Consumer Confusion on New Tax Credit Rules Will Limit EV Growth

As few as five weeks ago, electric vehicle (EV) sales were running along at a tremendous pace. As of the end of the first quarter, EV market share of retail sales was 7.99%. The industry appeared to be on track to sell 1 million pure battery-electric vehicles in this country in 2023.

But then industry and consumers received clarification on the next set of Inflation Reduction Act rules from the Internal Revenue Service and the U.S. Treasury Department. The sales climate for EVs changed radically.

The rapid run-up to 8% market share in the first quarter might have been partially spurred by consumers rushing to buy EVs in anticipation of a change in the available tax credits. Then the new rules let the air out of the balloon.

Less than six months ago, there were only a couple of rules concerning the federal income tax credits designed to promote the sales of emission-free EVs. One stipulated that each automaker could only sell 200,000 vehicles that qualified for the federal tax credit. After that cap of 200,000 qualified sales was reached, no more federal tax credits went to any buyers of vehicles from that automaker.

Only two carmakers hit that limit – Tesla and General Motors – and were disqualified from further tax credits. But all other automakers could offer their customers the promise of a tax credit of up to $7,500 if the vehicle met a few simple parameters. It had to have a plug, and it had to have a battery of a certain size that implied that it would often (plug-in hybrid) or always (battery-electric) be powered by electricity.

If you leased a vehicle, the substantial tax credit was included in your lease payment. If you bought a vehicle, you included it in your tax return at the end of the year, and you got the money back that way. It was easy to understand. Not so with the new IRA rules.

One game-changing new rule stipulates that for buyers to qualify for the federal income tax credit, the vehicle must be built in America. Suddenly EVs assembled in other countries have become ineligible for the tax credit – and to consumers, they instantly have become $7,500 more costly. That's a crushing disadvantage to European and Asian automakers who largely assemble their electric vehicles overseas and import them into the U.S. and other markets.

Besides establishing the built-in-America rule, the IRA contains rules about the composition of various vehicle components, primarily batteries. Qualification for the full $7,500 tax credit is based on critical minerals used in the batteries and where those minerals are sourced. Batteries and components must originate here or come from countries with which the U.S. has a free-trade agreement.

As the Internal Revenue Service guidance on this topic states, “…the credit amount will depend on the vehicle meeting the critical minerals requirement ($3,750) and/or the battery components requirement ($3,750). A vehicle meeting neither requirement will not be eligible for a credit, a vehicle meeting only one requirement may be eligible for a $3,750 credit, and a vehicle meeting both requirements may be eligible for the full $7,500 credit.”

These factors are opaque to shoppers and can also lead to confusion within the retail store. Even vehicles that appear to have the same powertrain can end up on both sides of this rule.

For example, the Tesla Model 3 Rear-Drive base trim has more non-compliant critical minerals than the Performance trim. So, within one vehicle line, the Performance trim qualifies its buyers for a $7,500 tax credit, while the base model qualifies its buyers for just half that: $3,750.

Many consumers are frustrated by the new cap on the manufacturer’s suggested retail price as well. To qualify its buyer for a federal income tax credit, a car can’t be priced above $55,000, and a truck or SUV can’t be priced above $80,000. In addition, the buyer of the vehicle must meet personal income requirements: $300,000 for married couples filing jointly, $225,000 for heads of households, $150,000 for all other filers.

This process, so straightforward six months ago, now has so many requirements that it is difficult to know if a potential purchaser will get the credit. Does the vehicle qualify? Does the componentry qualify? Does the buyer qualify?

An important question is, what will this do to demand for EVs?

While the rules aren’t clear, the answer to that question is quite clear. The new rules not only add several layers of possible confusion but also will result in higher transaction prices for many EVs. Only Tesla and GM, the two companies that are the big winners from the changes wrought by the IRA due to having several models qualifying for the full $7,500, are spared from this reality.

Though the new regulations are a boon for buyers of the Tesla Model 3, Chevrolet Bolt and Cadillac Lyriq, the IRA rules will result in higher overall EV prices, and demand will fall as a result. EV market share was at 8% in the first quarter of 2023. Now, barely into Q2, the EV market share is falling into the 7% range. Regaining an upward trajectory might be a challenge.

Tyson Jominy JD Power

In the short term, at least, it’s going to be harder to sell EVs. If the IRA was meant to spur EV sales, right now it seems to be having the opposite effect.

Tyson Jominy (pictured, left) is vice president of data & analytics at J.D. Power.