An Electric Debate: Local Content Requirements and Trade Considerations

In August 2022, U.S. Congress passed the Inflation Reduction Act (IRA). With $369 billion in climate investments, the IRA is the largest clean energy investment in history. The full package is expected to reduce economy-wide emissions by roughly 40 percent below the 2005 baseline by 2030. The legislation consists largely of incentives rather than regulation—carrots instead of sticks—and aims to bolster U.S. energy security and domestic manufacturing via tax credits and domestic content requirements. One provision of the bill that has garnered fierce debate is the electric vehicle (EV) tax credit scheme.

Q1: What incentives does the legislation provide for EVs?

A1: The IRA aims to make EVs more affordable to U.S. consumers as a means of spurring greater demand for EVs over autos with internal combustion engines (ICEs), but another goal of U.S. policy is to promote the development of domestic or near-shored supply chains for EVs.

Accordingly, the legislation includes caveats that limit the qualifications of many vehicles based on how the car and battery are produced. When Congress passed the law on August 16, 2022, only new vehicles with final assembly in North America could receive the tax credit, although the provision does not apply to previously owned or commercial vehicles.

Many of the additional qualifications are effective in 2023. This includes specifications on critical minerals and battery components. The EVs are eligible for a maximum $7,500 tax credit. Of the total, half is based on the number of critical minerals in the battery that are extracted either in the United States or a country with which the United States has a free trade agreement (FTA) or which have been recycled in North America. The threshold for batteries’ critical minerals increases over time from 40 percent. While the first half of the credit is therefore based on mineral content of batteries, the second half of the credit is based on assembly in North America. This part of the credit depends on at least 50 percent of the value of the battery’s components being assembled in North America, and this amount also increases over time.

Furthermore, in 2023, other requirements come into effect, including that qualifying sedans must be under $55,000, and larger vehicles must cost less than $80,000. Furthermore, qualifying consumers must be below a given income bracket, which is set at $150,000 for single applicants and $300,000 for those who file jointly.

There will be additional restrictions phased in starting in 2024 and 2025. Perhaps the most contentious part of the legislation is the provision that excludes EVs from qualifying for the tax credit if battery components, including refined minerals, come from “foreign entities of concern,” including China. This provision goes into effect in 2024. Furthermore, in 2025 the battery components cannot be extracted, processed, or recycled by a “foreign entity of concern.”

It is very challenging, if not impossible in the short term, for a vehicle to meet all these requirements and therefore to obtain the full value of the credit. The Biden administration put out a list of 21 cars that were immediately eligible for credits upon the passage of the law. As CSIS’s Jane Nakano notes, the Treasury Department put out a statement indicating that only one-fifth of 2022 and 2023 models will remain eligible for the credits next year. Furthermore, it is likely no vehicles currently on the market in the United States would be able to qualify for the full tax credit when the strict battery requirements take effect. China plays a critical role in refining most of the key minerals required for manufacturing batteries, meaning it will be burdensome, if not impossible, for companies to build supply chains without Chinese inputs. For example, China refines 73 percent of the world's cobalt, 68 percent of nickel, 59 percent of lithium, and 40 percent of copper.

Q2: What concerns does the provision invite at the WTO?

A2: Given that the EV provision entails a tax credit by the U.S. government to producers operating in North America, there are at least two measures of the World Trade Organization (WTO) this could violate. These are the national treatment provision in General Agreement on Tariffs and Trade (GATT) Article III, and the Agreement on Subsidies and Countervailing Measures (SCM).

The prevailing view among lawyers is that the domestic content requirements violate GATT Article III:4 and Article 3.1(b) of the SCM Agreement. With respect to Article III:4, Korea – Various Measures on Beef (2001) outlined three criteria for violations. The first criterion of a violation is that domestic and imported products be treated as “like products.” The second criterion is the enforcement of a law that would affect the internal sale, purchase, distribution, and use of the imported product. Third is that the imported product is afforded less favorable treatment than the domestic product. The EV tax credit meets all three of these criteria. Further, in India — Autos –India – Autos (2002) the panel declared that when the sole distinction criterion is the origin of the product, then the imported and domestic products must be treated alike. In the same case, the panel said that an internal tax could affect the conditions of the imported product in the market and thus constitute less favorable treatment. In ﷟Japan – Film (1998), the panel stated the words "" call for effective equality of opportunities for imported products in respect of the application of laws, regulations and requirements affecting the internal sale, offering for sale, purchase transportation, distribution or use of products.”

Under the SCM Agreement Article 3.1(b), in the case of US – Tax Incentives (2017), the Appellate Body observed that the SCM Agreement does not prohibit domestic subsidies but rather prohibits subsidies provided upon the condition of using domestic goods over imported goods. The EV tax credit provided in the IRA thus violate the SCM Agreement because it requires EVs to have critical minerals extracted in the U.S. or a country with which the United States has a free trade agreement to be eligible for the full tax credit.

However, Article XXIV of GATT permits WTO members to provide advantages to any WTO member with which they have a free trade agreement, but such a measure should not raise barriers to trade for other contracting parties. In the case of Turkey – Textiles (2001), the Appellate Body stated that the purpose of this article is to facilitate trade between constituent members and not to raise barriers to trade for other countries. Thus, the violation of Article III:4 of GATT and Article 3.1(b) of the SCM Agreement could be justified under Article XXIV of GATT, but the concern that the IRA provisions fundamentally discriminate against foreign goods remains. 

