The Biden administration on Friday released new rules that will significantly shorten the list of electric vehicles that qualify for federal tax credits. Officials hope the change will push automakers to move their supply chains out of China and into the United States or its allies.
The rules, issued by the Ministry of Finance, are a result of The Inflation Reduction Act, that Democrats passed last year to fight climate change by encouraging the use of zero-emission vehicles and green energy. The law also aims to reduce the industry’s dependence on China, which manufactures most of the world’s batteries and dominates the processing of critical raw materials.
For purchases of their electric cars to qualify for up to $7,500 in tax credits, automakers must meet strict requirements on where they assemble the cars and batteries and where they source the materials that go into the batteries. Only a handful of vehicles are expected to qualify for the full credit when the rules, which are stricter than previous requirements, take effect on April 18, down from 21 now.
The new rules, which could be revised in response to public comments, will require a certain percentage of the components and minerals in each electric car’s battery to come from domestic sources or countries with which the United States has trade agreements.
The full list of eligible cars won’t be published for a couple of weeks, but Tesla has begun informing buyers that the changes would affect its lineup. The company said on its website that the cheapest version of its Model 3 sedan, one of the most popular electric cars, would no longer be eligible for the full credit. The car uses a battery made in China.
James M. Wickett, a partner at Hogan Lovells who focuses on tax and energy policy, said the tax credit for electric vehicles “moves supply chains, up to tens of billions.”
“The details matter in a significant way,” he added.
A key detail on Friday expanded the program to include battery minerals from Japan and paved the way for adding more countries, such as the 27 members of the European Union.
It has officials in the United States, Europe and elsewhere also started discussing plans to build a sort of buyers’ club for critical minerals that could apply pressure on global industry, including setting higher labor and environmental standards for mining, processing and manufacturing.
The race is on for manufacturers whose vehicles do not qualify for US tax breaks to acquire minerals and components that meet the requirements. The credit gives a significant competitive advantage to all cars that reach the rating.
To be eligible, at least 50 percent of the components in an electric vehicle battery must be manufactured in North America. And 40 percent of the minerals used to make the batteries, which often contain nickel, manganese and cobalt, must come from domestic sources or from countries that have trade agreements with the United States. The mineral ratio will increase each year until it reaches 80 percent in 2027, and the component ratio will rise to 100 percent in 2029.
The administration said it would later issue rules clarifying how much investment companies can get from countries like China and Russia and still qualify for tax breaks. The law prohibits the use of critical minerals and battery components from a “foreign entity of concern,” a term that includes companies based in China, Russia, North Korea and Iran.
Siyu Huang, Managing Director of Factorial energy, a Massachusetts company that develops advanced batteries with support from Mercedes-Benz, Hyundai and Stellantis, welcomed the trade deal with Japan. But she said it would be “very challenging” to source battery-grade lithium because almost all refineries are in China.
“The critical part of this is really about where the lithium comes from,” Huang said.
In writing the rules, Biden officials have tried to balance two priorities: encouraging Americans to buy cleaner cars to mitigate climate change, and trying to get more factories for cars, batteries and battery materials to the United States and its allies.
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Business executives, and some analysts, said the administration had sided with the latter goal. Given the limited number of vehicles currently eligible for tax credits, some consumers may decide to wait to buy an electric car until more become eligible in a few years, said William Reinsch, Scholl Chair of International Business at the Center for Strategic and International. Studies, a Washington think tank.
“What always happens when people are unsure is they hold onto their wallets,” Reinsch said.
Jennifer Safavian, CEO of Autos Drive America, which represents foreign automakers such as Toyota, Honda and Volkswagen, welcomed Japan’s inclusion, saying it would help strengthen supply chains. Still, she added, the reduction in the number of eligible cars would slow the growth of electric cars.
But some lawmakers complain that the Biden administration has been too generous to foreign companies. Senator Joe Manchin III of West Virginia, a key player in the Inflation Reduction Act’s writing and passage, said this week that he may file a lawsuit challenging the administration’s interpretation of the law.
In a statement on Friday, Mr. Manchin that the Treasury Department’s guidance “completely ignores the intent” of the action.
“It is appalling that the administration continues to ignore the purpose of the law, which is to bring manufacturing back to America and ensure that we have reliable and secure supply chains,” he said. “American tax dollars should not be used to support manufacturing jobs overseas.”
The legislation has already shaken up the automotive industry. Immediately after President Biden signed the bill into law in August, a provision excluded from the tax credits all electric vehicles not manufactured in the United States, Mexico or Canada.
Hyundai and Kia cars made in South Korea no longer qualified, angering the country’s leaders, who felt betrayed by a close military and trading partner. Sales of South Korean-made electric vehicles have since lost market share in the United States.
The law turned out to be too a major source of friction diplomatically. Leaders of the European Union, Japan and other US allies feared the program would lure investment away from their countries or force them to offer more generous subsidies to compete with the United States.
Because the EU, Japan and the UK do not have free trade agreements with the US, products from these countries, including battery materials, did not qualify for any part of the tax credits.
Under pressure from foreign governments, the Biden administration proposed a solution. In a press release, the Treasury Department said the law did not define the term “free trade agreement,” which “may include recently negotiated agreements on critical minerals.” The Biden administration signed a limited trade agreement with Japan on Tuesday covers essential minerals and is negotiating a similar deal with the European Union.
But the strategy has received strong criticism by lawmakers in Congress, who have said the administration has failed to consult with them on trade policy, or argue that American taxpayer money will now subsidize Japanese industry.
For consumers, the new rules will likely make many electric vehicles more expensive.
At least some Tesla vehicles are likely to remain eligible. The company manufactures cars in California and Texas and batteries in Nevada. General Motors may also be able to qualify quickly as it has begun manufacturing batteries in Ohio in a joint venture with LG Energy Solution. Ford Motor said it would “soon” reveal whether any of its vehicles qualify.
Car manufacturers must certify whether their vehicles meet the requirements for components and minerals. The Internal Revenue Service will enforce the rules. Some vehicles may only qualify for half the credit if, for example, they meet the component quotas but not the mineral quotas.
The list of eligible cars is expected to grow as it becomes easier for companies to buy processed lithium and other materials from US trading partners such as Canada and Australia. Many companies are develop mines and build refineries. More cars will also qualify as Hyundai, Ford, Honda and other automakers finish building new car and battery factories in the United States.
And a loophole in the law allows companies to collect the credits if they lease vehicles to customers, even if the cars don’t meet the purchasing and manufacturing requirements. Automakers and their dealers can pass these credits on to consumers by reducing monthly lease payments.