An evaluation of efforts to expand use of electric vehicles

Biden administration efforts to speed the adoption of electric vehicles (EVs) while well intended, are expensive and will likly prove ineffective. A better result could be achieved through a revenue neutral tax reform, which raises the relative cost of conventional vehicles to EVs.

Introduction:  The Biden Administration has placed a high priority on the more rapid introduction of electric vehicles. Policy initiatives include a first round of grants for states and communities to build EV charging stations,  extended tax credits for the purchase of EVs enacted in the Inflation Adjustment Act, and substantial increases in emission standards, like rules adopted in California, to boost EV sales.

These policies, while well intended, comes at a high economic cost and result in adverse environmental consequences.

Some problems with efforts to spur the growth of Electric Vehicles:

Budgetary impacts: The official forecasts of the cost of the EV tax credit to the Treasury does not correspond with forecasted EV sales growth.  A forecast used by the Joint Committee on Tax assumes the sale of 4.1 million plug-in vehicles over a decade.  By contrast, the new emissions standards proposed by the Biden Administration would result in EVs becoming two thirds of all new car sales, around 11 million annually.  Hence, the loss in tax revenue from the EV credit in a single year could be substantially larger than the projected loss for a decade.

A tax credit for the sale of a used EVs is more cost-effective than the tax credit for new EVs.  However, all direct consumer subsidies are expensive and difficult to justify given budget deficits and competing needs for funds.

A regressive subsidy:  EVs are currently an expensive luxury item sold primarily to affluent people.  In 2022, the average price of an EV, around $61k was around 25 percent higher than the average price of a conventional car.  Around 57 percent of EV buyers had income greater than $100k.  Even though the tax code prevents people with high income from claiming the EV credit, most recipients of the credit are affluent and the subsidy itself is a regressive policy. 

Issues associated with lithium:  The supply and cost of EVs will be impacted by the scarcity of lithium, the key ingredient in EV batteries.  China controls 70 percent of global lithium production.  Currently, lithium prices have fallen because of lack of demand in China but that will reverse when production in China resumes.  A new lithium mine being created in Nevada may reduce prices but lithium mining results in adverse environmental impacts including damage to soil, water and air.

Is EV growth inflationary? A shift in demand from conventional cars to EVs will increase the cost of living because EVs are more expensive than conventional cars.  The shift will be inflationary even if the price of EVs falls somewhat.  The BLS could claim EVs are an improved product and part of the price differential could be excluded from the official Consumer Price Index calculation.  However, EVs have a smaller driving range than conventional vehicles; hence, any adjustment to the CPI because of product improvement will be small.  Go here for a discussion on how the BLS adjusts prices in the CPI for changes in quality.

The cost of fueling an EV is substantially smaller than the cost of fueling a conventional vehicle a clear cost reduction.

The cost of insurance on an EV is higher than the cost of insurance on a conventional vehicle since insurance costs are tied to the value of the vehicle.  The savings in fuel costs will likely be smaller than the additional insurance costs.

The EV tax credit was included in the Inflation Adjustment Act, in my mind a misnomer.  A more accurate description of the law might be the Inflation Mitigation Act.

Impact on Traditional Hybrid Vehicles:  Traditional hybrid vehicles, which rely on an internal combustion engine and do not use a plug to charge, do not receive a tax credit.  The Prius gets over 50 mpg, both in the city and on the highway while non-hybrid vehicles like the Corolla get around 30 mpg.  The starting MSRP for a Corolla is around $21k compared to the starting MSRP of a Prius of around $28k.  A small tax incentive designed to motivates purchases of traditional hybrids over non-hybrids would substantially reduce carbon emissions in a cost-effect manner.  Furthermore, if the EV tax credit causes some consumers to choose an EV over a Prius, the environmental gains from this proposal will be small.  The EV tax credit is a slap in the face to Prius owners.

Uncertain consumer demand and the emissions standard:  The proposed emission standards set a target for the emissions of the entire fleet sold by a manufacturer in the year. However, the demand for EVs may be less than anticipated leaving the manufacturer short of the emissions target or in a position where the automobile firm must sell EVs at a loss to meet the target.  

Impact of new small inexpensive hybrids:  This article on the proposed emission standard indicates most growth in the EV market will be among small vehicles.  Automakers are now introducing a $25k EV, substantially lower than the average new-care price.  However, a bare-bones small EV costing $25k could be substantially more expensive than a bare-bones small conventional vehicle.  The substitution of a bare-bones EV for a bare-bones conventional vehicle may increase costs for the consumer and have a relatively small environmental benefit.

Impact on the used-car market: Despite the tax credit and the regulations, many people, especially older consumers will resist switching to EVs.  This will cause them to hold onto their vehicles longer and will result in higher used-car prices.  The increase in the lifespan of existing conventional vehicles will reduce improvements in fuel efficiency and carbon emissions, at least temporarily offsetting environmental benefits of the new EVs.

An Alternative Approach:

The most troubling problem with the use of the EV tax incentive is the potentially large impact on the Treasury.  The most cost-effective way to achieve an environmental objective involves the use of the tax code to favor the item that pollutes less over the item that pollutes more.  In my view, it is difficult to justify direct expenditures subsidizing the purchase of personal vehicles when there are large funding needs for other priorities including, improvements in health insurance and expanded private retirement savings.

The EV market could be promoted without a loss of tax revenue through a revenue neutral tax change designed to alter the relative cost of owning EVs and conventional vehicles.  

One approach would involve combining an annual fee for the use of conventional vehicles with an increase in the standard deduction or more generous tax credits for funding a health savings account or an Individual Retirement Account.