June 21, 1996

An Analysis of the Low-emission
Vehicle Tax Credit Program

Executive Summary

From 1991 through 1995, the state offered an income tax credit to individuals and businesses for the partial costs of purchasing or converting standard-fuel vehicles to low-emission vehicles (LEVs). Our review of the credit finds that it provided a modest incentive to acquire LEVs, and that its impacts in terms of stimulating LEV purchases or retrofits, production and job creation, and reducing air emissions have been minimal. In addition, it has experienced several types of administrative problems.

Should the Legislature wish to reestablish the credit, we recommend that it consider several options for making it more effective and cost-efficient in achieving its underlying objectives.


The low-emission vehicle (LEV) income tax credit, which sunsetted January 1, 1996, was initially established in 1990 by Chapter 1611 (SB 2600, Vuich). Taxpayers were allowed to claim a credit equal to a percentage of either the total cost of converting to or the differential cost of purchasing an LEV, up to a specified dollar limit. This amount was applied against any income tax liabilities for the tax year in which the vehicle was either purchased or converted. In order to qualify for the credit, LEVs were required to meet emission standards established by the California Air Resources Board (CARB) and after 1991 operate using fuel other than gasoline. The California Energy Commission (CEC) was given the responsibility of administering the LEV credit program, including annually allocating to different taxpayers a maximum of $750,000 in tax credits.

The Legislature's intent in enacting the credit was to stimulate the conversion of existing vehicles to low-emission status and to encourage purchasers of new vehicles to consider low-emission vehicles rather than standard-fuel vehicles. At the time of its establishment, proponents of the credit argued that it would increase consumer demand for LEVs, thereby helping to mitigate air quality problems in California as well as aid in the development of "infant" LEV industries. In particular, the Southern California Gas Company, the measure's principal sponsor, argued that it would help "bridge a gap" until 1994, when stricter federal emission standards were scheduled to go into effect in the South Coast Air Quality Management District (SCAQMD).

In 1993, the California Legislature enacted Chapter 875 (SB 146, Lewis), which expanded the state's LEV tax credit to include nonrecreational off-road vehicles, and in conjunction with Chapter 873 (AB 35, Klehs), allowed for the carryforward for use in subsequent years of unused LEV credits earned after 1992. This measure also required the Legislative Analyst's Office (LAO) to prepare a report for the Legislature on the LEV credit, including its impacts on decisions to produce and purchase LEVs, and its effect on reducing vehicle emission levels in California.

Coverage of the Report

This report discusses:

Background Relating to the LEV Tax Credit Program

This section provides general background information relating to the LEV credit, including federal and state air quality regulations, the origins of the current LEV credit, and other LEV-related tax programs and incentives that are available to individuals and businesses. To assist in the discussion that follows, Figure 1 (see page 3) provides a list of key terms.

Federal and State Laws and Regulations Involving Air Quality

Pursuant to state law, the CARB in 1990 adopted LEV and clean fuels regulations. The regulations establish an annual, increasingly stringent, average emission standard that auto manufacturers must meet for their fleet of light-duty vehicles which are available for sale in California. These regulations do not specify the type of fuel to be used by the vehicles and do not require auto manufacturers to produce alternative-fueled vehicles. Rather, the auto manufacturers may produce any combination of vehicles (LEVs, alternative-fuel vehicles, etc.) as long as the average of the emissions out of the tailpipe do not exceed the mandated average emission standard for the light-duty fleet as a whole.

Figure 1

Listing of Key Terms

Clean Fuel Vehicles (CFVs))
  • Vehicles which operate on specifically designated low-emission fuels including methanol, ethanol, reformulated gasoline, clean diesel, natural gas, and propane.
Alternative-Fuel Vehicles (AFVs)
  • Vehicles which operate on any available fuel other than gasoline or diesel, including methanol, ethanol, natural gas, propane, and electricity.
Low-Emission Vehicles (LEVs):
  • Light-duty cars, trucks, and vans that are certified by CARB to meet certain emission standards and meet one of the following criteria: (1) operates exclusively on gasoline and is certified to meet hydrocarbon exhaust emission standards which are at least twice as stringent as otherwise applicable to light-duty gasoline vehicles, or (2) operates on any available fuel other than gasoline or diesel and will have an adverse impact on ozone levels no greater than a gasoline vehicle as described above.
  • For the 1991 tax year, the definition above was used to qualify vehicles for the state income tax credit. For tax years after 1991, only vehicles which qualified under criterion (2) could be approved for the tax credit.
Ultra-Low-Emission Vehicles (ULEVs):
  • Must meet guidelines specified above for LEVs. In addition, must meet more stringent emission standards with respect to carbon monoxide, formaldehyde, and nonmethane organic gases.
Zero-Emission Vehicles (ZEVs):
  • Certified by CARB to have zero-emission levels for carbon monoxide, formaldehyde, nonmethane organic gases, and nitrogen oxides. Currently, only electric vehicles meet these criteria.

