The Inflation Reduction Act includes complex new rules governing the $7,500 federal tax credit available to taxpayers who purchase electric vehicles, and strict new eligibility criteria will disqualify the majority of EV models. A major provision denying the credit to EVs assembled outside of North America went into effect immediately, angering U.S. trading partners in the European Union, Japan, and South Korea. Luxury models that exceed MSRP price caps will soon be disqualified, denying the credit to another broad segment of the EV market. The few EV models that remain eligible will face challenging new rules regarding the sourcing of battery materials, and these restrictions appear to favor plug-in hybrid electric vehicles (PHEVs) over battery electric vehicles (BEVs).

The new battery sourcing requirements are designed to end U.S. reliance on foreign supply chains, but a sufficient supply of locally sourced battery materials will be difficult to obtain during the early years of the program. While the sourcing requirements apply to BEVs and PHEVs in a uniform way, it will be easier to qualify PHEVs for the tax credit because of their much smaller batteries.

PHEVs are hybrid powertrains that can be powered exclusively by gasoline but can also travel short distances using electricity imported to a small battery. In order for a PHEV to qualify for the same generous tax credit as a fully electric BEV, the new rules are quite lenient, requiring just a 7 kilowatt-hour (kWh) battery. The batteries in BEVs are much larger. The standard Tesla Model 3 comes with a 50 kWh battery, and the dual-motor long-range and performance versions use 82 kWh batteries. The long-range version of the Ford F-150 Lightning requires a 131 kWh battery.

Faced with a limited supply of qualified battery materials, automakers that market BEVs and PHEVs will likely respond by prioritizing the smaller batteries in their PHEVs, securing the tax credit for these models as soon as possible. Even if they develop new supply chains quickly, it will be a couple of years before they can begin qualifying the larger batteries in their BEVs. Tesla currently sells the vast majority of U.S. BEVs and does not manufacture PHEVs. The company has already started developing domestic supply chains and is believed to be in a strong position to satisfy the sourcing requirements.

Sadly, the new rules allow PHEVs to qualify for the tax credit even when they do not provide significant reductions in tailpipe carbon dioxide. The Jeep Wrangler 4xe PHEV is a good example. It currently qualifies for the full $7,500 credit. The Environmental Protection Agency’s fueleconomy.gov website states that the PHEV’s 2.0 liter 4-cylinder engine gets just 20 miles per gallon, which is significantly worse than the Wrangler EcoDiesel’s 3.0 liter 6-cylinder engine, which delivers 25. When running on electricity, the Wrangler 4xe has a modest electric range of 22 miles and earns an MPGe rating of just 49, which is significantly worse than the least efficient BEV, an Audi e-tron S with an MPGe rating of 63. Toyota’s disqualified RAV4 Prime has an electric range of 42 miles and is almost twice as efficient as the Wrangler 4xe, earning a respectable MPGe rating of 94 and an MPG of 38.

The Treasury Department will implement the complicated new tax rules and is expected to announce specific administrative procedures by the end of the year.