How to screw up an incentive program: By the numbers

A couple days ago, I decried the impending end of the State of Texas’ “Light-Duty Motor Vehicle Purchase or Lease Incentive Program,” which provided $2,500 for certain types of vehicles, including my faves, plug-in electric & electric/hybrid vehicles.

Didn’t know I was into EVs? You must be new here…

Anyway, I’ve been thinking about how both the federal income tax credit and the Texas rebate could have been much more effective.

Don’t panic: The federal income tax credit is NOT expiring anytime soon, unless legislation repeals it. In the case of the Volt, there have only been 76,136 sold so far in the U.S. Nissan Leafs have 78,231 cars out there. The federal incentive does not begin to go away, until 200,000 of each vehicle is sold. We’ve got a ways to go…

Of course, there have been debates about how appropriate it is for the government to promote these vehicles through an “entitlement.” I have voiced my opinion on this before. If we throw out the debate on appropriateness, we’re left with thinking about the effectiveness of these programs. Of course, I have a few opinions…

First of all, to be effective as a program, it has to become known. I am astounded every week, when a potential EV customer come in, who is unaware of these programs. As I mentioned, in the post about the Texas program ending, not only the potential buyers, but even the sales staffs at dealerships who sell plug-in vehicles are woefully uninformed. Thankfully, there are dealerships who want to lead in this new market, who do make sure information is presented to their sales staffs and consequently, to their customers. Unfortunately, these are in the VAST minority of dealerships. But what about billboards, public service announcements, etc? “Spread the word” does not seem to be understood by our government officials.

Next, linking the purchase of a plug-in to other benefits can help. In California, owners of these vehicles can get a sticker (albeit large and ugly) for their vehicle that entitles them to drive in high-occupancy vehicle lanes, reducing their commute time. That program has been a huge success and, as a result, California is an EV hotspot. I’ve seen frantic posts on-line asking if California’s program was ending, how many stickers were left and other methods of gnashing one’s teeth. These Californians cared deeply about those stickers and I guarantee you there are plug-in drivers in California that never would have thought about driving a plug-in vehicle, had it not been for the program. (apparently it was well publicized) Texas has not done this yet, but with all the new toll roads popping up, I think it could be a great attractor to plug-ins.

But here’s the real problem:

The Income Tax Credit and the Texas Rebate are after-purchase incentives. In other words, if you want a plug-in that costs $40K, you will finance the entire amount (minus trade-in value, manufacturer incentives and down payment). Then, about eight weeks after you file the paperwork for the $2,500 Texas rebate, it arrives. But your monthly car payment is unaffected. In January or February, after your plug-in purchase, you can finally claim the tax credit on your income taxes. Eight to twelve weeks after you file your taxes you get your $7,500 refund. But your monthly car payment is unaffected. Sure, you could refinance your vehicle, but now it’s considered a used vehicle, so the terms aren’t as favorable and the length of finance term isn’t as long, driving payment back up a little. You could pay part (or all) of your monthly payment each month, by keeping the incentive funds separate from other monies, in order to make sure you’re using them for reducing the cost of the vehicle. But that’s a lot of work. It takes discipline, especially if there’s a new Apple device or big screen TV that’s just come out! 😉

However, if the government paid the incentives directly to the dealership or manufacturer, they could be applied to the purchase price, reducing it by up to $10,000! Here’s why that’s important:

Using 2014 Income tax brackets, here’s how much income would be required to get all of the federal income tax credit of $7,500:

• Filing as “Single”: $46,600
• Filing as “Married filing jointly or widow(er)”: $56,300
• Filing as “Married filing separately”: $46,700
• Filing as “Head of household”: $52,500

