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Key Takeaways

• The Clean Vehicle Tax Credit in the Inflation Reduction Act (IRA) is a prime example of the U.S.’s return to industrial policy.
• IRA’s stricter requirements slashed the number of EV models eligible for the credit, while allowing renewed access for some high-volume Tesla and GM EVs.
• Leasing is a gap in the friendshoring requirements of the consumer EV tax credit and enables high-income households and buyers of expensive EVs to benefit from the commercial EV tax credit.
• EV leasing has lifted off disproportionately, showing many EVs are getting the credit without meeting the stricter requirements.
• The EV tax credits are only one of many levers the Biden administration is pulling to promote electric vehicles.

The energy transition from fossil fuels to renewables is one of the hottest areas of industrial policy, with governments around the globe incentivizing green production at home with dual goals: winning leadership in rising industries and curbing greenhouse gas emissions. 

The Clean Vehicle (or EV) Tax Credit in the Inflation Reduction Act is a prime example of the U.S.’s return to industrial policy. This policy brief explains how the Clean Vehicle Tax Credit in the Inflation Reduction Act (IRA) works and evaluates it from an industrial policy perspective.

The Clean Vehicle credit for consumer EV purchases creates large financial incentives for friendshoring of EV supply chains — or locating supply chains in allied countries. Such arrangements are designed to prevent or alleviate U.S. industry’s dependence on China for essential inputs.

To be eligible, vehicles must be assembled in North America. And certain vehicle components needed to build them must be substantially friendshored, with percentages that escalate each year. Raw critical minerals used in EVs must come from North America or free trade agreement partners. And manufactured battery components must come from North America. Any critical minerals or battery components from China, Russia, or other “foreign entities of concern” will disqualify a vehicle from eligibility, starting in 2024 for battery content and in 2025 for critical minerals.

While these consumer EV purchase provisions are controversial among U.S. allies, the IRA contains a large loophole. The commercial EV tax credit can subsidize retail leases of EVs and plug-in hybrids without any of the origin requirements or the income and price caps of the tax credit for consumer purchases.

The new industrial policy

White House National Security Advisor Jake Sullivan articulated the Biden administration’s industrial policy in an April 27 speech at the Brookings Institution. That the National Security Advisor, and not an economic official, defined the new industrial policy underscores the importance of national security to it. His speech laid out three key criteria an industry must meet for support under the new policy: It must be economically critically important; it must have national security implications; and private investment alone in that industry is likely to fall short and catalyze less near-term growth than the administration sees as necessary to achieve the growth and national security goals.

Based on Sullivan’s speech, if old industrial policy focused on picking winners, new industrial policy would target must-win industries—arguably still picking winners. National security arguments are also not novel. Both go against the economic wisdom of the last era of U.S. industrial policy, in the early 1980s. In a 1983 Journal of Economic Literature review, “Industrial Policy and American Renewal,” R.D. Norton wrote, “In sum, the economic arguments against an American industrial policy are persuasive. The national-security case for a program of sectoral intervention is weak.... The microeconomic or market-failure rationale fails also....”[1]

Yet, the U.S. is not alone in resuscitating industrial policy. Despite outraged reactions to the IRA from U.S. allies, China and the EU introduced major industrial policies before the IRA or the CHIPS Act. That included China’s spectrum of policies to boost domestic EV and battery production,[2] and the EU’s Green New Deal. Arguably, the U.S.’s return to industrial policy began with the Trump administration’s tariffs on steel, aluminum, and imports from China. The U.S. also waded into national security- related industrial policy with bans barring the import of Huawei equipment and the export to China of chips with potential defense uses.

IRA’s new clean vehicle tax credits

The IRA replaces the longstanding EV tax credit for consumers buying battery electric vehicle (EV) and hybrid vehicles with three new Clean Vehicle tax credits: an extended and revised credit for consumer purchases of EV and plug-in hybrid electric vehicle (PHEV) purchases; a credit for commercial PHEV and EV purchases; and a credit for the sale of a used EV or PHEV.[3] Only the consumer purchase tax credit (known as 30D for its location in the tax code) comes with the origin requirements and makes Chinese battery or critical mineral content an outright disqualifier.

The original EV credit gave a $7,500 nonrefundable tax credit to any retail buyer of a new EV up to the first 200,000 EVs sold by an automaker. If the automaker had not exceeded its maximum sales, no other restrictions governed the vehicle or buyer’s eligibility—no price or income cap, no requirements on country of assembly, or other origin requirements.

Figure 1. The consumer purchase tax credit has strict requirements, but leases are an exception 

New Clean Vehicle Tax Credits for EVs (under 14,000 lbs.)

