CRS Reports on Hybrid Vehicle Credits

Credit for Hybrid Vehicles Weighing 8,500 Pounds or Less

For vehicles weighing 8,500 pounds or less, the credit amount is the sum of two components: a fuel economy credit, which varies with the rated city fuel economy of the vehicle compared with that of a 2002 model year vehicle, and a conservation credit, which is based on the estimated lifetime fuel savings of a qualifying vehicle compared with that of a comparable 2002 model year vehicle. The conservation credit is described in Table 1; the fuel economy credit is described in Table 2. In the case of the conservation credit in Table 2, a hybrid vehicle's lifetime fuel savings is estimated for a vehicle that is assumed to travel, over its lifetime, 120,000 miles.

                          Table 1. Fuel Economy Credit

The conservation credit is determined based on the estimated lifetime fuel savings of the hybrid vehicles over the 2002 base model. Assuming that each of the vehicles would be driven 120,000 miles (as specified by statute), the hybrid vehicle would use an estimated 2,000 gallons of gasoline (120,000 miles ÷ 60 mpg), and the standard 2002 vehicle would use 4,800 gallons of gasoline (120,000 miles ÷ 25 mpg). Thus, the estimated lifetime fuel savings would be 2,800 gallons. According to Table 2, the allowed conservation tax credit corresponding to this fuel savings is $750. Thus, the total tax credit that this taxpayer would be able to claim on his or her 2006 income tax return would be $2,750 ($2,000 + $750).

Credit for Hybrid Vehicles Heavier than 8,500 Pounds

In the case of any new qualified hybrid motor vehicle weighing more than 8,500 pounds (heavy vehicles), the amount of tax credit is determined by multiplying the applicable percentage by the qualified marginal or incremental hybrid cost of the vehicle, subject to certain limits. There are three applicable percentages, each corresponding to three differences in fuel economy relative to a comparable gasoline or diesel powered vehicle. These percentages are shown in Table 3. The right-side column shows the applicable percentages; the left-side column shows corresponding fuel efficiency differences. The marginal cost of the hybrid vehicle is the difference in the suggested manufacturer selling price between the hybrid vehicle and a gasoline- or diesel-powered vehicle comparable in weight, size, and use, as determined and certified by the manufacturer. As noted, the amount of the tax credit for heavy vehicles cannot exceed certain limits, which are also specified by statute. The applicable percentages (corresponding to those limits, which depend on the vehicle's gross weight), are shown in Table 4.

             Table 3. Hybrid Credit for Vehicles Weighing More than

Definition of Hybrid Vehicle

In each case, a hybrid vehicle is defined as a motor vehicle that draws propulsion energy from two onboard sources of stored energy: a standard internal combustion or heat engine using consumable fuel (primarily gasoline), and a rechargeable energy storage system (or battery). A qualifying hybrid vehicle must meet the applicable regulations under the Clean Air Act. For a vehicle with a gross vehicle weight rating of 6,000 pounds or less (passenger cars and many light trucks), the applicable emissions standards are the Bin 5 Tier II emissions standards of the Clean Air Act.² For a vehicle with a gross vehicle weight rating greater than 6,000 pounds and less than or equal to 8,500 pounds, the applicable emissions standards are the Bin 8 Tier II emissions standards. The tax credit for hybrid vehicles is available for vehicles purchased after December 31, 2005, and before January 1, 2010.

Rationale for the Hybrid Vehicle Tax Credits

The idea underlying the hybrid vehicle tax credits was twofold: first, to promote energy conservation by developing alternative vehicle technologies, and, second, to help the domestic automobile industry.

More specifically, the hybrid tax credits were part of the tax subtitle of EPACT05 that addressed the demand for energy in the transportation sector, the biggest single petroleum-using sector in the United States. They are part of an energy policy that focuses on reducing the demand for energy to address energy and environmental policy goals. Congress believed that further investments in ATVs would transform the mode of transportation in the United States toward cleaner and more energy efficient vehicles. This would reduce the demand for petroleum, which would reduce petroleum importation and promote U.S. energy and economic security. Also, reduced petroleum consumption would reduce mobile emissions of pollutants in addition to carbon dioxide. In this regard, hybrids and alternative-fueled vehicles (e.g., ethanol-fueled or flex-fueled vehicles) were viewed as the short-term options; advanced lean-burn and fuel cell vehicles were viewed as longer-term options.

