Automotive Tax Credits Explained
The automotive industry is at a tipping point, with a growing focus on sustainability and the need to reduce carbon emissions. Electric vehicles (EVs) have emerged as a preferred solution to combat climate change, and governments worldwide are taking steps to incentivize their production and adoption. Companies are responding by pivoting their production lines to focus on EVs – Tesla has become one of the largest companies in the world producing electric cars and domestic stalwarts like GM have announced a total conversion to EVs in their business plans. Government subsidies and tax credits are a significant driver of this strong company pivot.
Subsidies, or financial incentives provided by governments, are a key driving force behind EV production. Subsidies can take various forms, such as direct payments, grants, or discounts on purchase prices; they are designed to make EVs more affordable and competitive compared to traditional gas powered vehicles. In particular, the new tax credits that took effect on April 18th, 2023, are focused on reducing the cost for the end consumer to drive EV demand.
The new tax credits offer up to $7,500 to consumers who purchase a new eligible EVs. Unfortunately for consumers, the range of EVs meeting the regulatory criteria for the credit is narrow. Only a handful of models currently comply with the regulations around where the batteries and parts are sourced. Furthermore, a majority of the vehicles receiving credits are both expensive and in limited supply. The irony is that the funding for these tax credits comes from the Inflation Reduction Act. Rather than helping the inflation-impacted consumer, these subsidies for EVs are more likely to stimulate spending, making it harder for the Fed to reign in the economy. Furthermore, given the prices of the EVs right now, the subsidies will mostly be utilized by individuals with above average incomes – the population least impacted by inflation.
While the benefit of the tax credit for consumers is debatable, it’s definitely going to help the auto manufacturers. Some of the price mark ups we’ve seen suggest the consumer is simply an intermediary and a majority of the tax credit is essentially a direct transfer into the pocket of the automakers. In fact, automakers announced price increases in the summer of 2022 when the size and scope of the tax credits was finalized. Both GM and Ford fought a media campaign suggesting the price increases and the tax credit’s weren’t connected but the coincidental timing with the tax credits certainly raised some eyebrows.
A direct transfer to the automakers isn’t necessarily a bad thing. The shift to EVs is difficult and wildly expensive; it’s a true paradigm change. The whole automotive system is being rebuilt, from the factory floor to the supply chain to the dealer and aftermarket relationships. Simply building new plants costs billions of dollars, and that doesn’t even start to account for the costs of renegotiating Union contracts, training or hiring laborers with new skill sets, or building new electric focused service networks. This electronic evolution is expensive, and the automakers need every dollar they can get.
Furthermore, the competitive landscape is also shifting. 2023 sees competition finally coming back to the auto industry after years of consolidation, supply chain rearrangement, and a focus on margins over market share. For context; during Covid, supply chains collapsed and new car manufacturing slowed to a crawl. Meanwhile, consumer demand increased as people relocated to suburbs with underutilized disposable income. With limited manufacturing capacity and cash flush consumers, automakers focused on making higher margin vehicles with higher price tags. While this was good for the automakers in terms of their bottom line, it had the broader negative impact of making cars overall more expensive and less affordable; new and used cars were one of the early drivers of inflation.
High prices, low supply, and low interest rates made the automotive space attractive for new entrants. Several new auto manufacturers have sprung up across the globe. Some, like Tesla, have become established, while others, like Rivian or Lucid, are both still trying to find their footing. Foreign rivals selling in the US market have also seen an opportunity to take market share in lower cost tiers as much of the domestic EV production has shifted up the price chain.
Automakers Aren’t A Buy
In addition to the shifting landscape we’ve described above, there are three other reasons why we don’t believe the automotive industry is the place to invest right now, even with the new tax credits coming out.
First, on a macro level, it’s difficult to ascertain what direction the industry will head in the next few months. Rising interest rates are taking their toll on the industry, impacting both the consumer and the manufacturer. For the consumer, rising rates and elevated prices means larger loan payments. Similarly, the cost of capital matters for automotive companies who are financing new factories and building new supply chains.
Pressures from rising rates are compounded by broader economic pressures. The recent banking crisis and general pressure from inflation and interest rates has made large lenders more cautious. Broadly speaking, credit is tightening up and US consumers and small businesses will soon feel the pinch.
One example is Capital One’s recent withdrawal from the dealership financing space. Dealership financing is how car dealerships can afford to have large lots full of vehicles displayed to customers. As companies like Capital One pull back on financing it becomes more expensive for dealers to carry inventory. That means dealership margins or inventories have to get smaller.
Second, as alluded to in the previous section, the automotive industry is getting exceptionally competitive as EVs become more ubiquitous. The industry is seeing supply chains normalize and car availability is starting to rise. Although the tax credits are only available for a small range of vehicles, more and more companies are getting their electric production lines scaled up. The fierce competition for market share is about to begin. Tesla is a perfect example of this, having now cut the price for several vehicles more than a half dozen times in the past year. Gone are the days of having the cars sold before they’re made. Now it’s about manufacturing efficiency and market share.
Finally, there are still a lot of unknowns for EVs. Despite the considerable policy push in that direction, many American consumers aren’t sold on EV reliability or longevity. Furthermore, there are many lingering concerns around EV safety. For example, electric battery fires burn much hotter and longer than typical engine fires, and very few fire departments have experience dealing with EV accidents.
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