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Explainer: Why the U.S. Inflation Reduction Act has rattled Europe

2023-02-01T18:07:20Z

Electric car models of the Volkswagen Group Volkswagen ID.3, Seat Cupra Born, Volkswagen ID.4, Audi Q4 e-tron, Volkswagen ID.5 GTX and Audi Q4 Sportback e-tron are parked outside the production plant of Volkswagen, in Zwickau, Germany, April 26, 2022. REUTERS/Matthias Rietschel/File Photo

The European Commission presented its Green Deal Industrial Plan on Wednesday in response to the U.S. Inflation Reduction Act (IRA), with increased levels of state aid to help Europe compete as a manufacturing hub for clean tech products.

While EU countries welcome the U.S. commitment to energy transition, they fear the IRA’s $369 billion of subsidises for electric vehicles and other clean technologies could put companies based in Europe at a disadvantage.

EU countries are worried their companies will suffer because of U.S. tax breaks, many of which are only applicable for local produced content.

For electric vehicles, U.S. consumers can earn tax breaks of $7,500 but only if the vehicle’s final assembly is in North America, where at least half of the value of the vehicle battery components must also be manufactured.

EU countries say this goes against the basic World Trade Organization principle of non-discrimination, that one’s own and foreign products should be treated alike.

French Finance Minister Bruno Le Maire has said that, while subsidies to foster the energy transition are acceptable, they should comply with WTO rules and there should be a level playing field.

Europe-based companies are put at a disadvantage to U.S. rivals and, say EU politicians, may choose to relocate or at least prioritise investment in the United States, making it a leader in clean tech production at Europe’s expense.

Companies looking to set up factories may put U.S. expansion first.

The EU is not Washington’s only ally to take exception to the package, with South Korea also concerned its carmakers will not be eligible for the U.S. tax breaks.

The EU wants the same treatment as U.S. trade partners Canada and Mexico, whose production is largely included in the subsidy schemes, but many EU officials believe the bloc is unlikely to see all its demands met.

Any revision of the act by the U.S. Congress is out of the question, so European officials see their best hope in guidance on implementation issued by the U.S. Treasury Department.

In December, it secured a partial win when the Treasury said that electric vehicles built outside North America would qualify for tax credits if leased by consumers.

The Treasury is set to provide guidelines in March for electric vehicles bought by consumers, but there appears less room for manoeuvre.

The European Commission and the White House have set up a high-level task force to discuss the issue. One possible opening would be for Washington to grant the EU the concessions it will offer free trade agreement partners – such as on supply of critical materials for vehicle batteries.

The EU does not have a free trade agreement with the United States, although the transatlantic partners regularly discuss trade issues, such as in their Trade and Technology Council.

No one wants to rekindle trade tensions that damaged transatlantic relations during the Trump administration, so European officials say that challenging the United States at the WTO is only a final and unlikely option.

France has led calls for Europe to respond with state support of its own for European companies, including through a “buy European act” and large-scale subsidies.

The European Commission has proposed a loosening of state aid rules to allow support for investments in renewables, for decarbonising industry and for “strategic equipment”, such as batteries, solar panels, wind turbines and heat pumps.

Aware that not all 27 EU countries will be able to offer subsidies to the same extent as France or Germany, the Commission says EU members can draw on existing funds, much of them remaining from the EU’s post-pandemic recovery fund.

Longer term, the European Commission says it will propose a European Sovereignty Fund, but it is unclear how it will operate and how it will be funded.

There is already clear resistance from certain EU members to suggestions that the EU’s plan could eventually entail further joint borrowing.

($1 = 0.9649 euros)