The most successful EV makers quickly became ineligible. The original 30D design goes against the idea of an infant industry policy by punishing success. Tesla and General Motors, which first made EVs consumers wanted to buy in large numbers, hit the 200,000 cap and lost the credit in 2018 and 2019, respectively.[4]^,[5]

The IRA’s new 30D credit extends to 2032 for any EV meeting its new requirements: a threshold requirement that a vehicle is assembled in North America; caps on price and buyer income; and origin requirements on battery content and critical minerals. (See Figure 1.) Instead of a single $7,500 tax credit, it creates two $3,750 tax credits: one contingent on battery component origin and the other on critical mineral origin. The price and income caps, detailed in Figure 1, prevent subsidizing EV purchases by high-income buyers and others who can afford very expensive vehicles, whose decision is unlikely to be swayed by the tax credit.

Sen. Joe Manchin (D-WV) drove a last-minute bargain to add requirements that would force the development of not only North American EV production, but also a secure North American or allied supply chain to avoid dependence on China for essential inputs. Today, China dominates battery material and rare earth processing, including about 35 percent of nickel, 50-70 percent of cobalt, and nearly 90 percent of rare earth elements (used in magnets), according to the International Energy Agency.[6] These requirements further reduce the budget cost of 30D by narrowing the eligible vehicles.

Figure 2. EV Tax Credit: Content requirements ramp,          
zero China content rule kicks in 2024

The IRA’s content requirements mandate that EVs have a minimum percentage of critical minerals by value from North America or other free trade agreement partners to access that $3,750 credit, starting at 40 percent in 2023 and reaching 80 percent for 2027 on, as detailed in Figure 2. Similarly, eligibility for the $3,730 battery component credit requires an increasing percentage of battery components from North America by value, rising from 50 percent in 2023 to 100 percent from 2029 on. From 2024, any battery components from a “Foreign Entity of Concern” (FEOC), including China, will disqualify a vehicle from the $3,750 credit; from 2025, any FEOC critical minerals will disqualify a vehicle from the $3,750 critical mineral credit.

More specifically, a FEOC is defined by the Infrastructure Investment and Jobs Act as “... a foreign entity that is ... designated as a foreign terrorist organization [or] owned by, controlled by, or subject to the jurisdiction or direction of a government of a foreign country that is a covered nation....” The U.S. Treasury Department has not yet released guidance interpreting the FEOC definition that would inform whether, for example, a U.S. subsidiary of a Chinese corporation would qualify as an FEOC or a services agreement with a Chinese company, as Ford has announced

Chinese battery maker Contemporary Amperex Technology Co., Limited (better known as CATL), would trigger the FEOC provision.[7]

IRA’s stricter requirements slashed the number of EV models eligible for the credit

The IRA’s immediate effect was to reduce the number of vehicles eligible for the tax credit, in addition to restricting household eligibility by income. On August 15, the day before President Biden signed the IRA into law, 26 EVs were eligible for a $7,500 EV tax credit. Today, seven EV models are eligible for a $7,500 tax credit at least in part; another four are eligible for a $3,750 tax credit. (See Figure 3 below.)

Figure 3. Consumer EV Tax Credit eligible EVs down from 26 to 11since IRA passed 

In fact, the number of eligible EVs immediately narrowed to 11, effective the day after the law was signed, when the North American assembly requirement became effective. Starting Jan. 1, 2023, the list of tax-credit eligible vehicles changed as other provisions of the IRA became effective, although the total number of models stayed constant at 11. EVs made by Tesla and GM, which had used up their limit of 200,000 credits under the original 30D provision, became eligible, adding the Tesla Model3 and Model Y, as well as the Cadillac Lyriq, Chevrolet Bolt, and Bolt EUV. At the same time, the price caps disqualified the Lucid Air and Mercedes EQS.

Senator Manchin’s supply chain provisions disqualified two previously eligible EVs, the Nissan Leaf and Audi Q5, and halved the credit for four others made by Ford and Rivian, as Figure 3 details.[8] In doing so, those provisions reduced the fiscal cost of 30D, at least in 2023, while creating a binding incentive to shift battery and critical mineral supply chains to the U.S. and allied countries.

What has happened so far to EV demand?

New EV sales rose exponentially in 2022 even before IRA’s passage, boosted by high gasoline prices that increased the savings from EV ownership and broadening offerings of EVs that were increasingly close substitutes for gas-burning cars and trucks. A dozen years of steeply falling battery costs translated to the introduction of mainstream EV models with longer ranges, in a wide variety of styles and sizes, and a narrowing price gap.

