Jan 2, 2019 6:43 PM

Tesla's $7,500 Tax Credit Goes Poof, but Buyers May Benefit

To offset the phase-out of a federal tax credit, Tesla cut the price of its cars by $2,000—which might be better for some buyers.

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Tesla has built its business on being a pioneer. It was the first automaker to produce electric cars that were fast, fun, and desirable, with battery ranges measured in hundreds instead of dozens of miles. Now it’s pushing into another new, less welcoming, frontier. Elon Musk's company just became the first automaker to lose access to the full $7,500 federal tax credit designed to spur the adoption of electric cars. As of January 1, its customers qualify for only a $3,750 credit. Over the next year, the credit will disappear entirely.

In response, Tesla announced today it’s cutting the price of all its vehicles by $2,000. That doesn’t quite cover the shortfall, but for some buyers it could work out better than the full credit—particularly if it ever delivers on its promise of a much cheaper Model 3.

“If you look at behavioral economics, a $2,000 instantaneous price reduction, rather than a tax credit redeemable a year in the future, does have some benefits for some people,” says Mike Ramsey, an automotive analyst at the research firm Gartner.

The tax credit came to life with the 2008 Energy Improvement and Extension Act, as a tool to narrow the price gap between expensive electrics and cheaper gas-powered cars. It applies only to the first 200,000 cars a manufacturer sells—an arbitrary threshold beyond which, the thinking went, they shouldn’t need as much help. Tesla sold that magic milestone car in July last year and got another two quarters of full credit for its buyers. For the first half of this year, the credit is cut in half. It halves again to $1,875 for another half-year until the end of 2019, then disappears altogether. Tesla has joined with General Motors (which has reportedly also just hit the 200,000 mark)¹ to lobby for an extension, so far without success.

The thing is, getting a $7,500 tax credit isn’t always the same thing as buying a car for $7,500 less than its sticker price. Claiming a credit depends on having a tax bill in the first place. To owe at least $7,500 in federal tax (and therefore get the full amount back), you must make more than $52,000 a year. If you have other deductions to offset against your taxes, like a mortgage, student loan payments, or childcare costs, you must earn even more.

Most of those 200,000 Teslas were luxury Model S sedans and Model X SUVs, whose buyers were likely high earners. But Tesla is pushing downmarket with the Model 3. Musk has promised a $35,000 version of the car sometime this year. It’s reasonable to expect people with smaller paychecks to want one. People for whom an upfront, $2,000 price cut might just work out better financially than the full tax credit—and for whom it might make a bigger psychological difference, as well as reducing monthly payments on a loan.

Some states offer their own financial bonuses to encourage driving on electricity. California, for example, offers rebates of up to $7,000 for buying a zero-emission car. That comes as a check in the mail, after a few weeks, and the final amount depends on income. But to make buying an EV simpler for lower-income buyers, the state is experimenting with an instant rebate, where the check goes directly to a dealer, reducing the purchase price.

“Anything that makes it easier for the buyer is only a good thing,” says Chelsea Sexton, a longtime EV advocate. But dropping its prices comes with a risk for Tesla. “The concern is wanting them to succeed as an automaker, and this lowers the profitability of their cars,” Sexton says. Tesla is still a small automaker, teetering on the edge of profitability. It can’t absorb the loss as easily as GM could, if it were to lower the price of its Bolt EV. Indeed, Tesla’s stock price dropped 10 percent when it released the news this morning along with its production numbers for the final three months of last year, which were shy of expectations.

Still, that quarter was the company’s most productive ever. It pumped out 86,555 vehicles from its Fremont, California, factory, 70 percent of them Model 3s. It totaled 245,240 deliveries on the year. “To put our growth into perspective, we delivered almost as many vehicles in 2018 as we did in all prior years combined,” Tesla points out in a statement to investors.

“There remain significant opportunities to continue to grow Model 3 sales by expanding to international markets, introducing lower-priced variants and offering leasing,” the company says, attempting to reassure investors that there’s still plenty of room to grow sales and keep pushing into new territory—with or without the help of the US government.

¹ Updated at 8:15 pm EST on 1/2/2019 with the latest report on GM's electric vehicle sales.