I believe that the policy is bad economics for two reasons. First, governments are bad at picking market viable technologies. Michael Boskin recently quoted Larry Summers who was at the time President Obama’s chief economic advisor who said, “the government is a crappy venture capitalist” (“Washington's Knack for Picking Losers”). Second, the demand for vehicles like the Volt is probably inelastic meaning that it would take a large increase in the subsidy to cause a significant increase in the number of cars sold. The average Volt buyer earns $170,000 annually and approximately 50% drive a Prius or BMW (“Obama hikes subsidy to wealthy electric car buyers”). My guess is that the buyers are trying to make a personal statement about their commitment to the environment and this statement is not particularly dependent on price.
The Chevy Volt”), a lot of guess work went into the shape of the supply and demand curves. In this graph, I made demand more inelastic; I did try to find a realistic price but not sales volume. I almost certainly exaggerate sales. The supply (S) and original demand curve (DO) represent the market for the Volt prior to the federal tax credit subsidy. Without a subsidy Chevrolet sells 38,800 Volts at approximately $42,400 a piece (point E0). The $10,000 federal tax credit increases demand (D0 to DN). At the new equilibrium (E1), Chevrolet sells 4,000 more Volts and equilibrium price increases by $2,000 to $44,400. With the $10,000 subsidy, the buyer’s price falls to $34,400.
The EPA gives the Volt a combined gasoline/electric fuel economy of 60 mpg, or about twice the mileage of a similarly sized car. Assuming that a typical Volt owner will drive 15,000 miles per year, and that gasoline costs $4.00 per gallon, the Volt will save its owner approximately $1,000 per year in fuel expenses. If a traditional subcompact costs $20,000, and assuming the buyer does not respond to the lower operating cost by driving more, the Volt will have a fourteen year payback period ([$34,400-$20,000]/$1,000 per year=14.4 years) for the owner.
The private market has a new partner, the taxpayer—the forgotten man. The yellow rectangle is the subsidy paid by taxpayers. It is $428 million dollars ($10,000 times 42,800 Volts). The government estimates that approximately one third of buyers will not qualify for the subsidy, reducing the taxpayer’s bill to approximately $285.3 million, or approximately $71,300 per additional Volt sold. To benefit society, the sale of Volts must generate sizeable positive externalities like a reduction in pollution or a more rapid technological development, etc. I have a hard time believing that there will be a positive return on societal investment.