But here’s the kicker: These minimum income levels shown above are if the taxpayer has no other deductions (mortgage interest, property taxes, dependents, etc). Usually itemize deductions? Then you will have to have additional income, to make up for the other deductions. Otherwise, you won’t get the full $7,500 benefit. As an example, let’s say you are buying an average home ($191K) and the mortgage interest and property tax deductions add up to $12K. That would reduce your income by $12K and your income tax by about $3K, leaving you with only $4,500 of the incentive. (25% income tax bracket used). This is because you cannot roll over the unused amount of the tax credit from the program. If you’d been at the income level required to get the full $7,500 income tax credit, you’d have to earn an additional $12K to have the additional tax burden needed, to get the full benefit. This means wealthier buyers get more tax benefit than those with less income. In other words, those that would benefit the most are helped the least. Even if the program never becomes a time-of-purchase benefit, this rollover issue should be changed now, so as to give the same $7,500 to those with lower incomes, even if it is spread over several tax years. Also, saving on gasoline and vehicle maintenance has a much bigger impact on someone earning $30,000 per year, than it does to someone earning $200,000 per year. Yes, I understand that those with lower incomes may not have a place to plug-in a vehicle, but many, many do. By keeping the vehicle at an artificially higher price, the income requirement to purchase the plug-in vehicle is artificially high as well.

However, by making the incentives after-purchase, the income required to make the monthly payments is an issue. If I have to pay the full $40K, my payment would be $644.20 per month. However, if the incentives were able to be applied at time of purchase, I would finance only $30K, and my payment would be reduced to $483.15 per month. That’s a reduction of $161.05 per month! Would reducing monthly payment that much help? Of course it would! On top of the incentives, the savings on fuel and gas would make the vehicle seem that much less expensive per month. If the fictional buyer were to save $160 per month in fuel (as I am doing), the impact would be like having a gasoline-powered car that only cost $323.15 per month! That’s like getting 1/2 off the monthly payment! *(payments calculated on 6 year term, 5% interest and no trade or down payment)

Qualifying for the higher loan is an issue as well. Using the example above, where the buyer is also buying a $191K home, it can get quite daunting. If the maximum debt-to-income ratio used to qualify loans is 38%, and the monthly mortgage payment is $1,300 per month, to qualify for the loan for the $40K plug-in vehicle above, you’d have to have an annual income of at least $61K to even get the loan, NOT just the $46.6K income level to get all the income tax credit (filing Single on income tax).

Finally, there is the “depreciation issue” caused by the nature of the current incentives. In the U.S., the average car depreciation is about 15% per year, according to CarsDirect. If a person buys a car at $40K, even if they receive $10K after the purchase, they think of the car as a $40K purchase. So, after several years of enjoyment, it becomes time to sell that vehicle. The buyer is shocked to see the market value is only valued at $18K. They feel the vehicle depreciated 55% (or 18% per year), when in actuality, it only depreciated 40% (or 13% per year). Then they tell their friends how disappointed they are in their plug-in’s resale value, dissuading their friend from getting a plug-in. Here’s why the price seems to have dropped precipitously: A car buyer can get a brand new plug-in vehicle for which you paid $40K, minus the incentives, arriving at a price of $30K. At a $22K price difference ($40K perceived price vs. $18K), the buyer would be less inclined to buy the used vehicle, than if the price differential between new and used were only $12K ($30K vs. $18K). This makes the used plug-in difficult to sell and used car dealerships less inclined to buy, putting more downward pressure on the vehicle’s price. Another side effect of this depreciation ‘mirage’ is that leasing companies have reduced the residual value of leased plug-in vehicles. Reducing the residual value (the value of the leased vehicle at the end of the lease) means the person leasing the vehicle ends up with a higher monthly payment than those who leased just a few years ago. My original 2012 mid-level Volt leased for $330 per month with a $2,000 down payment. A similarly equipped Volt today would almost certainly lease at a significantly higher lease payment. Perhaps the used car market could benefit from an incentive that used the money left on the table by buyers who didn’t have a high enough income to get the full $7,500…

One note: all the info above is based on Texas, which has no state income tax and higher property and sales taxes than some other states.