Most Model 3 Buyers Will Not Get $7,500 Tax Credit

By · April 21, 2016

The response to the launch of the Tesla Model 3 earlier this month exceeded all expectations. Diarmuid O’Connell, Tesla vice-president of business development, told reporters last week that the total number of pre-orders was approaching 400,000. He was speaking at a conference in Amsterdam. Given the number of orders, it’s likely that the majority of Model 3 buyers will not benefit from the $7,500 federal tax credit, which phases out after a manufacturer sells 200,000 electric cars.

The Recovery and Reinvestment Act of 2009 was aimed to help get the young EV market off the ground by offering a $7,500 tax credit toward the purchase of eligible plug-in models. Like a similar (although smaller) tax credit for hybrid cars a decade ago, the $7,500 credit was never intended to be a permanent program. The sunset period is based on a manufacturer’s overall sales—not those of an individual model.

Beginning in the second calendar quarter after an individual carmaker records sales of 200,000 eligible EVs, the maximum credit drops to $3,750. Six months later, it drops to $1,875—and six months after that, it’s gone for good for that automaker. Congress could opt to extend the program, but that is far from certain in the current political climate.

A Victim of Its Own Success

The phasing out of the federal tax credit for Tesla—with Nissan and General Motors not far behind—requires a recalibration of EV affordability. Suddenly, the MSRP of, say, a $35,000 Model 3 or $70,000 Model S, will become an absolute price, rather than the figure resulting from subtracting $7,500 from the sticker. Besides, few customers buy these vehicles at the base price. For example, according to Morgan Stanley, the average transaction price for a Model S is nearly $105,000.

Perhaps automakers with the most sales will reach economies of scale on EV components such as batteries, resulting in reductions in the sticker price—thereby allowing them to compete with automakers that can still use the tax credit to entice consumers. Regardless, most of the intended buyers with deposits on the Model 3 should plan on not benefitting from the $7,500 tax credit.

Already a Smash Success

To put the response to the Model 3 in perspective, the best selling luxury vehicle in the United States in 2015, the Lexus RX, sold just over 100,000 units last year. If Tesla magically managed to deliver on first-year demand—keep in mind that $1,000 deposit are refundable—the Model 3 would smash every conceivable sales record for luxury cars several times over. In fact, the Model 3 would threaten the vaunted Toyota Camry—with nearly 430,000 sales in 2015—as the number one selling passenger car in America.

Why are so many people putting down money for a car that’s still in the design phase and more than a year and a half away from scheduled production? In some way, it’s the same reason people camp outside Apple stores when a new iPhone is released: buzz. Yet, the rush to be high on the list could also be partially assigned to consumers trying to take advantage of a dwindling allotment of federal EV tax credits for Tesla vehicles before it’s too late.

The Cruel Math

Through the end of March 2016, Tesla delivered cumulative US sales of more than 70,000 units of its Model S. In its year-end report, the carmaker projected global Model S and Model X deliveries of at least 80,000 units. Let’s assume that roughly half of those cars go to the US, and sales here remain flat in 2017. That would leave fewer than 50,000 tax credits left for Model 3 depositors. (Please correct any miscalculation in the comments section below.)

With the Model 3 due in late 2017, Tesla will likely pass the 200,000 sales mark by mid-2018 regardless of how fast it ramps up production on the $35,000 Model 3. That would give buyer just about 12 months of sales after the launch to purchase one with the full credit intact. By the start of 2019, Model 3 credits will probably shrink to $3,750, and at the end of the year, the help from Uncle Sam will entirely disappear.

Tesla says it still plans to sell 500,000 units per year by 2020—a lofty production target—although many analysts believe it will be a major challenge for Model 3 production to hit full capacity by that time. Those concerns are somewhat based on hiccups Tesla experienced during the ramp-up of production for the Model S and Model X.

As opposed to racing to maximum output, Tesla could also strategically throttle production in order to preserve the credit for as long as possible. It also might make sense to give American purchasers priority—and limit exports to other countries—for as long as the federal incentive still exists. Whatever measures are taken, its very unlikely that even half of the 400,000 early reservations will enjoy a full $7,500 off the Model 3’s starting price. And buyers not already on the list for the Model 3, or ready to buy an X or S in the next year or two, should not even think about the tax credit when considering a purchase of a Tesla vehicle.

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