It is good to see legislative progress in addressing the effects of climate change, as reflected in the deal announced last week between Senator Joe Manchin and Majority Leader Chuck Schumer. But in some ways the proposal falls short. In particular, subsidies for the purchase of electric vehicles may not be the best way to address global climate change.
The bill specifies a maximum tax credit of $7,500 for a new electric vehicle, extended from the status quo, and a new $4,000 credit for the purchase of a used one.
The first problem should be obvious from recent experience with the stimulus and resulting higher inflation rates: When you give consumers money, it sometimes leads to higher prices. The risk is that these subsidies will lead to more expensive electric vehicles, not more electric vehicles.
Currently, the electric vehicle market is bumping into some constraints on the supply side. If you order a Tesla right now, for instance, you may have to wait months. Ford and General Motors are producing electric vehicles, but it is hardly the major emphasis of their production. At the macro level, the world does not have sufficient battery capacity to succeed with a full-scale conversion to electric vehicles.
An alternative approach might focus on the supply side rather than the demand side. If policy could make electric vehicle batteries cheaper, more efficient and more available, the prices of electric vehicles would fall and consumers would buy more of them. Furthermore, the effects would be worldwide, rather than being limited to the U.S.
Of course it’s possible that increasing demand for electric vehicles would help drive down battery prices and expand supply. But the simpler and perhaps more likely outcome is that, in the short run, both prices and costs for electric vehicles will go up. U.S. consumers will bid away scarce inputs from the rest of the world. There are long lead times for establishing new lithium sources, and a subsidy that will not endure forever (under the bill, it would expire in 2032) may not be enough to give the needed push. Supporting new technologies for sourcing lithium might be a better strategy.
Another motivation for the electric vehicle subsidy might be to boost demand, encourage production, and spur auto companies to find ways to reduce costs. That might happen, but note that a country with rapidly falling per-unit costs in a particular sector is a country with a small number of dominant suppliers, perhaps only one or two. (The company that produces the most will end up with the lowest costs and hold a strong market position.) If the electric vehicle market is somewhat monopolized, more of the benefit of the subsidies will go to the businesses than the customers.
I am not bothered by that outcome myself. But it is not how the policy is being advertised. And if businesses reap most of the benefit in the form of higher profits, electric vehicles might not become so popular.
The bill also has mercantilist elements, which are not ideal from a climate standpoint. The subsidies apply to North American vehicles only, and the battery components must be increasingly American over time, not allowing Chinese components. So to the extent the policy is effective, it will slant the market in the direction of American products.
That is hardly a surprising feature of U.S. legislation. Still, U.S. producers may not be best situated to solve the problem of affordable, scalable electric vehicles. Is it so smart to push the critical growth in electric vehicle production into a relatively high-wage market?