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Due to a quirk in the clean energy rebates for electric vehicles recently passed by Congress, the IRS accidentally triggered a phony electric vehicle “price war,” as many news outlets called it, only to reverse its decision, likely costing Tesla millions in lost profit. The issue centers around a provision in the Inflation Reduction Act that governs the electric vehicle rebates. In order to prevent rich folks getting a rebate for super-luxury vehicles, the law only permits the maximum $7,500 rebate to be applied to cars with a manufactured suggested retail price (MSRP) up to $55,000 and trucks, sport utility vehicles (SUVs), and other large vehicles up to $80,000 in price.
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This sounds simple enough, but in the current American vehicle market, the difference between a car and an SUV is less of a line and more of a spectrum. Cars like a Honda Accord, Tesla Model 3, Hyundai Sonata, and Toyota Camrys are clearly sedans with four doors and a trunk (or, in the Model 3’s case, a frunk), and therefore cars. A tall, high-riding vehicle with a rear storage area contiguous with the passenger compartment and off-road capabilities that can fit seven passengers like a Nissan Pathfinder, Honda Pilot, Ford Expedition, and Chevrolet Tahoe is clearly an SUV. But what about a somewhat tall, medium-high-riding vehicle that can fit five passengers with two-wheel drive? Is that a car or an SUV? As amusing as it would have been, the IRS did not come up with its own definition of an SUV. Instead, it adopted the standards used by the Environmental Protection Agency when calculating the fuel economy standards for manufacturers. This standard sorts vehicles into the categories of “cars” and “light trucks,” with cars having stricter standards than light trucks. As a result, manufacturers routinely game the system to classify car-like objects as light trucks.Ironically, when the IRS chose to adopt these classification standards, it meant most models of the “crossover” Tesla Model Y would be a car, because Tesla has no incentive to game the system to hit fuel economy standards (the Model Y comes in two variations, a five-seater and a seven-seater; the seven-seater is a “light truck” even though the rest of the car is basically the same). As a result, the Model Y, with an MSRP over $55,000, was too expensive to qualify for the $7,500 rebate, which you can see in the archived version of the IRS’s list of qualifying cars and the MSRP limit, except for the seven-seater version, which is an SUV, and would qualify under the $80,000 MSRP limit.
The IRS announced it would be using this standard and the accompanying MSRP limits for each model at the end of 2022. Two weeks later, Tesla announced a massive price cut for the Model Y. The new entry-level version got the biggest price cut of $13,000, or 20 percent. The new starting price would be $54,630, just under the $55,000 MSRP limit for cars.Shortly thereafter, Ford announced its own price cuts for the Mustang Mach-E, its five-seat electric crossover. The media went nuts, declaring it an “electric vehicle price war” despite no other electric vehicle manufacturer participating. This is perhaps because the Mach-e was in a similar situation as the Model Y, classified as a car by the IRS and therefore many trims were too expensive for the tax credits. This state of affairs was confusing, because it is very hard for ordinary people to look up a vehicle’s size classification under the corporate average fuel economy standards. Meanwhile, the Environmental Protection Agency has a separate vehicle classification system that is much easier for people to look up because it is explicitly intended for consumers. That is at fueleconomy.gov, which classifies the Model Y as an SUV.On Friday, the IRS admitted this is needlessly confusing and announced it would switch from using corporate average fuel economy classification and start using the one meant for consumers. “This change will allow crossover vehicles that share similar features to be treated consistently,” the IRS said in a statement. “It will also align vehicle classifications under the clean vehicle credit with the classification displayed on the vehicle label and on the consumer-facing website FuelEconomy.gov.” Now, if you go to the current version of the IRS’s list of qualifying cars and MSRP limit, the Model Y is up to $80,000 for all models. So is the Mach-E. Of course, it is impossible to say for sure that the Tesla and Ford price cuts were entirely because of the IRS classification mess. But it sure looks like the IRS got thousands of people an unusually sweet deal on a Model Y. I’m sure the Thank You cards are already in the mail.