A second reason for the tax credits is that Congress reportedly wanted to help the ailing domestic automobile industry.³ That was the specific rationale for the 60,000 cap for each manufacturer. Because hybrids were developed in Japan, Japanese manufacturers had an advantage in their production. Congress did not want the benefits of the tax credits to accrue excessively to foreign hybrid manufacturers. The additional demand for hybrids stimulated by the tax credits, combined with the cap on individual manufacturers, would be filled by domestic production. As noted above, Toyota has already reached its production limit, and Honda is expected to reach it in 2007. Sales of domestic hybrids have been disappointing to many, however, as domestic manufacturers have concentrated on producing large hybrid vehicles (SUVs and trucks, such as the Chevrolet Silverado). While the SUV and truck hybrid are somewhat more fuel efficient than their gasoline counterparts, it is only marginally so, and the economics -- payback period or rates of return -- are not as favorable as the smaller, Japanese-produced hybrids, such as the Toyota Prius or Honda Insight. In addition, the overall demand for SUVs and other large fuel-inefficient automobiles has slumped recently in response largely to high gasoline prices.

Prior-Law Deduction for Clean, Alternative Fuel Vehicles

Prior to January 1, 2006, federal tax law provided purchasers of hybrids with a deduction from adjusted gross income, rather than a credit against tax liability. The deduction was for a portion of the cost associated with the purchase of a hybrid vehicle. A tax deduction is subtracted from income, thus reducing the amount of adjusted gross income on which the taxpayer is taxed. A tax credit reduces the tax liability dollar for dollar -- the taxpayer's marginal tax rate does not determine its value. Typically, the maximum deduction was $2,000. The deduction for hybrids was part of a tax code section that applied to clean-burning alternative fuel vehicles. An IRS ruling in August 2002 allowed hybrid vehicles to be eligible as clean-burning alternative fuel vehicles.

Example. An example of how this limitation works is as follows: Assume that manufacturer A sells its 60,000th hybrid and advanced lean-burn vehicle in February 2007 (the first quarter). Then the full tax credit is available for purchases made through June 30, 2007 (the second quarter). Half of the credit would be available on purchases made from July 1, 2007, through December 31, 2007. One-quarter of the credit would be available on purchases made from January 1, 2008, through June 30, 2008. No tax credit would be available for purchases made after June 30, 2008. However, the hybrid vehicle tax credit ends on December 31, 2009, which means that if the 60,000th vehicle is sold in September 2009, the full allowable tax credit is available on purchases made through December 31, 2009. Thus, there would not be a gradual phasing down of the amount of the tax credit. If the 60,000th vehicle sale occurs in May 2008, then 100% of the credit could be claimed on sales from July through September 30, 2009, and 50% of the otherwise allowable credit would be available from October 1, 2009, through December 31, 2009. No credit would be available after that -- there would be no reduction to 25%. Table 5 shows the credit levels for the seven Toyota hybrid models that qualify for the credit. Credit levels are shown through October 1, 2007. Because Toyota Motor Corporation reached its 60,000 threshold in the second quarter of 2006, the full credit ended during the third quarter, half of the otherwise available tax credit is available in the fourth quarter of 2006 and the first quarter of 2007, and one quarter of the otherwise allowable credit is available during the second and third quarters of 2007. The credit is completely phased out for Toyota beginning on October 1, 2007.

          Table 5. Scheduled Phaseout of Hybrid Tax Credit for Toyota

² The Tier II standards are described in CRS Report RS20247, EPA's Tier 2 Emission Standards for New Motor Vehicles: A Fact Sheet, by David M. Bearden.

³ Leonhardt, David. U.S. Hybrids Get More Miles Per Congress. New York Times, June 21, 2006, p. C-1.