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- Category: Tax Law
West Virginia Senator Joe Manchin set off environmentalists last week when he said tax credits to subsidize the purchase of electric vehicle (EV) tax credits are “ludicrous.” His argument: It makes no sense for government to subsidize EV purchases when demand for the vehicles far exceeds supply.
In the short run, Manchin is right. But in the long run his reasoning is exactly the justification for a carbon tax, though he might not want to admit it. If the goal is to use government policy to encourage manufacturers to dramatically increase the supply of EVs, a carbon tax would be much more efficient than an EV credit.
To understand why, start by reading what Manchin said: “There’s a waiting list for EVs right now with the fuel price at $4. But they still want us to throw [a] $5,000 or $7,000 or $12,000 credit to buy electric vehicles. It makes no sense to me whatsoever. When we can’t produce enough product for the people that want it and we’re still going to pay them to take it—it’s absolutely ludicrous in my mind.”
Manchin’s views matter because an increased EV tax credit is one element of the long-stalled effort by President Biden and congressional Democratic leaders to pass a climate, social spending, and tax bill. Currently, the non-refundable credit for a plug-in vehicle can be as much as $7,500. But House Democrats passed an expanded incentive package that could raise the credit to as much as $12,500.
How does that proposal–and Manchin’s criticism—fit with the reality of the EV market?
First, most experts believe the waiting list Manchin talks about is caused primarily by supply constraints rather than excess demand. Like all carmakers, EV producers are struggling with shortages of computer chips. And they also face limited supply of materials for their batteries. Thus, for now, bigger tax credits would result in higher EV prices and more profits for automakers, without putting more cars on the road.
At the same time, today’s high gas prices are caused by shorter-term market factors such as the recovery from COVID-19 that is boosting demand even as Russia’s invasion of Ukraine limits supply. Those higher gas prices—combined with the existing tax subsidies Manchin decries—have generated new demand for EVs.
In the medium-term, all these issues are likely to resolve. As supply chain problems sort out, supply of EVs will increase. And when gas prices fall, so will demand for these vehicles.
But longer term, raising taxes to more closely reflect the environmental costs of fossil fuels likely would drive even greater, more permanent increases in demand for electric vehicles. And by doing so, it will end the need for tax subsidies to encourage these purchases.
As a tool to change behavior, a non-refundable credit is a clear second-choice to a carbon tax.
It benefits only those relatively high-income buyers who least need the subsidy, since the full credit is available only to those whose tax liability is at least equal to the credit amount. And it does relatively little to encourage technological advances since the specific rules around tax subsidies almost always lag innovation.
A better alternative
Then, there is the curious mix of tax policy itself. Today, it has created a bizarre race to the bottom, where government subsidizes oil and gas production, then subsidizes alternative energy so it can compete with fossil fuels.
But imagine an alternative world where government ends all these tax subsidies and instead uses a carbon tax to properly price fossil fuels. It could lower the budget deficit, help limit the damage of climate change, and–properly designed–rebate at least some dollars to households.
There is yet another benefit: It generally takes many years for consumers to change behavior in big ways in response to higher energy prices. They may drive a bit less, but their ability to change driving habits is limited. They still have to get from their homes to work, school, or shopping. And public transit often is unavailable or not convenient.
At the same time, Americans keep their cars for an average of about 11 years. Dumping the gas guzzler and buying an EV requires significant investment. And consumers are unlikely to undertake those costs if they feel fuel price increases are temporary.
But a carbon tax would be permanent—and in fact, would likely increase over time in many versions. Consumers may be more inclined to buy that EV when faced with the prospect of long-term increases in their gasoline costs that better reflect the true price of carbon-based energy.
West Virginian Joe Manchin, who represents a state where coal remains culturally—if not economically—important, is no fan of the carbon tax. But in a funny way, he just made a strong argument in support of one.