When Looking to Reform Inflation Reduction Act, Start with EV Credits

The Treasury Department’s new report on taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.
expenditures highlights the rising fiscal cost of new InflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power.
Reduction Act (IRA) tax credits. Over the next 10 years, the IRA’s energy tax credits are projected to cost north of $1 trillion, adding to the federal government’s budgetary challenges and burgeoning debt. The IRA’s credits for electric vehicles (EVs) and charging infrastructure in particular are proving to be much more costly than anticipated, costing about $180 billion over the next decade. As the United States moves closer to the end of 2025 when major Tax Cuts and Jobs Act (TCJA) provisions are scheduled to expire, policymakers should reduce EV tax breaks.

Before the IRA, the electric vehicle tax credit offered a maximum credit of $7,500 per electric vehicle. However, vehicles were only eligible for the credit if they were produced by a manufacturer that had made less than 200,000 EVs to date. The goal of this limit was to focus the credit on new EV production programs, as the credit phased out once an EV program reached a basic level of maturity.

The IRA made several changes to EV credits. The IRA removed the per-manufacturer limit on the electric vehicle tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly.
, but it also introduced new restrictions related to critical minerals and battery components. After April 2023, companies must meet domestic sourcing requirements for both critical minerals and battery components to be eligible for the full $7,500 credit and are eligible for half if they meet one requirement but not the other. The extent of each domestic content requirement is scheduled to increase over the next several years, with separate tax subsidies for battery manufacturing intended to facilitate the expansion of U.S. clean vehicle manufacturing and supply chains over the coming years.

The IRA also introduced two new EV-related credits: a credit for used EVs and a credit for commercial EVs. The battery component and critical mineral requirements do not apply to the used and commercial EV credits. Thanks to the latter exemption, some dealerships have been able to avoid the domestic content requirements by purchasing electric vehicles that do not qualify for the main clean vehicle credit and leasing them out to consumers, passing through some of the benefits of the commercial EV credits.

Even with the IRA a year and a half old, the cost of the IRA EV credits is highly uncertain. The Joint Committee on Taxation’s (JCT) initial cost estimate of the EV credits in August 2022 was around $14 billion from 2023 to 2031. A later analysis from JCT in June 2023 found a proposal to strip down the EV credits would raise around $70 billion over the same time period. Meanwhile, the Penn-Wharton Budget Model estimated all of the clean vehicle provisions cumulatively costing $393 billion from 2023-2032, and a Brookings Institution paper using the US-REGEN model estimated the EV credits would cost $390 billion through 2031.

The cost estimates for the EV program have fluctuated so much several reasons. One, the IRS has loosened the restrictions regarding domestic sourcing of battery and critical mineral components to include content from free trade agreement partners of the United States. The supply-side subsidies for domestic battery production (which have also risen in estimated costs) could also expand the expected cost of the demand-side EV credits as more EVs could become eligible for them.

But perhaps the most important aspect of the rising projected costs of the EV credits is the Environment Protection Agency’s (EPA) tailpipe emissions regulation. In April 2023, the EPA released a new proposed set of tailpipe emissions regulations that targeted EVs constituting 67 percent of new light-duty vehicle sales in 2032. In the Congressional Budget Office’s annual budget and economic outlook, researchers estimated the clean vehicle credits would cost $224 billion more than expected over the next 10 years, in largest part due to these expanded EPA requirements pushing people to buy electric cars through the regulatory channel, and thus generating significant EV credit spending for purchases that would have occurred anyway. The EPA ultimately softened the rules when they were finalized in March 2024.

A new report from several energy and environmental research groups on the IRA’s progress showed electric vehicle adoption in 2023 reached the high end of their original range of projections. However, the costs have been dramatically higher, and compared to other credits, are less cost-effective in terms of emissions reduction. EV owners drive less than the average American, meaning an increase in EV ownership will likely not translate to a proportionate reduction in transportation emissions. Additionally, EVs are still reliant on the electric grid. EVs are less emissions-intensive than conventionally-powered cars across the United States, but we cannot unlock the full potential of EVs unless we build more low-emissions electricity production.

Unfortunately, the IRA has underperformed in generating more clean electricity production. In the Clean Investment Monitor report, the consortium of energy and environmental groups found new electricity production has fallen below their range of projections. While the IRA’s generous and improved tax credits for zero-carbon electricity investment and production make projects viable, legal challenges like permitting, (paradoxically) regulations on environmental impact, and localized opposition, have made completing these projects difficult. Additionally, the complexity of the tax breaks’ ancillary provisions (like bonus credits for domestic content, prevailing wage standards, and apprenticeship programs) have been a challenge for companies to comply with and for the IRS to administer, with the guidance process still ongoing 20 months after the law was enacted.

The IRA has underperformed in various ways, but the goal of reducing carbon emissions is a legitimate one. As the United States faces elevated budget deficits, and with the TCJA’s major individual tax cuts expiring in 2025, policymakers should put some reforms to the IRA’s most expensive and less efficient provisions on the table. An incremental reform could eliminate or reduce the generosity of the EV credits, paired with simplification of the credits focused on utility-scale electricity generation. Short of full repeal of the EV credits, one option would be to simply re-introduce the per-manufacturer limit, which would shift the credit back to a support for new EV production programs rather than a broad subsidy. Another option would be to apply a specific annual dollar cap on the credits, i.e., actually budget for their cost rather than just leave it open-ended.

A more aggressive reform to the IRA would involve repealing a large portion of the tax subsidies and replacing them with a carbon taxA carbon tax is levied on the carbon content of fossil fuels. The term can also refer to taxing other types of greenhouse gas emissions, such as methane. A carbon tax puts a price on those emissions to encourage consumers, businesses, and governments to produce less of them.
. This approach has several advantages. A carbon tax directly targets carbon emissions, meaning it will be more effective than green tax subsidies in reducing emissions. A recent Brookings Institution paper shows how a partial repeal of the IRA paired with a relatively modest carbon tax would reduce carbon emissions more than leaving the IRA in place (or even expanding the IRA) would. Furthermore, moving to a carbon tax would turn green tax policy from a fiscal sinkhole necessitating other tax increases to a revenue generator that could help pay for retaining certain tax cuts from the TCJA, and/or reducing the deficit.

Share

Twitter
LinkedIn
Facebook
Email