In addition, CARB has separate regulations dealing with the mandatory production of Zero-Emission Vehicles (ZEVs). (Currently, only electric vehicles qualify as ZEVs.) Originally, the regulations required, beginning in 1998, that 2 percent of large auto manufacturers' vehicle fleets available for sale in California be ZEVs, with the proportion increasing to 5 percent in 2001 and 10 percent in 2003.

In March 1996, however, the CARB adopted regulatory amendments that eliminated the pre-2003 model-year production requirements. The requirement that ZEVs represent 10 percent of cars available for sale by 2003 was kept in place, and incentives were provided to meet this goal even earlier. In addition, the amendments require each vehicle manufacturer to enter into separate memoranda of agreement (MOAs) with the CARB under which the automakers would commit to produce and sell nationwide cleaner vehicles several years before the EPA-required deadline. These MOAs would also contain commitments from manufacturers to continue ZEV research and development, participate in demonstration programs, and introduce ZEVs based on market demand. The CARB maintains that these amendments will not compromise air quality in California or delay the achievement of its long-term goal of introducing a significant number of ZEVs into the auto market.

There are also federal regulations which mandate clean fuel vehicle fleets, clean fuels, and LEV programs. However, the US EPA has approved CARB's request to opt out of these federal programs given that the California LEV and clean fuels regulations are more stringent than the comparable federal programs. The National Energy Policy Act of 1992 established tax incentives (discussed below) for the purchase of or conversion to alternative-fuel vehicles.

The State LEV Tax Credit

In light of the stricter emission requirements and the high incremental costs associated with alternative-fuel vehicles (discussed below), the California Legislature enacted Chapter 1611 (SB 2600, Vuich) in 1990. This measure provided an income tax credit to individuals and businesses that either purchased new alternative-fuel vehicles or retrofitted their standard vehicles using a CARB-certified alternative-fuel vehicle conversion kit. In 1993, Chapter 875 (SB 146, Lewis) extended the credit to include nonrecreational off-road vehicles, and in conjunction with Chapter 873 (AB 35, Klehs), provided for the carryforward into future years of unused credits.

Under the LEV credit, a taxpayer could receive 55 percent of the incremental cost (that is, the additional cost beyond the purchase price of an equivalent, standard-fuel vehicle) associated with purchasing a new vehicle or converting an existing vehicle to LEV status, up to a maximum credit amount of $1,000 for vehicles under 5,750 pounds. For vehicles over 5,750 pounds, the maximum state tax credit was $3,500. The credit was nonrefundable, and initially had to be used in the year that the vehicle was purchased or converted. After 1992, however, credit carryforwards were permitted. The credit could be reduced if a federal LEV tax credit (see below) was claimed.

The Legislature's goal in authorizing the tax credit was to stimulate the conversion of gasoline-powered vehicles and the purchase of new alternative-fuel vehicles by bringing the costs of LEVs more in line with standard-fuel vehicles. This LEV tax-credit program, which is the focus of this report, sunsetted January 1, 1996.

Other Incentive Programs

Taxpayers who purchase new alternative-fuel vehicles or convert existing gasoline-dependent vehicles may benefit from federal, state, and local tax incentives other than the state's LEV credit. Figure 2 lists the various incentives that are available to individuals and businesses who purchase or convert to alternative-fuel vehicles.

Figure 2

Various LEV Incentive Programs

Federal Government Programs
  • Electric Vehicle Tax Credit--10 percent of the purchase price of the vehicle, up to a maximum of $4,000, for vehicles placed into service after June 30, 1993 and before January 1, 2005. Credit is gradually phased out beginning in the year 2002.
  • Clean-Fuel Vehicle Tax Deduction--Tax deduction up to $2,000 for the incremental cost associated with the purchase of or conversion to an alternative fuel vehicle. Applies for vehicles placed in service after June 30, 1993 and before January 1, 2005. Deduction cannot be taken if credit has been claimed. A $5,000 tax deduction is available for trucks and vans between 10,000 and 26,000 pounds, and a $50,000 tax deduction is available for specified vehicles weighing more than 26,000 pounds.
  • Clean-Fuel Refueling Site Tax Deduction-- Tax deduction of up to $100,000 for clean-fuel refueling sites put into service after June 30, 1993 and before January 1, 2005.
  • State Government Programs
  • LEV Income Tax Credit--55 percent of the incremental cost of purchasing or converting to a LEV, up to $1,000 for vehicles under 5,750 pounds and $3,500 for vehicles over 5,750 pounds. Applies to vehicles put in service after January 1, 1991 and before January 1, 1996. Any federal tax credit claimed is deducted from the incremental cost before state credit is allocated. Credit program sunsetted January 1, 1996.
    • LEV Sales Tax Exemption-- Sales tax exemption on the incremental cost of purchasing or converting to a LEV. Exemption program sunsetted December 31, 1994.
  • CEC Flexible-Fuel Vehicle Rebate-- $400 off the purchase price of a 1995 model-year Ford Taurus Flexible-Fuel Vehicle. Incentive paid directly to manufacturer and taken directly off of the sticker price of the vehicle.
  • Local Government Programs
    • Sacramento Metropolitan Air Quality Management District (SMAQMD) Fuel Incentive-- $500 of M85 fuel provided to purchasers of flexible-fuel vehicles.

