The Inflation Reduction Act (IRA) that was recently passed by the Senate has a complex set of assembly and content requirements for its electric vehicle (EV) tax credits. This post offers a few thoughts on domestic content requirements as a matter of policy, possible U.S. justifications under WTO law for those requirements as they are set out in the IRA EV tax credit provisions, and the practical effect of this measure given the strictness of these requirements.
Regional Content Requirements
In addition, the bill adds production requirements for automakers to have their vehicles qualify for the tax credits. For a vehicle to qualify, it must undergo final assembly in North America. This provision is less restrictive than a previous version of the policy, which required American production and favored unionized factories to manufacture these vehicles. Because of the integrated automotive supply chains in North America, neighboring countries were very concerned with the original proposal. Canada even suggested that the previous version would violate the United States-Mexico-Canada Agreement. The Inflation Reduction Act avoids that issue, but it could still be viewed as discriminatory against other foreign automakers, namely those based in the United Kingdom, the European Union, Japan, and South Korea. Automakers have diverse global supply chains, and some may not be as present in North America.
Starting in 2024, under the Inflation Reduction Act, EVs would need to have at least 40 percent of their critical minerals sourced for batteries from countries with which the United States has a free trade agreement (FTA). Critical minerals can also be made from materials recycled in North America. The required percentage of content for critical minerals would then increase over the following two years and by 2026 the regional content for critical minerals would rise to 80 percent.
The bill also specifies that no vehicle produced after 2024 can have a battery with critical minerals that were “extracted, processed, or recycled by a foreign entity of concern.” A “foreign entity of concern” is defined very broadly and could feasibly apply to China. That China performs an estimated 80 percent of global mineral processing and refining makes this particular provision problematic.
Under the bill, the battery of an EV would be required to have at least 50 percent North American content by 2024 and be of 100 percent North American origin by 2028. In 2020, the United States was home to 70 percent of battery cell capacity, meaning an overwhelming portion of the end process to make a battery takes place domestically. The raw materials in a lithium-ion battery, however, represent most of the total cost of the battery. The cost of cathodes and anodes, the positive and negative electrodes in a battery, alone are estimated to represent 40 percent of the total cost of a lithium-ion battery.
In terms of the consistency of the IRA provisions with WTO law, I’m going to focus on the WTO’s non-discrimination obligations as applied to the assembly/content requirements, but there is also an issue with how the tax credit itself would be examined under the subsidy provisions. (And let me note that my thinking here has been informed by discussions with David Kleimann and Jesse Kreier, but of course all errors are my own).
As a general matter, domestic content requirements will violate GATT Article III:4. The law is clear on this, and in my view the policy is a good one. The WTO doesn’t prohibit protectionism entirely, but it does try to steer it towards more transparent methods such as tariffs. If governments want to protect their domestic EV industry from competition, they are allowed to do so, but they have to negotiate for that ability as part of an exchange of tariff concessions. If governments undermine the carefully crafted balance of tariffs by using domestic content requirements in national and local laws and regulations, the system could quickly fall apart. If one government does it, others are likely to respond with their own content requirements, and we could get into a protectionist spiral. A core purpose of trade agreements is to prevent this sort of thing from happening.
In addition, large wealthy countries would have a general advantage in a system without rules, but also a specific advantage in a system with complex domestic content requirements, because implementation of such measures is more technical than tariffs and requires more resources.
As a result, there is broad agreement that domestic content requirements are a bad idea, and they should be, and are, prohibited by WTO and FTA rules. Obviously, there are some protectionists (and perhaps a few others) who disagree, but I’m just saying the consensus is pretty clear on this.
Of course, this consensus doesn’t mean that governments never use these measures. It just means that when they do, a WTO complaint is brought in response, and there have been several WTO disputes over the past few years reaffirming all of this.
In the case of these new IRA EV tax credits, however, things get a little complicated. I’m not sure I have all the answers at this point, but I’m going to set out two key issues here and offer a few thoughts.
First, a “final assembly” requirement strikes me as different than a content requirement in ways that could be important. In theory, final assembly can take place with 100% foreign parts, and as a result, maybe it does not actually require that inputs be from any particular place. Thus, perhaps it is not the same thing as a “domestic content” requirement. Now, in practice, such a requirement might steer the assembler to use local or regional inputs, because those inputs are physically close to where the assembly has to take place. But that ends up being a de facto content requirement rather than a de jure one, and those can be difficult to prove.
Second, there is a question that comes up under all three of the aspects of the IRA EV tax credit measure (final assembly, critical minerals, batteries): Could these requirements be justified under GATT Article XXIV as measures related to a free trade area? Each of the three requirements works a little differently, but all of them are tied to the North American region (and thus perhaps to the USMCA) or to U.S. FTAs. I don’t see how else the U.S. can justify these measures under WTO law, so I’m wondering if at least someone involved in the creation of this measure had in mind an Article XXIV defense (others may not have been concerned about WTO law).
It’s important to think about what WTO obligations we are talking about, and the obligations that come to mind here are GATT Articles I:1 and III:4, as well as SCM Agreement Article 3.1(b). With 3.1(b), there is a question about whether Article XXIV could apply at all to a non-GATT agreement. But putting that aside, does Article XXIV even work here? How do these requirements fit under GATT Article XXIV:8(b), which states:
(b) A free-trade area shall be understood to mean a group of two or more customs territories in which the duties and other restrictive regulations of commerce (except, where necessary, those permitted under Articles XI, XII, XIII, XIV, XV and XX) are eliminated on substantially all the trade between the constituent territories in products originating in such territories.
Are these North America/FTA assembly/content requirements just part of the elimination of duties and other restrictive regulations of commerce on substantially all trade in the free trade area, and therefore justified under Article XXIV? At this point, I’m not sure, and I’m reluctant to spend too much time thinking about it until 1) the measure actually becomes law, and 2) the U.S. actually invokes Article XXIV. If the U.S. doesn’t invoke Article XXIV, it’s not clear to me what they will cite as a justification though. (Obviously there is GATT Article XX(g), but I don’t see how these requirements could satisfy the Article XX chapeau).
One other legal point here: The “foreign entity of concern” language probably means that GATT Article XXI (security) would be invoked for that specific provision.
Finally, with regard to the effectiveness of the policy as set out in this statute, Tori raises a point about the difficulty of fulfilling the particular requirements in the IRA:
The regional requirements in the Inflation Reduction Act are likely impossible for automakers to fulfill because they severely reduce the sourcing options for inputs. For example, Argentina is responsible for roughly 10 percent of lithium production, but the United States does not have a free trade agreement with Argentina. Moreover, virtually all cathode and anode production is concentrated in China, Japan, and South Korea. South Korea is the only country with which the United States has a free trade agreement, and it represents only 15 percent of cathode production.
If we want these tax credits to be helpful in encouraging people to buy electric vehicles, fewer restrictions on their use would be better. A version of the measure that did not have assembly/content requirements would lead to more electric vehicles being used, but that is not the version we have right now. It will be interesting to see whether the vehicle-makers and government officials interpreting and applying the rules will find a way to adapt so that consumers can actually make use of them.
Simon Lester is President of WorldTradeLaw.net LLC and Trade Policy Analyst of the Cato Institute.
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