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Saturday, July 26, 2008

What's Wrong with the Hybrid Tax Credit for Gas-Electric Cars

[Note: This is a "director's cut" of some scribbling that appeared in the Sunday opinion pages of the Atlanta Journal Constitution on July 20. That version is not available online.]

There's an old saying in politics that as every new crisis arises, Congress strives mightily to appear to do something about it. Whether or not it actually does something constructive is another question.

Take the matter of the tax credit for people who buy hybrid gas-electric powered cars, worth up to $3,400 per purchase. Preparing this article I asked a half-dozen acquaintances whether they approved of the credit and would like to see it continued or expanded. They all said "yes", emphatically. Why? Because, they say, the hybrid credit puts more gas-efficient cars on the road to reduce gas consumption and help the environment. And because it enables them to pay less when buying an energy-efficient car.

So Congress has succeeded in its objective -- it appears to have addressed the gas crisis with the tax credit.

But here are five reasons why this tax credit may actually achieve much less than my friends think, both for the environment and their pocketbooks:

1) Say you are driving an old Oldsmobile getting too-few miles to the gallon, and $4 gasoline has finally convinced you it's time to upgrade. You are looking to get the best deal for yourself and the environment.

As you shop around you'll find you get no tax credit for buying a high-mileage conventional-engine car like the Toyota Corolla (32-mpg), nor for improving your mileage whatever car you buy by getting it with a standard transmission. But you can get a $2,200 tax credit for buying a SUV with a hybrid engine, like the GMC Yukon that gets only 20 mpg.

In other words, the tax credit rewards not high gas mileage but the makers of hybrid technology -- even when it is the lower-mileage option.

Well, you may think, you can use the credit to buy a top-mileage hybrid-powered car like the 48-mpg Prius. But no, you can't. Congress never wants to be too generous, so it limits the number of vehicles each maker sells that are eligible for the credit. There's no more credit for the Prius.

But as the most popular, top-mileage hybrids like it "sell out" and become ineligible for the credit, the credit remains in place to help sell other unpopular low-mileage vehicles. The Chevy Tahoe SUV, also around 20 mpg, gets a $2,200 tax credit too. And if your Chevy dealer has a 2007 Silverado pickup still in stock, about 17 mpg, you can use a credit of up to $650 to buy it.

2) What Congress gives through the tax code openly with one hand it often takes back slyly with the other. With the hybrid credit it does this through the Alternative Minimum Tax (AMT).

Persons subject to the AMT aren't eligible for the credit. And the profile of hybrid purchasers closely matches that of those subject to the AMT -- they have above-average household income and disproportionately live in states with tax rules likely to make them subject to the AMT, such as California, New York, Massachusetts, and Virginia.

Four million taxpayers were subject to the AMT last year -- but you can't tell if you will be this year because Congress hasn't set the AMT rules for 2008 yet. (Last year it didn't set them until December.) If you might be subject to the AMT this year, you'll just have to guess whether you'll be eligible for the hybrid credit.

3) The price of hybrids is increased by the tax credit for them. Whenever the government creates a purchase subsidy for a product, sellers try to grab it by raising their price. Compare the sale prices of car models that are the same except for having a hybrid engine and you'll find the hybrid versions consistently are significantly more expensive. Part of this is due to the tax credit.

If you are eligible for the credit you will still benefit from it, just by not as much as you think. If you lose the credit to the AMT, you will be stuck with a higher price, period.

4) Buying a car that gets better gas mileage is not the same as consuming less gas. Double the miles-per-gallon your car gets and you'll feel you can afford to drive more miles. To the extent you do, you give back your reduced fuel consumption. If you double your driving you don't reduce fuel consumption at all. You are better off personally because you've reducing your cost of driving (or perhaps not*) -- but the environment isn't any better off.

If you buy a hybrid you probably won't increase your driving by that much. But to the extent you (and other hybrid drivers) do so at all, environmental savings are less than you expect.

5) The total gas savings from all the hybrid cars on the road amount to barely a drop in the ocean of oil consumption. The savings may increase of course, but only over many years.

This is a basic problem with trying to reduce gas consumption by focusing on vehicle fuel efficiency -- you have to turn over the entire fleet to get the result you want. With CAFE standards that mandate increased miles-per-gallon for all cars this can take a decade or more. With the hybrid credit that applies to only a small percentage of cars it will take ... well, a lot longer.

So as a hybrid driver you may feel that you are doing your small personal part to reduce oil consumption and help the environment. But Congress for its part has done basically nothing at all to improve the big picture with the hybrid tax credit (even assuming it isn't used to sell SUVs and pickups!)

Is there a better, more efficient way to reduce gas consumption and help the environment through the tax code?

Yes, certainly: increase the tax on gasoline. This trumps the hybrid credit in all five ways above...

(1) It encourages all fuel saving practices -- including buying standard transmissions -- exactly in proportion to the fuel savings they obtain, with no handouts to makers of a favored technology even when perversely inefficient. (2) No hidden rules or tax traps affect it. (3) It adjusts prices and resale values of vehicles exactly in proportion to their fuel efficiency -- not giving a price "bonus" to sellers. (4) It focuses tightly on reducing gas consumption, and (5) its gas-saving impact is universal and immediate.

Moreover, it doesn't even have to cost taxpayers anything on net, because the gas tax could be rebated through lowered income taxes, employment taxes or some other way.

Yet my own friends, and the voters in general, have made it very clear they don't want a gas tax increase, while they do approve a hybrid tax credit that is far less effective at reducing fuel consumption, inequitable in its application, and more costly to them. So that is what Congress has given them.

Which brings to mind a saying of H.L. Menken's that may be paraphrased in a family newspaper thusly: Democracy is the political system that assures the voters get what they want, no matter how much it costs them.
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* Footnote: This wasn't part of the story because it doesn't relate to the tax credit per se, but hybrids are just plain expensive. In rankings of auto model affordability by total ownership cost by Edmunds.com, the highest-ranked hybrid was only 14th, the Honda Civic, followed by the Prius at 26th and the Altima at 59th. Forget the rest. (These rankings include the effect of the tax credit.)

"Same model" vehicles that differ only by having conventional engines typically are less expensive, for instance the conventional Civic ranked 5th. In fact, even with gasoline costing $6 a gallon, Edmunds.com has the conventional Civic costing less to own than the hybrid version.

So if your objective is to "save the planet", a hybrid-powered car may be an option, though usually not as good a one as most people think, with the psychic reward being worth the dollar cost to you.

But if your objective is to save money due to $4 gasoline, you'll almost surely do best by making a smart purchase of a conventional gasoline-engine car.
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PS: The endorsement of gas taxes above does not mean I've joined the Pigou club (as if anyone has invited me). It's made only in comparison to other interventions such as CAFE standards and the hybrid credit.