    • SMAQMD Emissions Credit Trading Market-- Gives businesses extra emissions trading credits for purchasing more LEVs than required. These credits may be sold to other participants in the trading market.

    Federal Incentives. Currently, the federal government offers an income tax credit towards the purchase of (or conversion to) electric vehicles. Thus, the federal tax credit does not apply towards the purchase or conversion of other, alternative-fuel vehicles. The credit equals 10 percent of the total purchase price of the vehicle, up to a maximum credit amount of $4,000. If the federal credit is claimed, the individual or business must reduce the incremental cost of the LEV by the amount of the federal credit received when also claiming the state tax credit. For example, if an individual paid $20,000 to purchase a new electric car (of which the incremental cost was determined by the CEC to be $10,000), the federal tax credit received would be $2,000 (10 percent of the total vehicle cost). In calculating this individual's state tax credit, the incremental cost would be adjusted by the $2,000 federal tax credit claimed. In this case, the state income tax credit still would be $1,000, because 55 percent of the $8,000 incremental cost is $4,400, well-above the $1,000 maximum. (As discussed below, data collected by the CEC show that in most cases the maximum per-vehicle state tax credit--$1,000--was allocated to individuals and businesses claiming the credit.)

    In addition, there is a federal tax deduction towards the purchase or conversion to alternative-fuel vehicles. The amount of deduction that may be claimed is based upon the incremental cost associated with purchasing or converting to alternative-fuel vehicles and the vehicle's weight. For alternative-fuel vehicles weighing less than 10,000 pounds, a $2,000 credit is available. For alternative-fuel vehicles weighing between 10,000 and 26,000 pounds, taxpayers may claim a deduction of up to $5,000. For trucks and vans that are over 26,000 pounds and buses that seat at least 20 passengers, a $50,000 tax deduction is available. Taxpayers claiming the federal electric vehicle tax credit may not also claim the tax deduction. Also, these tax incentives can be claimed only for vehicles placed into service after June 30, 1993 and before January 1, 2005.

    A federal tax deduction of up to $100,000 can be claimed for clean fuel refueling sites (including those that support electric vehicles). This deduction also is available for refueling sites put into operation after June 30, 1993 and before January 1, 2005.

    State Incentives. Up until December 31, 1994, the state offered a sales tax exemption for the incremental costs associated with alternative-fuel vehicles. Taxpayers, as well as state and local governments, could qualify for this exemption. There was no cap on the dollar amount of the exemption that could be claimed or the number of taxpayers that could claim them. As another example of a state incentive, the CEC offered a $400 rebate toward the purchase of the 1995 model-year Ford Taurus Flexible Fuel Vehicle, which runs on methanol. This rebate was directly taken off the sticker price of the vehicle.

    Currently, two bills under consideration in the Legislature would provide tax incentives to certain taxpayers who purchase or produce specified LEVs. Assembly Bill 2489 (Firestone) requires the CARB to adopt standards for certification of high-occupancy ZEVs to qualify for an exemption from state sales and use taxes until January 1, 1999. Assembly Bill 3322 (Kaloogian) would provide a tax credit beginning January 1, 1996, to ZEV and ULEV (Ultra Low-Emission Vehicle) manufacturers for each vehicle produced.

    Local Incentives. Local entities also offer incentives to encourage the use of alternative-fuel vehicles. For example, the SMAQMD provides $500 of M85 fuel to purchasers of flexible-fuel vehicles. It also gives businesses participating in an emissions credit trading market extra credits for purchasing more LEVs than regulations require. These extra credits may then be sold to other participants in the trading market.

    Costs and Other Characteristics of LEVs

    Purchase price, maintenance and operations costs, size of vehicle, fuel efficiency, engine power, and emission levels are some of the key factors that influence vehicle purchase decisions. This section discusses how these factors compare for alternative-fuel vehicles versus standard-fuel vehicles, focusing primarily on comparisons of electric and compressed natural gas (CNG) vehicles to gasoline-powered vehicles. Electric and CNG vehicles were the primary types of alternative-fuel vehicles for which taxpayers actually have claimed the state's LEV tax credit.

    Alternative-Fuel Vehicle Attributes Vary Widely

    As with standard-fuel vehicles, the attributes of alternative-fuel vehicles vary according to the make and the model. Even if one standardizes for the general classification of vehicle (for example, by focusing on a passenger car or van), factors such as miles per tank of fuel and engine power can vary significantly between different alternative-fuel and standard-fuel vehicles. Figure 3 (see page 8) summarizes some of the general attributes of electric passenger vehicles and CNG passenger vehicles.

