US Favors Securing EV Supply Chains over Subsidizing Consumers

Given the blowback from US allies on the Inflation Reduction Act’s (IRA) Clean Vehicle Credit, the US Treasury Department has responded by amending some sourcing requirements. If these changes are implemented as planned in March, they will modestly ameliorate allies’ concerns by allowing “friend-shoring” of certain parts of the electric vehicle (EV) battery supply chain. But the changes won’t make it much easier for EV manufacturers to qualify for the full $7,500 EV tax credits.

So when it comes to the competing goals of securing a domestic EV supply chain versus consumer subsidies to accelerate EV adoption, as highlighted in our previous analysis, the US administration appears to have made its choice in prioritizing supply chains over faster adoption.

In fact, the IRA’s subsidy scheme is similar to China’s that once excluded those EVs with foreign batteries from qualifying for subsidies. The main difference, of course, was that China already had its own domestic battery manufacturers.

“Friend-Shoring” Battery Inputs Made Easier

While the US government has not changed the North American EV final assembly requirement to qualify for the full tax credit, it has tweaked around the edges to mollify allies. These tweaks amount to 1) allowing allies to keep some of the battery supply chains in their countries and still benefit from the tax credit; and 2) expanding the network of countries that can essentially substitute for China in the supply chain because that is a key plank of the US government’s industrial policy.

One of those changes—which was welcomed by the European Union and South Korea—stipulates that leased EVs can qualify for the commercial clean vehicle credit that isn’t subject to North American assembly or other sourcing requirements. Another change is that the US government is expected to negotiate and identify new trade agreements to allow more allied countries to be involved in securing upstream critical minerals. The European Union and Japan, which don’t have a free trade agreement (FTA) with the United States, could benefit from these negotiations.

The adjustment with the most immediate impact, however, is permitting certain essential battery ingredients, such as cathode and anode active materials and foils, to be made outside of North America via simply recategorizing them as “constituent materials.” By contrast, under the current rules these ingredients are categorized as “battery components,” which are subject to strict North American manufacturing requirements (see Figure 1).

Figure 1. More Battery Ingredients Can Be Made Outside of North America

1a. Component Sourcing Requirement under Current Rule

1b. Component Sourcing Requirement under Proposed Rule
Source: UL Research Institute; author modifications.

As such, a company like South Korea’s LG Energy Solution (LGES) can plausibly qualify for half of the tax credit ($3,750) with a little effort. That’s because LGES already makes the cathodes, anodes, cells, and modules that account for nearly 90% of the battery cost and has already made a choice to invest in North America (see Figure 2). It just needs to expand scale to meet the mandate of having 100% battery components made in North America after 2028. In essence, these changes to the IRA can help the handful of South Korean and Japanese battery makers that have already invested in or intend to expand production in North America, as highlighted in our previous case study.

Figure 2. Battery Cell Cost Breakdown
Note: Breakdown doesn’t include costs related to module manufacturing.
Source: BloombergNEF.

Supply Chains over Affordable EVs

However, these adjustments to the IRA are moot unless battery makers can completely wean themselves off of Chinese battery inputs. Starting in 2025, any vehicle containing critical minerals or battery components from a “foreign entity of concern,” which includes China, won’t qualify for the tax credits even if the entire battery is assembled in North America.

What this amounts to is a US government that is doubling down on industrial policy and friend-shoring to secure a domestic supply chain at the expense of subsidies to incentivize EV adoption.

After all, if the main goal were to promote EV adoption, qualifying for the tax credit would be much simpler and more straightforward. It would look a lot more like the playbook adopted by Norway, where 80% of the new cars sold in 2022 were EVs. Norway in effect subsidizes the consumer by exempting EV purchases from the 25% value-added taxes. In addition, Norwegians don’t have to pay an acquisition tax based on emissions, making EVs cheaper than internal combustion engine vehicles regardless of where the EVs are made.

Even major auto producers like Japan and Germany don’t have their EV consumer subsidies tied to sourcing requirements. South Korea, potentially in response to the IRA, recently introduced a new EV subsidy scheme that favors Korean brands but eschews sourcing or local content requirements.

If anything, the IRA’s sourcing and local content requirements most resemble China’s EV subsidy program that promoted domestic manufacturing. At the same time, however, China was also able to get consumers to adopt EVs at a fairly rapid pace by selling affordable models.

Whether the United States will see a similar outcome after it has secured the EV supply chains remains to be seen. Over the next few years, though, with difficulty qualifying for tax credits and the costs associated with suppliers trying to comply with the IRA, EVs could become pricier rather than cheaper. That seems like a price the US government is willing to bear.