GATT Article III says that foreign products should not be treated differently from like domestic products. Different treatment of domestic and foreign products can take the form of different taxation—as seen in the Japan – Alcoholic Beverages (1998) case where the Japanese government taxed vodka and other alcohols at higher rates compared to Sochu, a local liquor in Japan. The Appellate Body upheld the panel finding that vodka was unfairly taxed.

Article XX provides broad protection for countries to enact policies that protect the environment. However, the United States would have to demonstrate that the EV tax credit is “necessary to the protection of plant and animal life” or “relating to the conservation of exhaustible natural resources.” Furthermore, the EV tax credit must meet the requirements of the chapeau of Article XX, which states that the regulation is applied in a nondiscriminatory manner between countries. Arguably, it could be a challenge for the United States to justify its action under the chapeau of Article XX because the EV tax credit includes special treatment for North American countries and U.S. FTA partners.

Q3: How does the EV tax credit intersect with the USMCA?

A3: The United States-Mexico-Canada Agreement (USMCA) laid out detailed language on rules of origin (ROO), particularly related to autos. Existing USMCA rules of origin for autos have content and wage requirements that determine what constitutes a North American auto. However, a major shortcoming of the USMCA is that it failed to consider EVs and the complex nature of batteries and their supply chains in determining ROOs.

Under GATT Article XXIV, the United States can claim that it is not creating a restricted environment for EV and EV products that are imported from other countries, but rather facilitating and promoting trade in North America under the USMCA. However, as noted previously, this could be a weak argument due to the discriminatory nature of the EV tax credit against foreign goods. 

Mexican and Canadian government officials have welcomed the IRA. Canadian trade minister Mary Ng said that the IRA “recognizes the Canada-United States integrated supply chain, by giving tax incentives for the purchase of electric vehicles made by North America.” Canada has reserves of each of the critical minerals necessary for EV production, and it is also a USMCA partner. As a result, it stands to be one of the major beneficiaries of the provision. Mexican officials, meanwhile, heralded this legislation as inspiring greater regional integration by encouraging the manufacturing of batteries and EVs in North America.

Q4: How have partner countries responded?

A4: Some countries have responded negatively to the U.S. EV subsidies because of the strict criteria on assembly in North America and other limiting criteria that could be seen as discriminatory.

The European Union is generally supportive of the United States’ IRA because it represents a step in the right direction regarding sustainability. However, the European Commission has come out against the discriminatory nature of these tax credits. European Commission spokesperson Miriam Garcia Ferrer publicly stated, "We think it's discriminatory, that it is discriminating against foreign producers in relation to U.S. producers . . . Of course this would mean that it would be incompatible with the WTO."

In Europe, industry critics have been vocal as well, including German automakers. Hildegard Mueller, who heads a lobbying group representing German auto companies, said, “We are critical of the fact that the subsidy is tied to conditions which relate to local value creation and therefore disadvantage products from third countries. . . . The European Commission is called upon to clearly advocate for non-discriminatory support here.”

South Korea has also expressed similar concerns and highlighted that the IRA would not only violate WTO rules, but also its bilateral free trade agreement. "Korea is deeply concerned that the recent U.S. Senate's EV tax incentive bill includes provisions for providing tax incentives discriminating between North American-made and imported EVs and batteries," the Korea Automobile Manufacturers Association said.

South Korea requested that the United States ease the rules regarding battery components and final assembly. In September, the Korean and U.S. governments agreed to hold ongoing ministerial-level talks over the provision. South Korean trade minister Ahn Duk-geun said, “I plan to meet [U.S. trade representative Katherine] Tai every week, including next week and the week after that.” Furthermore, on the sidelines of the recent United Nations General Assembly (UNGA), President Yoon Suk Yeol addressed President Biden on this topic and expressed South Korea’s concerns at the highest level. South Korean officials have requested that the administration considers greater flexibility for Korean car companies, including possibly postponing the strict tax credit qualifications on manufacturing until key Korean manufacturer, Hyundai, finishes building a factory in Georgia in 2025.

Q5: What does the EV tax credit say about the U.S. approach to the nexus of trade and industrial policy during the energy transition?

A5: The pursuit of the EV tax credit in the United States is the result of a hard-fought compromise over the Biden administration’s Build Back Better agenda, the hallmark of its plan to combat climate change. However, it also underscores an emerging tension at the nexus of trade and climate, which is the inherently conflicting nature of protectionist trade measures and the need to accelerate the green transition. By providing tax credits only for vehicles that meet assembly and mineral content rules, the United States risks slowing down the transition since manufacturing a fully compliant vehicle would require the standing up of new mines, processing facilities, and manufacturing plants, which cannot be accomplished ahead of the EV tax credit implementation deadlines.

The rules do not preclude a foreign manufacturer from constructing a supply chain that adheres to the rules and whose products thus qualify for the tariff benefit. There is already some evidence to suggest that companies are headed in this direction. Kia, for example, recently announced its intention to expand North American production of EVs to meet the tax credit criteria. While the EV tax credit has already cooled diplomatic relations with some of the United States’ closest allies, it remains to be seen whether additional foreign companies will pursue policies that will eventually enable them to receive the full tax credit—or whether they will decide it is not worth the hassle. Alternatively, there is also the possibility Congress can be persuaded to adopt a standard that can be met more quickly and easily.

William A. Reinsch holds the Scholl Chair in International Business at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Apeksha Chauhan and Elizabeth Duncan are interns with the Scholl Chair in International Business.

The Scholl Chair also thanks former intern Kaycee Ikeonu for his helpful input.

Critical Questions is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

© 2022 by the Center for Strategic and International Studies. All rights reserved.

Apeksha Chauhan

Intern, Scholl Chair in International Business

Elizabeth Duncan

Intern, Scholl Chair in International Business