    Electric Vehicles. While electric vehicle technology has made significant advances in recent years, certain vehicle features, such as speed attributes and miles per battery recharge, still lag far behind comparable features for the current combustion engine technology. For example, the average electric passenger vehicle commercially available has a range of 40 to 100 miles per recharge (limited production vehicles and prototypes have an average 70-to-100 mile range) and requires three to seven hours to recharge. The maximum speed of these vehicles generally ranges from 40 to 80 miles per hour.

    Prototype vehicles with a greater range and speed are currently being designed and tested. However, their competitiveness will depend on future advances in battery technology, which will be necessary to provide more power to the vehicles than is currently available. Increasing the amount of energy held in the battery without increasing its weight is one significant challenge facing the electric car industry. Electric motors run more efficiently than gasoline engines, but currently do not retain enough energy to produce the same vehicle performance as a standard-fuel motor. Another key challenge involves creating a refueling technology that takes minutes rather than hours. A quick-recharge system has been developed but needs to be tested further to ensure that safety standards are met. Thus, its future at this point remains uncertain.

    Figure 3
    Comparisons of Low-Emission Passenger Vehicle Attributesa
    Electric LEV
    Purchase price: $16,000 to $40,000
    Retrofit costs : $4,000 and up
    Passenger capacity: 2 to 4
    Mileage range per tank of fuel: 40 to 100
    Maximum speed (miles per hour): 40 to 80
    Vehicle emissions: Zero emissions
    Compressed Natural Gas LEV
    Purchase price (incremental cost): $3,000 to $5,000 more than standard-fuel vehicle

    $1,500 to $4,000 (uncertified by CARB)

    Retrofit costs:
    Passenger capacity: 4 to 6

    120 to 180

    Mileage range per tank of fuel:
    Maximum speed (miles per hour): Same as standard-fuel vehicles
    a Specifications listed represent average industry ranges. Certain limited production and prototype vehicles may differ significantly from these averages.

    Electric vehicles require less maintenance than standard-fuel vehicles because there are fewer moving parts in the engine. The newer-style batteries are sealed so that they do not require watering, and no oil or transmission fluid changes are needed. As with a standard-fuel vehicle, though, the batteries on electric vehicles may have to be replaced after a certain period of time, depending on the battery type, the climate in which the vehicle is operated, and how much the vehicle is driven. The cost to replace electric vehicle batteries is much higher than standard vehicle batteries, ranging in the thousands of dollars depending on the battery type.

    In addition to fuel and speed attributes, the size and appearance of vehicles also play key roles in consumer purchase decisions. Many newly manufactured electric cars differ significantly in appearance from standard-fuel vehicles. Most recognizable are the two-seater electric vehicles, though prototypes and retrofitted electric vehicles accommodate more passengers. As with all motor vehicles, a tradeoff exists for LEVs between size and capabilities--the larger (heavier) the vehicle, the fewer miles of driving can be realized before refueling. This factor is particularly significant with respect to electric vehicles because of current maximum-achievable mileage limitations per battery recharge.

    CNG Vehicles. Compressed natural gas vehicles presently come closer than do electric vehicles to achieving the driving-distance range of standard-fuel vehicles. The average CNG three-cylinder vehicle has a range of 120 miles to 180 miles per tank of fuel. Because the natural gas is compressed, however, the temperature and time of day can affect the amount of fuel that can fit in the tank. If it is a hot day, the tank may only fill to 75 percent of capacity because the gas will expand due to the temperature. (According to the CEC, CNG retailers currently are trying to develop a means to correct for this problem.) Compressed natural gas engines are basically similar to standard-fuel engines. However, the use of compressed natural gas necessitates that the vehicles be equipped with reinforced fuel tanks and high-pressure fuel lines and cylinders. The refueling process is similar to that for standard-fuel vehicles, although refueling sites are much less common.

    Aside from a slight decline in trunk space, CNG vehicles do not differ significantly from standard-fuel vehicles in size or appearance. Compressed natural gas vehicles generally have the same maintenance requirements as gasoline vehicles. Their engines use the same type of oil as standard combustion engines and require oil changes and lubrication. Although it is still rather early to tell, some studies have indicated that CNG vehicles need less-frequent maintenance because CNG is a cleaner burning fuel. This may translate into lower overall maintenance costs for CNG vehicles compared to standard-fuel vehicles.

    Alternative-Fuel Vehicles Have High Incremental Purchase Costs

    Scale Economies Are Lacking. Alternative-fuel vehicles cost more to purchase than standard-fuel vehicles, due to several reasons. Presently, no auto manufacturer produces a production-line alternative-fuel vehicle. However, General Motors will produce the EV1 for sale in limited areas of the country beginning fall 1996. Thus, the industry cannot take advantage of the scale economies and related reductions in average production costs achievable through mass production.

    Research, Development and Certification Costs. Other important factors contributing to the high incremental costs of alternative-fuel vehicles include research and development (R&D) costs directed toward improving the LEV technology, and the expense of the LEV certification process.