After IRA’s passage, EV sales continued to trend up, with no abrupt shift at either passage or January 1. (See Figure 4 below.) Perhaps that’s unsurprising given that IRA’s passage first sharply reduced the number of EVs eligible from 26 to 11, as discussed above, effectively making EVs more expensive by taking the tax credit away from EVs not assembled in North America, without making Tesla or GM EVs eligible.

From Jan. 1, 2023, Tesla and GM EVs became tax-credit eligible, while other requirements kept the number of eligible models steady at 11 and cut the tax credit to $3,750 on four of those. Given Tesla’s large market share, making Teslas eligible again undoubtedly brought down the price of EVs sold on a weighted average basis. Tesla’s January price cuts increased the weighted average price reduction effect.[9]

Figure 4. U.S. EV sales continue rising

EV leasing has lifted off disproportionately, showing EVs are getting the credit without meeting the stricter requirements

Leasing is a gap in the friendshoring requirements of the consumer EV tax credit, as well as a backdoor to the credit for high-income households and buyers of expensive EVs.

Lenders buy an EV, get the commercial EV tax credit of $7,500, and can pass some of the credit to the lessee in terms of a lower lease payment; leases are often made by captive finance companies like Ford Credit and GM Financial. Lenders can access the commercial EV tax credit for vehicles and buyers that would not qualify for the consumer EV tax credit: that is, EVs that are not assembled in the North America or do not meet the origin requirements on battery content and critical minerals; EVs with prices above caps; and borrowers with household incomes above the caps.

The jump in EV leases in January 2023 shows that the back door is very popular. Leases as a share of EV sales jumped when the commercial EV tax credit went into effect, enabling lenders to use it to lower lease prices, research from Chad Bown of the Peterson Institute of International Economics finds.[10] As Bown’s graph below (Figure 5) reveals, EV leases jumped to about 35 percent of sales in March 2023 after dipping below 10 percent in 2022. At the same time, the overall share of leases out of new vehicle sales ticked up to 20 percent from the high teens in late 2022.[11]

Figure 5. U.S. electric vehicle leases have increased since the eligibility for IRA tax credits was expanded

Biden’s multi-faceted pro-EV industrial policy

The EV tax credits are only one of many levers the Biden administration is pulling to promote EVs. While others do not explicitly require U.S. or North American content, all contribute to accelerating EV adoption, benefiting both U.S. and imported EV sales and mitigating emissions. Figure 6 shows the full suite of “carrots” and “sticks” for EV production and sales.

Among the carrots are other tax subsidies and grants to support U.S. EV production and promote adoption.

Figure 6. Biden Administration carrots and sticks for EV adoption

 The IRA also includes production tax credits for critical mineral processing and battery production in the U.S. For critical minerals, the credit covers 10 percent of production costs; for batteries, it covers 10 percent of electrode active materials and provides $35 per kilowatt hour (kWh) for battery cells and $10 per kWh for battery modules.[12]^,[13] GM has estimated that these benefits could be as much as $3,500-5,500 per vehicle.[14] Reducing costs will improve the profitability of EVs versus internal combustion engine (ICE) vehicles powered by gasoline or diesel at legacy automakers and encourage them to ramp their production more rapidly. Recent battery plant announcements indicate that the suite of EV manufacturing incentives, including the North American content requirements for the battery components, are driving more investment in EV assembly and supply chains in the U.S. [15]

The Biden administration is also leveraging the U.S. Department of Energy Loan Programs Office to make loans to spur the EV industry. On June 22, 2023, the Department of Energy announced a $9.2 billion loan to BlueOval SK LLC, a joint venture of the Ford Motor Company and Korean battery manufacturer SK On, for the construction of three battery manufacturing plants in Kentucky and Tennessee.[16] 

In September 2022, the Department of Energy closed a $2.5 billion loan to the Ultium Cells, LLC joint venture between General Motors and Korean battery maker LG Energy Solution for three battery plants in Ohio, Tennessee, and Michigan.[17]

The Infrastructure Investment and Jobs Act of 2022 (or Bipartisan Infrastructure Law) included $7.5 billion to support investment in and maintenance of public EV charging, including DC fast charging along highways and community charging.[18] Arguably, those investments are primarily climate focused, creating the conditions for faster EV adoption. Yet they also have an industrial policy angle: Faster growth of the domestic EV market better positions U.S. automakers and auto suppliers to compete with Chinese and European EV makers. New vehicle sales in those countries are shifting to EVs faster than those in the U.S., enabling them to develop expertise and economies of scale faster.

