IRA EV Tax Credits: Requirements for Domestic Manufacturing

The Inflation Reduction Act (IRA) included a $7,500 consumer tax credit for electric vehicle (EV) purchases, renewing and modifying the existing tax credit. EV sales substantially increased their market share in recent years, rising from 3.2% of all vehicles sold in the U.S. in 2021 to 5.8% in 2022. The Biden administration hopes to continue that trend by setting a target to make zero-emissions vehicles half of all new vehicles sold in 2030. The administration views tax credits as an important tool to encourage EV purchases because, while buyers save on the cost of fuel, EVs typically cost more than non-electric vehicles due to the high cost of producing EV batteries.

Requirements for Vehicle Components and Assembly

Manufacturing EVs and their batteries is a complex process involving several stages of production that can each take place in different countries.

The IRA includes three sets of requirements related to vehicle components and assembly for EV models to qualify for tax credits, with the intention of bolstering domestic production.

• Assembly in North America:
  As part of the IRA, final assembly of electric vehicle models must occur in North America to be eligible, effective immediately after the enactment of the legislation.
• Critical minerals and battery components:
  To qualify for the full $7,500 credit, vehicles must meet two sets of standards related to their vehicle components. If a vehicle only meets one of these two requirements, it qualifies for a $3,750 tax credit.
  • 50% of the value of battery components must be produced or manufactured in North America in fiscal year 2023, with the minimum percentage increasing annually.
  • 40% of the value of critical minerals used for the vehicle must be extracted, processed, and/or recycled domestically or in a country the U.S. has a free trade agreement with, with the minimum percentage increasing annually. EV manufacturing requires a range of minerals, including cobalt, copper, nickel, graphite, and lithium.

However, the Department of Treasury announced it will need until March 2023 to develop guidance for the critical mineral and battery component requirements, including which countries are considered free trade partners and what activities are considered battery component manufacturing. As a result, these provisions have not been in effect as of February—a delay that invited criticism from Sen. Joe Manchin (D-WV).

• Entities of concern: Starting in 2024, vehicles with any battery components manufactured or assembled in an “entity of concern” are not eligible for the tax credit. Beginning in 2025, vehicles with critical minerals extracted, processed, or recycled by entities of concern will not qualify. Nations of concern include China and Russia.

Notably, requirements for final assembly in North America as well as battery and critical mineral requirements do not apply for the commercial clean vehicles tax credit.

Potential Impact of Domestic Requirements

The congressional intent of the domestic EV content and manufacturing requirements was to support jobs, grow the economy, and protect national security while building energy independence. Beyond just their use in EVs, diversifying critical mineral supply chains, creating increased domestic sources, and insulating them from disruption is necessary in the long run to support decarbonization through clean energy projects.

Currently, the U.S. accounts for only 10% of global EV assembly and 7% of battery production—and a tiny fraction of critical mineral mining and processing. China, on the other hand is responsible for more than 75% of lithium-ion battery production and supplies over half of the world’s processing and refining capacities for lithium, cobalt, and graphite.

Domestic manufacturing standards may not substantially affect the rate of EV sales in the immediate future, because demand has recently outstripped supply due to supply chain and other constraints. In fact, automakers sold every EV they could produce with long waiting lists for some models for much of 2022, though waiting lists have diminished lately. The challenge Congress tasked automakers with is to adapt their manufacturing operations to meet increasing standards over the next decade while building up sufficient supply to satisfy the growing demand for EVs. Meeting IRA standards necessitates also increasing domestic critical mineral mining—efforts underway and supported by some of the steps Congress has taken discussed below.

Building Supply Chain Capacity

The American auto industry is better prepared to meet the final assembly requirements, with 10 best-selling EV models assembled in the U.S. Ramping up critical mineral and battery production is a greater challenge. Fortunately, a slate of recent policies advance this goal:

• The Energy Act of 2020 and the Bipartisan Infrastructure Law (BIL) together implement several new programs and initiatives to drive innovation in processing, recycling, and alternatives for critical minerals. Notably, the BIL includes $2.8 billion awarded to 20 companies to extract and process critical minerals for EVs and manufacture and recycle battery components.
• The Inflation Reduction Act made battery manufacturing and critical mineral processing and mining eligible activities under the 45X production tax credit.
• The BIL and IRA both include measures for a more efficient federal permitting process, including the establishment of a committee to address critical mineral permitting.
• The Biden administration invoked the Defense Production Act and leveraged the DOE’s Loan Program Office—which is also supported by the BIL and IRA—to fund the expansion and modernization of critical mineral sites.
• The CHIPS and Science Act supports research to advance critical mineral mining strategies and technologies.

Early Signs of Progress

The Thacker Pass Lithium Mine project in Nevada, which was permitted in 2018, is expected to produce 60,000 tons of lithium chemicals a year by 2025, about 9% of expected global demand by one estimate. However, local opposition to the project highlights the challenge of bringing new mines online while limiting pollution, reducing other environmental impacts, and generating buy-in from local communities. While EVs produce far less in greenhouse gas emissions over their lifecycle than gas vehicles even when accounting for mining, refining, and manufacturing, these processes do require significant emissions and pose risks such as potential biodiversity loss, water pollution, and air pollution. However, other innovative mining projects, such as those at the Salton Sea in southern California, are showing early promise for greener mining with robust community support.

Honda and LG Energy made a $4.4 billion investment to build a battery plant in the U.S. with mass-production capability projected by 2025. Toyota also announced a $3.8 billion investment to build a battery plant in North Carolina. Meanwhile, the Loan Programs Office recently announced a $2 billion loan commitment for the construction and expansion of a battery components campus in Nevada, among other loans for battery recycling and lithium and graphite processing.

Conclusion

When it comes to EVs, the IRA aims to have its cake and eat it too—increasing sales through tax credits while limiting those incentives to vehicles developed in North America and trade-partner nations. For this to work, the auto and manufacturing industry will have to rapidly transform their operations to scale up domestic manufacturing quickly.

Industry efforts to meet the IRA’s tax credit requirements will be shaped by federal policy. Treasury’s upcoming guidance could include added flexibility, for example outlining a broad definition of free trade partners that includes many of our allies. On the flip side, a perceived weakening of domestic content and assembly requirements could anger key congressional champions of these measures. Accelerating domestic manufacturing will also require more efficient permitting and environmental review processes.

While it is encouraging to see ambitious investments in EVs and EV charging, the ultimate success of legislation like the IRA will depend on its strategic implementation over the next decade, along with coordination between the public and the private sectors.