    Costs Differ by Fuel Type. Alternative-fuel vehicle costs vary widely by model and by type of fuel. In the case of electric vehicles, those produced by specialty companies today have an incremental cost ranging anywhere from $4,000 to over $30,000. The costs of converting a gasoline vehicle to an electric vehicle generally are less, although industry sources report that these costs still can be significant. Much of the variation in incremental cost is due to the type of battery installed in the vehicle. For example, at low production levels, sodium-sulfur batteries can cost ten times more than the more-standard lead-acid batteries. At higher production volume levels, industry sources note that they expect the cost differences between various types of batteries to become smaller over time.

    In the case of cost differentials between CNG vehicles and standard-fuel vehicles, these vary according to the size of the vehicle and the number of cylinders. Currently, the only CNG vehicles that have been certified and able to receive the state LEV tax credit are commuter vans, and there are no certified CNG conversion kits available. Incremental costs for CNG vehicles range from $3,000 to $5,000. These costs tend to be lower than for electric vehicles largely because much of the technology for building CNG vehicles is already in place, and the only modifications that need to be made to a vehicle involve strengthening its cylinders, fuel lines, and gas tank.

    Incremental costs for both electric and CNG vehicles are predicted by industry sources to decline in the next twenty years, as environmental regulations mandate the sale of ZEVs and require stricter fleet emission standards, which in turn will require increased use of alternative-fuel vehicles. Until these vehicles are mass produced and the savings from greater scale economies of production are realized, however, the costs for purchasing or converting LEVs will remain higher than the costs for standard-fuel vehicles.

    The Effect of LEVs on Air Quality

    Alternative-fuel vehicles are designed to emit significantly lower emission levels compared to most standard-fuel vehicles. In 1994, the CARB conducted a study comparing emission levels of various types of vehicles. For most pollutant types, emission levels were reduced by over one-half for LEVs and ULEVs compared to automobiles that have the least amount of mandated emission reduction equipment installed in them under current law. These reductions are most dramatic for electric vehicles because they do not emit certain pollutants at all. According to the Union of Concerned Scientists, emission reductions for electric vehicles compared to standard-fuel vehicles are close to 100 percent for reactive organic gases and carbon monoxide emissions, and over 75 percent for nitrogen oxides.

    On the other hand, sulfur oxide emissions may increase nationally because of expected increased emissions--particularly from coal burning power plants attributable to the recharging of electric vehicle batteries. Most California power plants are not coal burning; though, many burn fossil fuels and would add additional pollutants into the air to the extent that they would need to increase production of power for charging electric vehicles. However, the additional pollution emissions produced would be less than emission reductions achieved through the use of electric vehicles.

    Program Administration

    Allocation of Credits

    The LEV tax credit program allocated credits on a "first-come, first-served" basis. The procedure followed was for parties interested in purchasing an alternative-fuel vehicle to contact the CEC to find out if tax credits were available for the year in which they would purchase or convert their LEV. Taxpayers then filled out the appropriate forms, giving information on the type of car purchased or the type of conversion kit used and the incremental cost associated with them. If the LEV or conversion kit was certified by the CARB, then the CEC would approve the application and send the taxpayer a certification letter. The taxpayer would keep this letter and make it available if requested by the Franchise Tax Board (FTB) for income tax audit purposes.

    The CEC generally begins compiling data on tax credits allocated for a specific year midway through the following income year. This information has been kept in a spreadsheet-like format for recordkeeping and transmitted to the FTB for income tax auditing purposes, once the aggregate $750,000 credit limit for a year is reached or once it appears that they will receive no additional applications for tax credits.

    Comments Regarding the Allocation Process. Normally, when programs such as the LEV tax credit have "caps" placed on the funds they can annually use, it is important that the funds be allocated as effectively and efficiently as possible so as to provide the "biggest bang for the buck" in terms of program results. A first-come, first-served approach may not be the best one to use for allocating limited funds, such as was done with the LEV program.

    In theory, a variety of factors should be considered in credit allocation decisions. For example, if the program's objective is to improve air quality, one could structure it to give first priority to taxpayers seeking to convert older, more polluting vehicles (for example, vehicles that are 15 years or older).

    In reality, the effectiveness of the allocation of the tax credits was not as significant an issue as it might have been. This is because, as discussed below, the supply of credits available far outweighed the number of applicants in most years. But, if the program was extended in the future and the demand for credit allocations exceeded the supply, the Legislature may wish to revisit the issue of allocation criteria.

    Timely Reporting and Auditing

    In order for a program such as this one to function well, there needs to be good coordination and information flows between the CEC, which allocates credits, and the FTB, which processes and audits the tax returns of LEV credit claimants. This is important, for example, to ensure that credits are benefiting only those parties who are entitled to them.

