IRA and the EV Tax Credits—Can We Kill Multiple Birds with One Stone?

This commentary is part of Action Impending, a series exploring the impact of the Inflation Reduction Act on the energy transition in the United States.

Nearly $369 billion worth of clean energy and climate incentives under the Inflation Reduction Act (IRA) include a set of provisions for the supply chains for clean vehicles, including electric vehicles (EVs) and hydrogen fuel cell vehicles. In particular, the levels of support and types of conditions that the EV tax credits would merit have garnered much attention since the EV tax credit provisions originally appeared in what is known as the Build Back Better legislation. EV deployment has not only become a synonym for decarbonizing the transportation sector, but also the return of supply chains to the United States.

For passenger vehicles, the $7,500 tax credit is designed to stimulate EV demand and follows administration action to jump-start a nationwide deployment of EV charging stations, such as the National Electric Vehicle Infrastructure Formula Program.

Under the IRA, EV tax credits are available at different levels to both new and used EVs, and for non-passenger vehicles. Specifically, half of the EV tax credit is available if EV battery components are manufactured or assembled in North America. The other half of the credit is available if battery minerals are extracted, processed, or recycled in the United States or come from a country which has a Free Trade Agreement (FTA) with the United States. When these tax credits go into effect in January 2023, the North American share of battery component manufacturing and assembly (per monetary value) must be at least 50 percent, and the FTA or North American share of mineral contents (per monetary value) must be at least 40 percent.

With this tax credit system, Congress wants to support the deployment of EVs, but only if the auto companies can create a domestic supply chain. Such domestic content requirements underscore the challenge of balancing decarbonization, domestic economic interests, and energy security. These different objectives are sometimes aligned and sometimes in tension. For example, the IRA requirements significantly narrow the list of models that qualify for the EV tax credits. Only one-fifth of 2022 and 2023 models will remain eligible for the full federal tax credit starting next year, according to the mid-August guidance by the U.S. Treasury Department. The number of eligible models will likely decrease as the mineral content threshold rises to 80 percent by 2027, and the battery component manufacturing and assembly threshold will rise to 100 percent by 2029. If companies wish to access the credits, they will need to change their production plans and build new supply chains, potentially slowing EV deployment.

Indeed, the content requirements will likely slow the growth of the U.S. EV market in the next few years. However, the EV deployment will not come to a halt. For example, EV sales in the United States continued even after several manufactures hit the 200,000-vehicle cap and lost the incentives under the previous tax credit system. As seen in the past, some manufacturers may choose to reduce prices to offset the absence of tax credits. Also, tax credits do not need to be the only or primary incentive. Some consumers will likely buy EVs even without a tax credit in order to lower their monthly spending on transportation, avoid gas price volatility, or to satisfy climate or other consumer preferences. Indeed, the prospect of mitigating exposures to high and volatile gasoline prices may remain as an important incentive. By the end of this decade, the share of EVs in the total light-duty vehicle sales could hit 57 percent due to the IRA.

Fundamentally, these provisions create incentives to build a more resilient supply chain. If the incentives are sufficient, industry stakeholders can expect to see an EV battery supply chain that will have more resilience to disruption, either from natural disasters, trade barriers, or geopolitical forces. Indeed, the EV tax credit provisions are not just about decarbonization and economic competitiveness. The law imposes an additional condition prohibiting the application of EV tax credits where any components or critical minerals is sourced from a “foreign entity of concern,” i.e., China, Russia, Iran, or North Korea. The U.S. vision for secure EV supply chains has an undeniable dose of geopolitical assertiveness.

To date, China is the world leader in global EV supply chains, especially midstream battery component manufacturing and downstream EV manufacturing and assembly. China is not only home to over half of the global processing and refining capacities for lithium, cobalt, and graphite—key EV battery minerals—but also accounts for about 75 percent of lithium-ion battery production, 70 percent of cathode production capacity, and 85 percent for anode production capacity in the world. While companies can still use battery components and materials in EVs meant for the U.S. market, they will not be eligible for subsidy.

Also, although this is somewhat overlooked, Russia currently plays an important role in the global EV supply chains by supplying 20 percent of global high-purity nickel, which is highly valuable for nickel-based cathodes that dominate EV battery chemistries today, and “are expected to remain so in the future,” according to the International Energy Agency analysis. This will limit the supply of nickel for U.S.-bound EV battery materials and components.

Notably, the U.S. approach to EV “friend-shoring” has raised some frustration and consternation among its allies. The European Commission has called the IRA “discriminatory” against non-U.S.-made cars while Japan has raised “a doubt about its WTO conformity.” Moreover, South Korea raised the concern over the law’s potential violation of the U.S.-South Korea FTA during a recent meeting between the two countries’ national security advisors. In fact, South Korea, like Japan, is a key source of global processing capacity for EV battery components (the two countries together account for about 29 percent of the global cathode material production capacity, where China accounts for the remainder), but the battery content criteria under the IRA do not include FTA countries, and thus preclude the Korean components from qualifying for the manufacturing/assembly half of the EV tax credits. How the U.S. administration will address these trade concerns from close partner countries, some of them also important investors in the emerging U.S. EV battery supply chains, warrants close attention.

The key question is whether the EV tax credits will actually work to establish U.S. and nearshore supply chains for EV battery minerals and components. The United States’ FTA partner countries, such as Australia, Canada, and Chile, are rich in battery minerals. For example, Australia is the largest producer of lithium in the world. Meanwhile, the United States is still in some early days of scrutinizing the existing web of federal and local mining permits and addressing NIMBY-ism. The U.S. Department of Energy has started making investments in battery manufacturing capacity and critical mineral processing facilities through the Defense Production Act (DPA) and Loan Programs Office (LPO) authorities, but a domestic supply chain is years away at best.

In terms of battery component manufacturing and assembly, Canada’s growing investments demonstrate an important and viable path towards more secure supply chains through the North American partnership, although the country had no EV battery production capacity as of 2021. The United States itself accounts for only 10 percent of EV production and 7 percent of battery production capacity in the world today.

Prior to the IRA, about 70 percent of battery production capacity that has been announced through 2030 is in China. Since the IRA enactment in mid-August, however, several major announcements to investment in U.S. EV battery capacity have been made. These include the $4.4 billion investment by Honda of Japan and LG Energy Solutions of South Korea to build a battery plant, which is scheduled to come online in 2025, and the $3.8 billion investment (an increase from $1.29 billion) by Toyota of Japan to build a battery plant in North Carolina that is scheduled to open in 2025. By the time that the IRA EV tax credits expire in 2032, about 30 to 50 percent of EVs could meet the content requirements, according to the BloombergNEF. Advancing the decarbonization of transportation sector and securing supply chains for EV battery components and minerals is an arduous task. Delivering concurrently on both goals is even more challenging, but that is precisely the mission that the IRA has set.

Jane Nakano is a senior fellow in the Energy Security and Climate Change Program at the Center for Strategic and International Studies in Washington, D.C.

Commentary 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).

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Jane Nakano
Senior Fellow, Energy Security and Climate Change Program