The federal electric vehicle tax credit is the primary policy being used to induce drivers to purchase EVs, and last Wednesday the bipartisan Driving America Forward Act” was introduced to expand the tax credit by 400,000 vehicles on top of the existing 200,000 vehicles eligible per auto manufacturer in terms of cumulative sales.  Given that proposal, it is useful to ask, what are we buying with these tax credits?

There is no doubt that the tax credit program is a straight-up subsidy program with some unsavory aspects. While it is not all that expensive in the grand scheme of the federal government—The Congressional Budget Office estimated that the federal credit will cost $2.0 billion between 2009 and the end of 2019, that cost will go up if the vehicle cap is raised by 400,000—it is a gift to the rich. A study by Severin Borenstein and Lucas Davis found that the EV tax credit was disproportionately going to high-income households, with the top income quintile receiving about 90 percent of all the tax credits. Lastly, on a cost per ton basis, the tax credits are expensive. As of 2012, CBO estimated that the EV tax credit reduces emissions at a cost between $300 and $1,200 per ton, depending on the battery size of the EV, which is significantly higher than most estimates of the social cost of carbon.

However, as the volume and market share of EVs grow, the costs of producing these vehicles should drop, subsequently bringing down the per-ton costs of the tax credits. This begs the question of how effective the tax credits have been at incentivizing the adoption and deployment of EVs in the United States, and if further subsidies should be expected to reduce costs.

Measuring the effectiveness of subsidy programs to incentivize the purchase of EVs is hard, but it has been tried. A 2016 study by Gil Tal and Michael Nicholas used a choice experiment to establish the impact of the federal tax credit on the EV market. The authors concluded that 32.5 percent of plug-in EV sales between 2010 and 2014 could be attributed to the federal incentive, because the purchaser would have purchased an internal combustion alternative without the tax credit. Almost 257,000 of the EV models they assessed were sold in the United States between 2011 and 2014; implying the tax credit incentivized the purchase of about 83,500 EVs that would have otherwise not been sold. Their results also indicate that the tax credits advanced the purchase time of a new vehicle by at least 12 months. If correct, that study indicates that tax credits will spur some EV purchases, but only a minority of them.

The cost competitiveness of EVs is heavily dependent on the cost of the batteries, which comprise roughly 49 percent of the cost of an EV. Cost reductions in battery technology are reliant on the mass manufacturing of EVs and the federal electric vehicle tax credit is driving the scale-up of EV manufacturing. Almost every industrial activity shows signs of a learning curve, i.e., as volume scales, learning occurs, and prices drop, and the battery sector is benefiting from the integration of lessons and innovations that build over time. Research from Bloomberg New Energy Finance indicates that there is a 19 percent learning rate in electric vehicle batteries, meaning that for every doubling of cumulative capacity, we observe a 19 percent reduction in price.

A little back-of-the-envelope math shows how that learning rate could justify the extension of the EV tax credit. Using EV stock forecasts from the Edison Electric Institute, we can expect EV batteries to break the $100/kwh threshold by roughly 2026, at which point most experts agree that EVs would be cost competitive with traditional vehicles. Without the tax credit, the cumulative stock of EVs would grow more slowly, and price parity would not be reached till roughly 2029.  Increasing the vehicle cap by 400,000, as the Driving America Forward Act would do, would mean that the tax credits for EVs would have a total budgetary cost of $4.5 billion per manufacturer spread over the years it would take the manufacturer to reach the 600,000 vehicle cap.

The EV market, and the battery technology supporting it, are both nascent industries, and the premature removal of these tax credits could negatively affect their growth. These tax credits can reasonably be expected to speed up the adoption of EVs and help companies push down the learning curve, and in the absence of something better, it makes sense that policymakers would support their expansion. The tax credits’ role in expanding the EV market, and the beneficial spillovers being realized by the battery industry, make this a worthwhile incentive to keep pursuing to achieve emissions reductions in the transport sector … at least for the time being.