    We believe that this process is not working in as timely a manner as it should. As of March 1995, for example, the FTB had received information from the CEC on tax credit allocations only for the 1991 tax year. As part of its regular audit cycle, FTB has indicated that, on a case-by-case basis, it may seek substantiation from individuals claiming the credit. It does not currently have numbers to indicate the extent to which LEV credit claims are valid. As discussed below, there appear to be noticeable discrepancies for all years after 1991 between the CEC credit allocation data and the FTB credit usage data which have yet to be reconciled. More timely communication would allow the FTB to identify filers that have wrongly claimed the credit and to rectify the situation before these taxpayers are "lost" to the system (for example, taxpayers who have gone out of business or have moved out of the state).

    Use of the LEV Credit

    Two basic types of information are available relating to the use of the LEV credit. The first is CEC data on the number and dollar amounts of LEV credits that it has allocated to applicants. The second is FTB data regarding the number and dollar amounts of LEV credits actually claimed by taxpayers. Figure 4 summarizes these data and indicates that:

    Figure 4

    LEV Credits Allocated Versus LEV Credits Claimeda

    (Dollars in Thousands)
    CEC Allocations FTB Claims
    Year Number of Taxpayers Number of Vehicles Credits


    Number of Tax Returns Credits Claimed
    1991 12 750 $750 185 $63
    1992 37 38 43 160 68
    1993 46 54 80 264 293
    1994 19 27 27 186 1,139


    1995 23 37 36 NA NA
    a All information is preliminary and as of May 1996. Corroboration between FTB's information and CEC's information has not been completed. Applications for credit allocations for tax years 1993 through 1995 are still being received. The symbol "NA" indicates information not available.
    b Exceeds $750,000 maximum due to carryover provision and improperly claimed credits.
    Source: California Energy Commission and California Franchise Tax Board.

    Several other things stand out about these data:

    As to why the amount of LEV credits allocated is so far below the amount available after 1991, several factors may be responsible. One is that the demand for LEVs is simply not all that much at present, even with the LEV credit in place. A second is that certain LEV purchasers may not be taking advantage of the credit, either because they are not aware of it or do not bother to claim it. A third reason is that, while state and local governments have made a significant number of purchases of LEVs in recent years, they cannot claim income tax credits. Regarding this latter factor, state and local governments were able to claim the LEV sales tax exemption when it was in effect prior to 1994. If one compares the number of taxpayers claiming the sales tax exemption in 1993 to the number claiming the income tax credit for the same year, the sales tax figure is three times higher (177 sales tax exemptions claimed compared to 54 income tax credits), undoubtedly reflecting purchases of LEVs by governments.

    Regarding why the amount of credits actually claimed has been exceeding that allocated, this again could be due to several factors. Some purchasers, for instance, may not be aware of the requirement that the CEC allocate them a credit, or may not bother to go through the allocation procedure. Alternatively, it is likely that some taxpayers are claiming credits for vehicles that do not qualify for the credit, including certain taxpayers whose allocation requests have been among the many rejected by the CEC.

    Effects of the LEV Tax Credit

    This section discusses the impacts of the LEV tax credit in terms of LEV purchase decisions, the amount of LEVs produced, and air quality in California.

    LEV Purchase Decisions

    How much of an impact does the LEV credit have on decisions by individuals and businesses to purchase LEVs? This depends primarily on the extent to which the credit raises the economic rate of return perceived by individuals and businesses who buy LEVs, reduces the period of time that it takes for LEVs to pay for themselves in terms of the benefits they generate, and the sensitivity of purchase decisions to these two factors.

    As noted previously, the LEV credit allowed taxpayers to claim a nonrefundable credit equal to 55 percent of the incremental cost of purchasing an LEV or converting a non-LEV to LEV status, up to a maximum of $1,000 for vehicles under 5,750 pounds and up to $3,500 for heavier vehicles. Figure 5 shows the amount of tax savings that would result from the state LEV credit for illustrative assumptions regarding LEV incremental costs and selected other factors, based on information from the CEC. (Actual incremental costs depend on the type of LEV involved. For example, retrofit costs can vary significantly among sedans, pickup trucks, and commuter vans.) Specifically, the example shown is for a $25,000 LEV with incremental cost of $7,000. (The CEC reports that actual incremental costs for taxpayers claiming the credit averaged $7,500 in 1992 and $7,200 in 1993, but ranged from a low of about $2,000 to a high of about $16,500 in these years. In these years, most taxpayers retrofitted their vehicles.)
    Figure 5

