The United States government has a long history of providing tax incentives to encourage desirable individual behavior. Classic examples include tax breaks for owning a home, paying for employee health insurance, and making long-term capital investments. We can judge the merits of incentive programs on two primary dimensions: the beneficial side effects the behavior creates for the rest of society (positive externalities), and the reduction of economy inefficiency that might occur in a free market (deadweight loss). Similarly, we can criticize tax incentives that do not provide sufficient benefits in comparison to the cost: lower than expected positive externalities, an undesired distortion in individuals’ behavior, or an unintended participant capturing a majority of the benefits.
For example, various complex government policies lower the effective cost of borrowing money to buy a home. In theory, higher home ownership stimulates job creation and tends to improve the surrounding neighborhood. On the other hand, the same policy might encourage consumers to take on high-leverage, risky loans. Rising housing prices may form or fuel an asset bubble that can wreak havoc on the economy at a future, inconvenient time. The improved return on investment may invite speculators who buy multiple homes and operate illegal hotels.
Back to electric cars, Exhibit 1 shows a screenshot of the ordering page for a typical new Tesla Model S. The top price shown is actually the “Cost After Estimated Savings” price. Only after more careful examination below do we see the cash price.
Tesla also sells certified pre-owned cars (not eligible for tax credits), which carry generous manufacturer warranties of 4 years and 40,000 miles. Exhibit 2 shows a very lightly used vehicle from the certified pre-owned store within the Tesla site, with features that closely match the new vehicle in Exhibit 1. As expected, the used car pricing is a predictable function of the new car price AFTER subtracting tax incentives. Both parties are mindful of the subsidy, but are they the only ones capturing any value? Is the tax incentive a pure transfer of wealth from the public to a luxury car buyer?
The initial goals of electric vehicle incentives are admirable. Americans want to reduce their reliance on foreign oil and encourages the research and development of alternative energy sources. When the first electric hybrids arrived on the market (Toyota Prius), the price was significantly higher than comparable sedans, even after factoring in gasoline savings. The policy aimed to encourage faster adoption of low emission vehicles among price-sensitive consumers.
The tax credit also helped overcome a subtle chicken-and-egg problem from being the first manufacturer to sell plug-in electric vehicles. Early on, there is little demand to build a network of plug-in charging stations, which makes the vehicles less convenient to own, which further reduces demand. By having the government stimulate some initial demand of vehicles and supply of charging infrastructure, the industry can overcome the difficult initial period and later utilize the network effect to accelerate faster diffusion.
Today, we have already reached excellent coverage along most major highways and urban centers. Communities exist that map out entire routes of charging stations so that electric vehicle drivers can travel confidently without worrying about finding a charging location.
Who is really benefiting from the tax credits today? At least for higher end luxury vehicles, the demand should be relatively inelastic, and almost all of the benefits are going to parties that would have transacted without the subsidy. If that were the case, the government should phase out and end the subsidy.
To examine the demand elasticity, one could analyze electric vehicle sales as a function of consumer gasoline prices, expecting a substitution effect as people opt for electric cars when gas prices rise. So far, the limited data is discouraging, with some studies citing 0 correlation. Although we need more robust studies before drawing firm conclusions, my hypothesis would be that many electric vehicles are long past the need for a government subsidy. A Tesla is clearly a luxury goods and the buyer or seller should not receive a public subsidy.
Fortunately, we are seeing some reaction from governments around the world to exclude luxury vehicles from the tax incentives. In the United States, the latest proposal expands the federal tax credit to a maximum of $10,000, except the increase excludes cars with a purchase price over $45,000. That’s an encouraging step, but in my opinion, if the data shows the tax credits no longer serve the right purposes, we should phase out incentives for all electric vehicles as soon as possible. (Word Count 800)