By: Samuel Pinson
January 30, 2023
The World Economic Forum in Davos is an annual meeting where leaders from government, business, and civil society address the state of global affairs. Typically, the Forum is a platform for constructive and forward-thinking dialogue to address the most pressing challenges facing the global economic system. A transatlantic trade war between the U.S. and the EU is being thrust into the spotlight amidst inflation, the war in Ukraine, and continued COVID challenges. The catalysts of this conflict are special provisions of the Inflation Reduction Act (the ‘IRA’) that limit accessibility to Clean Vehicle Credits to vehicles and batteries assembled in the United States. Approved in August, the Act houses more than $350 billion of stimulus schemes, ranging from EV subsidies to infrastructure allocations. The Inflation Reduction Act of 2022 (Public Law 117-169) amended the Qualified Plug-in Electric Drive Motor Vehicle Credit (IRC 30D), now known as the Clean Vehicle Credit, and added a new requirement for final assembly in North America. The IRA provisions in question effectively condition Clean Vehicle Credit eligibility on the final assembly of batteries, and the processing of minerals, within U.S. borders.
The Clean Vehicle Credit is the sum of two amounts: the Critical Minerals amount and the Battery Component amount. The Critical Minerals credit totals $3,750. In 2023, to qualify for this portion of the credit, at least 40% of the value of the battery’s applicable critical minerals must have been extracted or processed in the United States or in a country with which the United States has a free trade agreement, or recycled in North America. The 40% threshold increases to 50% in 2024, 60% in 2025, 70% in 2026, and 80% in 2027 and beyond. The Battery Components credit totals $3,750. To qualify for this credit, at least 50% of the battery’s component value must have been manufactured or assembled in North America. The 50% threshold increases to 60% in 2024 and 2025, 70% in 2026, 80% in 2027, 90% in 2028, and 100% in 2029 and beyond
The IRA’s two-fold requirements of critical component extraction and battery component manufacturing favor neighboring countries like Canada and Mexico, where a free trade agreement exists. Importantly, there is no dedicated free trade agreement between the U.S. and the EU. However, the U.S. has free trade agreements with 14 other countries.
Generally, the EU and the U.S. are trade partners. The primary concern highlighted by the EU is that the IRA is anti-competitive, especially from the perspective of the EU auto industry, which exports a large volume of vehicles to the U.S. each year. Moreover, the U.S. accounts for roughly 30% of the total export value of EU-manufactured vehicles. At first glance, subsequent EU-assembled EVs exported to the U.S. would be at an economic disadvantage to U.S.-assembled EVs sold in the U.S. that receive the credit. From the EU perspective, the IRA’s EV tax credit provisions could create a barrier to transatlantic trade.
The EU is concerned that roughly $200 billion of the IRA is predicated on local production requirements for EV components. The EU also claims that the IRA may violate World Trade Organization (WTO) rules. The EU also contends that the IRA is discriminatory against EU-produced clean vehicles and imputes violations of international trade law that unfairly disadvantage EU companies on the U.S. market. The provisions ultimately reduce the choices available to U.S. consumers and weaken the climate effects of the IRA subsidies. The EU is moving towards securing exemptions from local production requirements. Further, some member states are calling for an EU response, or legislation of its own, to put EU manufacturers on equal footing with those in the U.S. Proponents of a counter-legislation favor EU industrialists, and contend that such a response may be necessary to remain competitive.
In addition to general concerns vocalized by EU member states, the IRA may also implicate World Trade Organization (WTO) provisions. Specifically, in the General Agreement on Tariffs and Trade (GATT), to which the U.S. is a signatory, Article III Section 4 states:
- The products of the territory of any contracting party imported into the territory of any other contracting party shall be accorded treatment no less favourable than that accorded to like products of national origin in respect of all laws, regulations and requirements affecting their internal sale, offering for sale, purchase, transportation, distribution or use.
A quick read poses the dilemma of whether the IRA’s twin final assembly requirements implicate the “no less favourable” treatment clause. This language deters member states from favoring domestically produced goods over those produced abroad. Although this matter is not settled, it emphasizes the impact of U.S. policy on the global economy.
The U.S. has addressed concerns from the EU regarding the IRA’s assembly and battery composition requirements. Before the New Year, in December 2022, the U.S. Department of the Treasury published a white paper clarifying various portions of the IRA. Noteworthy was the admission that the term “free trade agreement” is not defined in the IRA. The Treasury and the IRS expect to seek comment in the proposed guidance on what criteria should be used to identify free trade agreements for the Critical Minerals requirement. Expected criteria include:
- [W]hether an agreement reduces or eliminates trade barriers on a preferential basis, commits the parties to refrain from imposing new trade barriers, establishes high-standard disciplines in key areas affecting trade (such as core labor and environmental protections), and/or reduces or eliminates restrictions on exports or commits the parties to refrain from imposing such restrictions, including for the critical minerals contained in electric vehicle batteries.
The EU reacted positively towards this white paper, which also announced that Commercial Clean Vehicle Credits would be available without modifications to auto producer supply chains. However, the white paper did not extend the carve-out to consumer EVs. The EU continues to seek similar, non-discriminatory treatment for the Clean Vehicle Credits of the Inflation Reduction Act that apply to consumer vehicles. The EU’s position is that it is de facto excluded from the relevant IRA provisions. In addition, the EU established an EU-US Inflation Reduction Act Task Force. The purpose of the Task Force is to review solutions to EU concerns. For example, treating the EU the same way as all U.S. free trade agreement partners. The Task Force is necessary for close collaboration between the U.S. and the EU in this dispute.
Complimenting mutual collaboration across the Atlantic, the EU aims to supercharge its EV industry with the proposition of a similar EV scheme to compete with IRA subsidies. The Net Zero Act will launch a series of green initiatives stretching towards the end of the decade, although it has yet to be formally proposed. As part of the broader EU Green Deal, the Net Zero Act would center the global climate industry in the EU.
Domestic auto names like General Motors, Ford, and Tesla, along with European brands Volkswagen and Mercedes-Benz, have all shifted production capacity for EVs to the U.S. For example, Tesla recently announced a $3.6 billion investment in a battery manufacturing plant in Nevada. GM, in September 2022, committed $760 million to retrofit an Ohio plant for EV capacity. Ford committed $5.8 billion to a battery plant in Kentucky. Volkswagen, back in 2019, invested $800 million in a Tennessee plant to manufacture its flagship IQ-4 vehicle; production started at the facility in 2022. Lastly, Mercedes-Benz has committed nearly $1 billion to EV production infrastructure in the U.S., most recently in Alabama. All told, 2022 investment in EV battery plants totaled more than $70 billion, a colossal figure for a revolution decades in the making.
Especially in light of the IRA, these investments in U.S.-based manufacturing are likely to pay dividends moving forward. Domestic manufacturing brings production closer to consumers and ultimately creates a less burdensome logistical situation for auto companies. EU auto manufacturers will likely increase investment in U.S.-based EV battery and production facilities. Under that approach, EU manufacturers are likely eligible for tax credits provided for in the IRA. If the IRA expands to allow for tax credits on EU-assembled EVs and batteries, manufacturers must decide whether to commit to U.S. manufacturing or continue the transatlantic supply route.