    Illustration of Tax Savings From Federal and

    State Income Tax Creditsa

    1995 Tax Year
    Without LEV Credit With LEV Credit
    Federal Tax Effect
    Adjusted Gross Income (AGI) $50,000 $50,000
    Adjustments to federal AGI 38,693 39,500 b
    Personal exemptions -10,000 -10,000
    Taxable income 28,692 29,500
    Tax liabilities 4,304 4,425
    LEV credit -- -2,500
    Tax liabilities after credits 4,304 1,925
    State Tax Effect
    AGI $50,000 $50,000
    Taxable income 39,500 39,500
    Tax liabilities 1,076 1,076
    Personal/dependent credits -269 -269
    LEV credit -- -1,000 c
    Tax liabilities after credits 807 --
    Net Tax Effect
    State tax liabilities $807 --
    Federal tax liabilities 4,304 $1,925
    Total tax liabilities $5,111 $1,925
    Tax savings $3,186
    a Assumes $25,000 electric vehicle with incremental cost of $7,000. Example is for a married couple filing jointly with two children, average itemized deductions for that income level, and no tax credits other than state personal and dependent exemption credits.
    b Federal AGI rises because of lower state tax liabilities due to LEV tax credit.
    c While $1,000 of the LEV credit is claimed, only $807 of it can be applied in the 1995 tax year.

    While the amount of the LEV credit compared to the incremental cost of a LEV is relatively low in percentage terms (under 15 percent in our example, and only about 10 percent after accounting for the interaction between state and federal taxes), the question remains whether it is effective at influencing vehicle purchase choices.

    Rate of Return and Payback Effects. Economists define the "economic rate of return" on an asset, including vehicles purchased by individuals and businesses, as being the annual average percentage return on the investment. The rate of return calculation takes into account such factors as the stream of benefits from using an asset, along with its original purchase cost, operation and maintenance costs, lifespan, and salvage value. (In technical terminology, an asset's rate of return is that rate which equalizes its purchase cost with the present-value stream of net benefits resulting from its use.) The higher this rate of return, the greater the likelihood that an asset, such as a vehicle, will be purchased, whether for business or personal use. Alternatively, an asset's "payback period" is the period of time that it takes for the net benefits from its use to equal or exceed its purchase cost. The lower an asset's payback period, the greater the likelihood that it will be purchased. Thus, the extent to which the LEV credit will stimulate purchase decisions depends on how much it raises an LEV's rate of return and reduces its payback period.

    To provide some indication of the effects of the LEV credit in terms of these factors, we calculated (using specified assumptions) the rates of return and payback periods for both a hypothetical CNG passenger van used for commuting purposes and an electric-powered passenger commuting van. These illustrative examples assume that the vans are being operated strictly on a for-profit basis, and do not take into account any broader benefits of using LEVs, such as improved air quality. For each vehicle, we performed these calculations both with and without the LEV credit being taken into account. In order for the case to be made that the LEV credit has materially stimulated LEV purchases, the credit must be shown to be capable of causing significant improvements in these rates of return and payback periods. Figure 6 (see page 17) shows the results. It indicates that:

    Figure 6

    Effectiveness of Tax Incentives on Vehicle Purchase Decisions

    Illustrative Examplesa

    Type of Vehicle and Tax Incentive Economic Rate of Return (Annual Average Percent) Payback Period (Years)
    CNG Passenger Van
    No state or federal tax incentives 8.9% 6.1
    State tax credit only 9.9 5.8
    State and federal tax incentives 10.7 5.6
    Electric Passenger Van
    No state or federal tax incentives 0.6 9.8
    State tax credit only 1.2 9.7
    State and federal tax incentives 2.4 9.3
    a Each scenario above takes account of tangible net benefits for operating a 10-person passenger carpool van. However, various tangible and intangible costs associated with such factors as the limited driving ranges of LEVs, and the inconvenience of more frequent refueling and limited sites for refueling and servicing, have not been accounted for due to data and related measurement problems. The examples incorporate data that reflect 1995 vehicle purchase prices and operating costs, including maintenance, licensing, and fuel costs.

    Conclusion. No one knows for sure exactly what the credit's effects on purchase decisions have been, and some LEVs undoubtedly would not have been purchased in the credit's absence. However, given the credit's relatively marginal-to-modest effects on LEV rates of return and payback periods, its effects on purchase decisions probably have been limited. This seems consistent with the finding that only a very modest number of LEVs have been sold since the credit was put in place.

    Impact of LEV Credit on Manufacturing Jobs and Decisions

    During the early 1990s, the overall manufacturing sector in California downsized considerably. This was largely due to the decline in the aerospace industry, with many high-paying jobs being lost in the process. The supporters of this tax credit believed that the credit would indirectly help the California manufacturing sector by increasing demand for alternative-fuel vehicles, which in turn would translate into more jobs in areas such as the development of component parts, assembly activities, service and repair, and perhaps even manufacturing of vehicles. The California Council on Science and Technology predicted that by taking the proper steps to encourage high-technology transportation development, the electric vehicle industry alone would create some 70,000 manufacturing jobs by the year 2010.

    Tax Credit Has Played Limited Role in Creating New Manufacturing Jobs. From the information we collected for our analysis, the credit had a minimal impact on the demand for new LEVs. Even if one assumes that the state tax credit was the single determinant of purchase decisions for all taxpayers that received credit allocations by the CEC, the associated employment effects would be relatively small. As noted earlier, the number of vehicle purchases or conversions for which credits were allocated was only 38 in 1992, 54 in 1993, 27 in 1994, and 37 in 1995. Numerous other LEVs were purchased by state and local agencies because of federal and state mandates, but these purchases were not eligible for the tax credit. Thus, federal and state regulations affecting government fleet purchases, not the tax credit itself, have been responsible for most of the new alternative-fuel vehicle purchases in California in recent years.

