Incentive Math

Many people are excited about the fuel-saving potential of "plug-in" hybrid vehicles (PHEVs.) Once they can be produced in large numbers, they look like a good way to decrease our consumption of gasoline--and hence our imports of foreign oil--and to shift more of the burden of transportation energy onto electricity, allowing renewable sources such as wind and solar power to fuel cars. In the meantime, developers face the classic barrier of low volume and high initial cost, and must hope for assistance from government policies to get them over this hurdle. A recent article in MIT's Technology Review described current efforts to legislate tax incentives for the purchase of PHEVs and the conversion of existing hybrids to PHEVs. At the suggested levels, however, we need to examine our priorities carefully. If reducing gasoline consumption is our top imperative, boosting plug-ins to the extent of a $4,000 tax credit is hardly the most cost-effective option.

This all boils down to some simple math, calculating the fuel savings from conventional hybrids and PHEVs, and then comparing the effective cost of the gallons saved over the life of each vehicle. To do this, let's look at three hypothetical cars, all running on gasoline, and all driven 15,000 miles per year. Vehicle A has a standard internal combustion engine and gets 22 miles per gallon--fairly typical for the US fleet. Vehicle B is a Honda Civic hybrid (or equivalent) averaging 50 mpg. Vehicle C is a PHEV getting 150 mpg on gasoline, ignoring the electricity it uses--or the implications of that for road-tax revenues.

Using these figures, a buyer switching from Vehicle A to Vehicle B saves 380 gallons of gas a year, while a buyer switching instead to Vehicle C saves 580 gallons. Thus, the PHEV avoids an extra 200 gallons of gasoline per year versus the conventional hybrid, which certainly merits a higher subsidy, if the government's aim is to reduce total fuel consumption. However, when we look at the current subsidy structure, which provides a $2,100 tax credit to someone buying the Civic Hybrid, and compare it to the proposed $4,200 tax credit to promote PHEVs, we see that over 10 years, the avoided fuel consumption for the Civic Hybrid costs taxpayers $0.55/gallon, while that from the PHEV costs us $0.72/gal. Conversely, for the money spent subsidizing one PHEV, we can promote two Civic hybrids that together yield an extra 180 gallons of savings.

The comparison looks even worse from the consumer's perspective. A Civic Hybrid is priced roughly $4,000 higher than the comparably-equipped non-hybrid Civic, while Technology Review estimates that a PHEV will be a $10,000 upgrade. So after tax credits, the Civic customer is paying an extra $1,900, while the PHEV buyer must pony up $5,800. The equivalent lifetime fuel savings cost 50 cents per gallon for the hybrid, vs. a dollar for the PHEV, again ignoring the cost of using enough electricity to reach an effective 150 mpg. Throw in power at 10 cents/kW-hr, and you're pushing $1.65 for each gallon saved. You can run this calculation for different combinations of standard cars, hybrids and PHEVs, and it will come out very much the same. Even someone buying a Toyota Prius, for which the hybrid tax credit has been virtually phased out, would end up better off than if they bought a PHEV for which they got a big tax credit, but still had to pay for electricity.

What does all this mean? For starters, I am not against plug-in hybrid cars. However, I believe we should evaluate their benefits objectively and provide incentives based on our larger goals. If those are simply to save the most oil for the least investment, then we ought to treat regular hybrids and PHEVs evenhandedly, rewarding the buyers of each proportionally for their contribution to reducing our oil imports. Using the figures above, that would result in a $3,200 tax credit for a PHEV, rather than $4,200. Better yet, if we're serious about saving gasoline, the incentives should be entirely technology-neutral, which might encourage carmakers like GM to import a few of their thriftier non-hybrid European models to the US.

If, on the other hand, we see this as a national technology play to build an advantage for manufacturers by driving PHEVs down their cost curve as rapidly as possible and making them as large a part of the vehicle fleet as rapidly as possible, then a disproportionate subsidy for PHEVs makes sense. In that case, however, should all PHEVs qualify, or only those produced by US auto firms? If the goal is to create a US edge in PHEVs, rather than just saving oil, then we ought to be explicit about it and target the incentives to deliver just that. At a time when tactics too often stand in for strategy, and technology is the answer to every question, I wonder how far such a debate would get.