The Biden administration’s hopes to mitigate climate change by promoting green technologies in electric vehicles are partly pinned on the tax credits provided by the Inflation Reduction Act of 2022 (IRA). But the Act also contains so-called domestic content provisions in keeping with its “Made in America” goals. These provisions require that for a vehicle purchase to quality for a tax credit, the minerals in the vehicles and their batteries —including cobalt, lithium, and nickel-- must have been produced by the United States or countries with which the United States has a free trade agreement.
But these two provisions create a problem. The United States and its trading partners do not produce nearly enough of these minerals to make the incentives work. Caught between contradictory imperatives, the administration will have to rethink its priorities. It should start by expanding the number of trading partners who can provide these minerals.
What is meant by "domestic content," and who are "friends"?
At the end of March, the US Treasury Department and the and Internal Revenue Service (IRS) promulgated guidance on implementing the IRA that indicated some latitude in interpreting what is meant by “domestic content.” On the one hand, the guidance signaled that the United States is prepared to move beyond “Made in America” and will expand its critical mineral import sources to include more friendly countries. But this latitude will still exclude vehicles containing Chinese content. Along with the guidance, in a notice of proposed rulemaking, US Treasury and IRS officials also clarified the IRA’s domestic content requirements for critical minerals and electric vehicle (EV) battery components; the rules are due to take effect April 18.
The guidance’s definition of friends – countries with which the United States has comprehensive free trade agreements (FTAs), including Japan, under a recently concluded deal specific to critical minerals – mean cobalt and nickel will remain a challenge, however. To tackle this problem, the United States should widen its aperture on what constitutes a friendly country to include those with which it has significant security partnerships. Cecilia Malmström notes such a deal could be in the works with the European Union, but the bloc faces the same domestic sourcing challenges as the United States.
A $7,500 tax credit is available to a purchaser of a vehicle containing these energy-saving elements in its manufacture and its batteries. This credit is actually two: a $3,750 credit for meeting specific targets for “domestic” critical mineral sourcing (i.e., the raw materials) in the EV battery and a $3,750 credit for “domestic” sourcing of battery components (i.e., the assembled product). The new guidance elaborates specific content requirements to be phased in by 2027. These requirements are already creating confusion among both producers and consumers; many vehicles that currently qualify for the full credit, like the Chevy Bolt and some versions of the Tesla Model 3, may only qualify for partial credit after April 18.
Climate change mitigation goals cannot be met solely through mineral production at home
The United States cannot hope to meet its goals solely through domestic or even North American production. While the IRA has been quite successful in catalyzing investment in US-based EV battery assembly plants and critical mineral recycling, it has not expanded domestic mining capacity. And even if it had, the time lags between announced investments and production with greenfield mining projects are measured in years (if not decades) rather than months.
Time lags notwithstanding, there does not appear to be much appetite for expanding domestic critical mineral production. While EV batteries are produced in state-of-the-art, high-tech facilities like Panasonic and Tesla’s joint venture Gigafactory in Nevada, mining remains an industry fraught with environmental concerns. The Interior Department’s January decision to block planned copper and nickel mining upstream from Minnesota’s Boundary Waters Canoe Area Wilderness highlights many of the environmental and social challenges of trying to widen US supplies through new domestic sources.
In order to address this challenge, the Treasury and IRS guidance lists countries that currently meet the sourcing requirement: 21 with which the United States has a comprehensive free trade agreement, plus Japan through the aforementioned critical minerals deal. The list includes large lithium producers like Australia and Chile but not the world’s top producers of nickel (Indonesia, the Philippines) or cobalt (Democratic Republic of the Congo). An additional challenge is the fact that investments in expanding processing capacity for all three minerals – which is currently dominated by China – lag behind battery assembly. Only two projects (one Tesla lithium processing plant in Texas, one pilot multipurpose facility in Illinois) have been announced since the IRA went into effect. A strategy based on friendshoring will be hard pressed to meet the challenges necessary to access the IRA’s full tax credits unless the United States is able to craft narrow, critical minerals agreements with non-FTA countries.
If accessing the IRA’s incentives will be a challenge, avoiding its punishments may be even more so. Beginning in 2024, any vehicle containing battery components manufactured by a “foreign entity of concern” – a diverse list of terrorist organizations and states but specifically the People’s Republic of China – will not qualify at all. In 2025, the ban extends to critical minerals.
US firms are interpreting the “foreign entity of concern” rule in creative ways that reflect China’s leading position in EV battery markets and test the limits of the domestic content provisions. Ford and Tesla have recently announced new EV battery production sites in the United States in an attempt to comply with the IRA’s foreign entity provisions. Both auto manufacturers are partnering with a Chinese firm, Contemporary Amperex Technology Co. Limited (CATL), to license that firm’s lithium iron phosphate battery technology. Although CATL is not state owned, Senator Marco Rubio (R-FL) has publicly questioned whether the firm might benefit indirectly from the IRA’s tax credits.
These challenges reveal significant limitations in an FTA-based friendshoring approach to securing critical mineral supply chains. At present, the United States’ narrow definition of friendship excludes many third countries like the Philippines, with which the United States has clear (and expanding) security arrangements, and Indonesia. If the goal is to build more resilient supply chains and lessen dependence on China, the United States will need to widen its definition of what friendship means. The foreign entity of concern clause already makes clear who its perceived enemies are.
1. Based on the U. S. & Canada Electric Vehicle Supply Chain Dashboard maintained by James Morton Turner (last updated April 6, 2023; accessed April 7, 2023).
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