    As mentioned earlier, most taxpayers claiming the credit retrofitted their existing automobiles, as opposed to purchasing new ones. Thus, businesses that specialize in converting vehicles did experience an increase in demand for their services. The "Big 3" automakers, however, currently have no plans to produce or set up assembly lines for LEVs in California, though some important component parts may be manufactured or assembled here in the state (particularly computer-related parts for electric vehicles).

    Lack of Investment Capital Is a Problem for LEV Industry Development. Investment capital plays a vital role in new, infant-industry manufacturing decisions, including those in the LEV industry. The start-up companies in such industries depend heavily on infusions of financial capital to develop their new technologies. Without such funds, these newer companies have a difficult time competing with well-established businesses.

    For example, U.S. Electricar, a Santa Rosa-based maker of electric cars, announced in early 1995 that it had halted production of electric cars and laid off nearly one-third of its workers, because investors have been shying away due to a perceived relaxed attitude towards environmental regulation at the federal level. If it is unable to restructure its liabilities and receive adequate investment funding for research and development costs, U.S. Electricar may be forced out of business. This may occur even though various incentives geared towards the purchase of ZEVs currently exist. Thus, many of the smaller companies active in the high-technology industries servicing LEVs continue to face considerable risks and uncertainties.

    The Effect of LEVs on Air Quality

    The LEV tax credit can lead to air quality improvements to the extent that it influences taxpayers to select alternative-fuel vehicles over standard-fuel vehicles, thereby causing aggregate vehicle emission levels to be lower than they otherwise would be. To have a significant benefit in terms of air quality, particularly in major emission nonattainment areas such as Los Angeles and Sacramento, substantial shifts away from standard-fuel vehicle usage are necessary. Thus, purchased or converted alternative-fuel vehicles must replace standard-fuel vehicles to a significant extent, both numerically and in terms of miles driven, and not serve simply as occasionally used or recreational vehicles.

    The CARB projected in 1994 that a 5 percent reduction directly attributable to the LEV program would occur in most pollution component levels by the year 2000. This 5 percent projection assumed that two percent (approximately 40,000) of the new vehicles sold annually in California would be ZEVs. If achieved, a 5 percent reduction in emission levels would be significant, particularly given the difficulty that has been experienced in meeting increasingly tight air quality standards in California.

    Compared with the above estimates, the number of vehicles that have qualified for the tax credit in the past few years is too small to have made a measurable difference in overall air quality levels in California during this period. In fact, industry observers have noted that a few hundred LEVs will make no difference to air quality in a state of tens of millions of cars, trucks, and buses on the road. Californians would need to purchase or convert hundreds of thousands of LEVs to make more than a dent in the air pollution problem.

    Proponents of the LEV credit argued that it would help in the transition to tighter air quality standards. The credit may have influenced certain individuals and businesses considering alternative-fuel vehicle purchases and served as a starting point toward a more fundamental, long-term transition toward using the new LEV technologies. However, its direct impact on overall air quality levels up to this point has been minimal.

    Conclusions and Recommendations

    California's now-expired LEV income tax credit has provided a limited incentive to purchasers and producers of LEVs. Although it has undoubtedly had some impacts on consumers and producers by somewhat raising the rate of return and lowering the payback period for LEV investments, its overall effects have been minimal in terms of stimulating LEV purchases and production. And because of this, its impact on air quality also has been limited. Thus, the program has not scored well in terms of effectiveness or cost efficiency. The "bottom line" is that the incentive provided by the state credit is simply not strong enough to overcome the current economic and technical disadvantages and impediments to purchasing LEVs and investing in LEV technologies relative to standard-fuel vehicles. Thus, we recommend that the program not be reinstated as previously constituted.

    Despite this specific conclusion, there still may be conditions under which the Legislature might choose to reestablish a LEV credit. For example, the Legislature may wish to continue to devote some resources to promote the LEV technology, despite its current limitations, recognizing that this technology may become more economically viable and competitive in the future. The Legislature may also want to explicitly recognize that current gasoline prices understate true economic costs, given the pollution that fossil fuels create. This, in turn, would strengthen the argument for subsidizing LEVs in some fashion with the size and refundability of a credit reexamined by the Legislature.

    Should the credit be reinstated (whether at the current or some other level), we recommend that certain administrative changes be considered. For example:

    This report was prepared primarily by Kristin Szakaly, under the supervision of Jon David Vasché. Brad Williams and Mark Newton also made key contributions to the report, and various other staff participated in reviewing the document.

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    The Legislative Analyst's Office is located at 925 L Street, Suite 1000, Sacramento, CA 95814.

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