A Tale of Two Policies: Electric Vehicle Tax Credits

Finally, after being distracted by other events the past two weeks, I am able to take on the electric vehicle (EV) tax credit. Conveniently, the Scholl Chair will publish a Critical Questions publication on the same subject later this week that will tell you what you need to know.

First, here is an abbreviated summary of the provisions that have aroused controversy. There are other limitations, such as a cap on the price of vehicles that can qualify and on the income of consumers seeking to receive the credit, that do not raise trade issues.

EVs are eligible for a maximum total credit of $7,500, of which $3,750 is based on the amount of the battery’s critical minerals extracted in the United States or a country with which the United States has a free trade agreement, or have been recycled in North America. At least 40 percent of the value of the battery must contain critical materials extracted from these areas, and that percentage will increase over time. The remaining $3,750 is based on the value of the components of the battery manufactured or assembled in North America. At least 50 percent of the value of the battery’s components must come from here, and that amount will increase over time.

Additional restrictions will be phased in starting in 2024 and 2025, including the exclusion of EVs from the tax credit if battery components, including refined minerals, come from “foreign entities of concern,” meaning primarily China. Furthermore, in 2025 the battery components cannot be extracted, processed, or recycled from a “foreign entity of concern.”

The issues I would like to discuss are whether the provisions violate World Trade Organization (WTO) rules and whether WTO legality really matters—in other words, how are companies going to respond in the real world?

The developing legal consensus appears to be that the provisions violate GATT Article III (national treatment) as they treat some imports worse than domestic autos, and also GATT Article I (most favored nation) because they treat some countries (Canada and Mexico) better than others. The provisions also violate the Agreement on Subsidies and Countervailing Measures (SCM) because the credit is contingent on the vehicle being assembled in North America. There will be debate among lawyers—no surprise—about the last two, but the national treatment violation seems clear cut.

The outcome is predictable. We will be sued in the WTO by other producing countries, most likely the European Union, Korea, and Japan. We will lose and appeal to the currently nonexistent WTO Appellate Body, thus leaving the case in limbo. If the other countries retaliate even though the case is not finally resolved, we will sue them, win, and the other countries will appeal, which will go into the void. So, there is not likely to be a practical effect from the litigation except that lots of lawyers will make lots of money. The sinners will keep on sinning.

There will be, however, the institutional effect of further weakening the WTO and the embarrassing effect of putting the United States at odds with an institution it helped create and has strongly supported since its inception. That will make it harder for the United States to criticize other countries, such as China and India, for failing to adhere to the international rules when it is itself a prime offender. In other words, our credibility is shot, and the rules-based trading system takes a big hit.

In the real world, however, that may not make much difference. Congress appears to have created a standard that no one, including the U.S. auto manufacturers, can meet, at least in the short run. CSIS’s Jane Nakano has produced a commentary on this that concludes no vehicles currently on the market in the United States are likely to qualify for the full tax credit when the strict battery requirements take effect because of the prohibition on using Chinese minerals. For example, China refines 73 percent of the world's cobalt, 68 percent of its nickel, 59 percent of its lithium, and 40 percent of its copper.

The Biden administration defends the provisions by arguing they are intended to incentivize the development of domestic battery supply chains but acknowledges that will take time. It is right about that, but the question is how much time. Since the average time in the mining sector from discovery to production is 16.5 years, even with accelerated permitting, an entirely domestic supply chain will take longer to create than the restrictions on the tax credit, which come into effect in 2024 and 2025. So, the United States will remain dependent on imports for the near term. There are Chinese alternatives—Canada and Chile are prime candidates, as is the Democratic Republic of the Congo.

Meanwhile, auto companies have to figure out what to do, which is also predictable. They will moan and whine for several more months, but at the same time, develop plans to either meet the requirements or produce vehicles that will be competitive without the tax credit. Many foreign producers already have assembly plants in the United States which they have decided to convert to EVs in response to the anticipated shift in market demand. Others may decide to build plants here, as Kia recently announced. You can also be confident that all of them are busy developing alternative supply chains that exclude Chinese materials. So, while they will no doubt continue to complain, and their governments will support them, over time the problem may solve itself, albeit in a way that produces more expensive autos made with more expensive parts.

There is an alternative. Congress could decide that creating a standard no one can meet may not have been the best idea, and it might take a second look at it. It might also be encouraged to do that by the environmental community, which will remind it that the point of all this, in its view, is to accelerate the transition away from internal combustion engines and toward EVs, and this standard slows that down.

The administration once again is caught in the trap of conflicting policies. It wants more EVs for climate reasons, but it wants them to be U.S.-produced with U.S. or friend-shored materials for supply chain resilience reasons. As with solar panels, it appears not to be possible to achieve both objectives at the same time. It appears that Donald Trump may not be the only one who cannot have his cake and eat it too.

William Reinsch holds the Scholl Chair in International Business at the Center for Strategic and International Studies in Washington, D.C.     

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