $4,000 of the credit.
For the six months following the quarter where that automaker's sales milestone is reached, the credit for that make's customers diminishes by half to a maximum of $3,750, then halves again to $1,875 for the next six, before expiring entirely thereafter.
It is most certainly not a straight discount or refund on the MSRP of an electric car, as is frequently described in talking about EV sticker prices. According to a tax accountant consulted by The Drive, owing the IRS $7,500 in the first place generally requires at least $65,630 of adjusted gross income as an unmarried, childless individual not accounting for varying state taxes and the income that incurred them. Your typical EV owner makes a lot more than that.
... And Why It's Flawed
The tax credit was not, when codified in 2008, a bad idea. It unquestionably seeded the premium EV segment that helped Tesla find its footing with the radical Model S, whose role in igniting demand for EVs and spurring legacy automakers into action can't be overstated. Without Tesla—thus the tax credit—the auto industry almost certainly wouldn't be on track toward the grand-scale electrification even its most conservative players now consider inevitable.
Because of how the tax credit awards this benefit, though, it has not motivated carmakers to venture out of the premium EV segment and into economy cars that aren't compliance-car afterthoughts. As outlined above, the financial incentive is only fully available to car buyers above a specific threshold of income. Shoppers below that mark, who are more likely to shop economy cars than a fancy Tesla, pay less in taxes and thus receive reduced tax breaks, which by virtue of being smaller won't be as influential in their car selection process.
So says the National Bureau of Economic Research, which in 2019 concluded wealthy households were "more likely to buy EVs in the absence of an incentive, relative to lower-income households." Even then, utilization of the credit was heavy, as discovered by a survey of EV owners by J.D. Power.
"Incentives are shown to be very effective at driving EV purchases," explained Brent Gruber, Senior Director of Global Automotive at J.D. Power. "In fact, our Electric Vehicle Experience (EVX) Ownership Study shows that 64 percent of owners who purchased a mass market brand EV indicated that tax credits or incentives were a key factor in purchasing an EV over a gas or diesel powered vehicle. Among this group, this was the second most frequently cited purchase reason, behind only expected lower running costs."
In other words, everyone's relying on subsidies, particularly lower-income buyers. Or at least, they would, had they been addressed by both an accessible incentive and an economy EV, the likes of which aren't yet sold in the United States.
No Demand Means No Supply
Just about the cheapest EV sold here by a legacy carmaker is the Mini Cooper SE; a short-range subcompact that, with a price tag starting around $30,000, is no economy car but a premium good, like all other EVs on sale in America. In effect, then, the tax credit as it stands is a subsidy for luxury goods, one that is most accessible to a demographic—new car buyers—that is already statistically wealthier than the average American.
Considering new car transaction prices have since soared almost 20 percent, from $34,023 in October 2015 to $40,753 in December 2020, it comes as no surprise to learn the average car buyer's income has swelled too—67 percent of buyers take home over $75,000 annually. A group that needs government financial incentives to make conscientious purchases, this isn't.
So if the EV tax credit has reached the limit of its effectiveness, what's the next step? Given government action's proven effectiveness at kickstarting EV markets so far, it makes sense to take more, this time tailored to the economy car segment automakers (looking at you, GM, Tesla, and VW) proclaim they'll be ready to address—and which the National Bureau of Economic Research considers a cheaper, equally effective way to spur adoption.
"The researchers calculate that a modified program that provided a larger tax incentive for low-income vehicle buyers, who are more price-sensitive than their high-income counterparts, could have induced the same increase in overall EV purchase at a smaller revenue cost," said its 2019 study.
Rather than a tax credit, though, and never mind the issue-ridden expansion of that credit to $12,500 that's currently being debated in the U.S. Senate, incentives should be simpler, less abstract. The program's sheer complexity is already discouraging potential EV adopters, as determined by J.D. Power's Electric Vehicle Consideration Study.
"Thirty percent of BEV non-considerers cite a lack of information (about incentives, tax credits, utility rate adjustments, resale value and help from automakers and retailers) as a key reason why [they didn't switch]," said Stewart Stropp, J.D. Power's Senior Director for Automotive Retail. "Providing more accessible and transparent consumer resources and tools may help increase shopper understanding and confidence, potentially leading to higher purchase consideration."
Instead, as advocated by Senate Majority Leader Chuck Schumer per Automotive News, the incentive should be awarded at the time of purchase, rather than be locked away for months until tax season. Point-of-sale rebates, these are called. After all, too many Americans aren't prepared for financial emergencies, and may need that liquidity far more than they need a new car.
The Niceties of the Next Step
To prevent double-dipping, taking the up-front incentive should disqualify a buyer from claiming any further tax credits. This money should also be available exclusively for economy EVs, a category possibly best defined by MSRP. Congress seems to think so, as evidenced by the aforementioned expansion proposal that includes a hard cutoff for vehicles retailing above $80,000. This threshold, however, is ludicrous for two reasons.
For one, $80,000 is far too high. This figure still far exceeds the transaction price of most new cars sold in the U.S., which are only getting more expensive, and for reasons of bewildering complexity. Additionally, because $80,000 is an arbitrarily chosen number, one behind which there should be an informed decision and a clear goal.
Spitballing has no place in our efforts to fix the status quo of who's getting help with buying EVs, which as we've established is the problem. And if this presidential administration is serious about getting Americans out of combustion-engined cars and into EVs, it needs to do far more than perpetuate a program that has already run its course.
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