Tougher fuel economy (CAFE) and greenhouse gas (GHG) regulation similarly have a primary purpose of lowering U.S. transportation emissions faster. On April 10, 2023, the U.S. Department of Energy proposed revising its calculations of EVs’ petroleum-equivalent fuel economy used in the CAFE program in a way that would reduce the fuel economy calculation for EVs and force automakers to either sell more EVs as a share of sales or improve the fuel economy of its ICE vehicle sales to meet the existing CAFE standards.[19]

Three days later, the U.S. Environmental Protection Agency (EPA) announced stricter proposed GHG regulations for model years 2027 and later.[20] The EPA projected that the new rules could force EVs to comprise 67 percent of new light-duty vehicle sales by model year 2032.[21] On July 28, the National Highway Transportation Safety Administration (NHTSA) proposed to increase its fuel economy standards in line with the EPA’s proposal.[22]

Like the funding for public EV charging, accelerating U.S. EV sales through tougher CAFE and GHG regulation ramps up the domestic EV industry faster, making the U.S. a more potent EV producer, dampening EV imports, and better positioning U.S. automakers to win in overseas EV markets.

Evaluating the Biden EV policy in future research

The assembly and content requirements create a decade-long incentive for automakers to make EVs in the U.S. and develop friendshored, China-free battery supply chains to get the credit — precisely its industrial policy goals of developing a U.S. EV industry that is not dependent on and vulnerable to China for its supply chain.

If successful, it will have enhanced climate impact, driving more EV sales and faster decarbonization of private transportation by narrowing the price gap between EVs and gas powered, internal combustion engine vehicles. Success would also carry higher fiscal costs than the old 30D, as automakers supplying substantial number of EVs would have hit the volume cap and become ineligible long before the 2032 expiration of the IRA provisions.

How should future economic research evaluate the success of the Clean Vehicle Tax Credit and the full suite of Biden administration policies to promote EV adoption; decarbonize transportation; and drive EV production and supply chains into the U.S., North America, and free trade agreement partners? Three questions would ideally be answered:

1. Were U.S. EV adoption and the resulting decarbonization of personal transportation accelerated by these policies?
2. Did supply chains develop to be more localized in the U.S., in North America, and, for critical minerals, in free trade agreement partner countries?
3. Did IRA enable the U.S. to be a leader, or at least a larger participant, in global EV markets, compared with a no-IRA counterfactual?

References

[1] R.D. Norton, “Industrial Policy and American Renewal,” Journal of Economic Literature, March 1986, Vol. 24, No. 1 (Mar. 1986), pp. 1-40.

[2] Greg Ip, “ Wall Street Journal, June 7, 2023.

[3] The Inflation Reduction Act of 2022, Public Law 117-169, August 16, 2022, Part 4-Clean Vehicles, 136 Stat. 1954-136 Stat. 1969.

[4] Wired, “,” January 2, 2019.

[5] Internal Revenue Service, ,” March 26, 2019.

[6] International Energy Agency, “” March 2022, p. 12.

[7] Ford Media Center, “,” February 13, 2023.

[8] The Rivian EDV likely lost eligibility because it is a purpose-built delivery van, not a consumer vehicle.

[9] ",” Forbes, January 13, 2023.

[10] Chad Bown, “,” Peterson Institute for International Economics Working Paper 23-1, May 2023.

[11] Overall lease penetration fell in 2022 due to the chip shortage, as lessors bought their vehicles out of lease at below-market prices either to capture the profit or due to very limited availability of new vehicles for lease. EV leases have gyrated more dramatically. Prior to the chip shortage, EV leases as a share of sales ran higher than the overall market, ranging from 45 to 65 percent of sales, both because they skewed to the higher-lease luxury end of the market and because EV buyers were concerned about rapid technological change and wanting an EV next generation in a few years. The combination of a surge in EV demand in due to high gasoline prices and lower supply due to the chip shortage drove the EV lease share under 10 percent in late 2022.

[12] The Inflation Reduction Act of 2022, Public Law 117-169, August 16, 2022, Part 4-Clean Vehicles,136 STAT 1973.

[13] ",” Automotive News June 9, 2023.

[14] .

[15] U.S. Department of Energy, .

[16] U.S. Department of Energy, “” June 22, 2023.

[17] U.S. Department of Energy, .

[18] Owen Minott, Erin Barry, “," Bipartisan Policy Center, July 26, 2022.

[19] Federal Register, “,” Reuters, “” April 11, 2023.

[20] ". 

[21] Ibid.

[22] ”