South Korea’s Concerns Over Inflation Act EV Tax Credit Shows Need for Managed Trade

Less than three years after updating its free-trade agreement with the U.S., South Korea’s read of the electric vehicle tax credit in the Inflation Reduction Act has them understandably upset. What happens to that tax credit now will be worth watching.

The Hyundai Kona is made in Europe for both European and U.S. markets. It’s had success in the U.S. market, but the new inflation reduction law means it is no longer eligible for a $7,500 tax break. Going forward, EVs will have to be assembled in North America and meet other battery content requirements.

South Korea is considered a strong ally of the U.S.  But it must be pointed out, despite writing rules into the U.S.-Korea free trade agreement meant to help our domestically-made vehicles enjoy success in the Korean market, that never really happened. They’ve always sent us ten vehicles for every one we send them.

This highlights the need to move away from rules-based trade agreements, which Ambassador Katherine Tai says becomes a, “we let the chips fall where they may” trade agreement, and instead move towards managed trade agreements, where we look for balance in trade volumes. This could be what comes out of the new South Korea imbroglio.

The U.S. has started to pivot towards this recently for the steel industry, setting up tariff-rate quotas with other countries. There are limits the volume of steel the U.K. and Japan, for example, can sell to the U.S. with a low tariff. Anything above-quote gets a higher tariff.

This week, South Korea’s trade minister, Ahn Duk-Geun, said he will be meeting with Tai over at USTR. “The U.S. fully understands the seriousness of this issue…and we plan to resolve it with practical measures,” Ahn reportedly said.

South Korea won’t be the only one to challenge the EV tax credit. Moreover, to get the full tax credit, batteries and the minerals that go into the batteries, such as lithium, need to be sourced from countries with whom the U.S. has free trade agreements (FTA). South Korean battery makers, like LG Chem and SK Innovation, are big investors in the U.S. EV battery space. Hyundai also said it was already increasing investment in the U.S., but it is unclear if that will include the battery-powered Kona or other models.

Europe will likely submit a complaint through the World Trade Organization (WTO) about the Inflation Reduction Act, signed by President Biden last month. China did the same after the Section 301 tariffs were imposed by the Trump administration. Both Trump and Biden, so far, have ignored the WTO saying those tariffs were against WTO member rules.

Europe does not have an FTA with the U.S., but South Korea does, so Korea has two avenues to complain. The South Korea issue will be a tough nut to crack. It will set the table for whether or not the new EV credit mechanism will work, or if it will be sacrificed at the altar of rules-based trade agreements.

Other than Singapore, South Korea is the only Asian country in which the U.S. has an FTA and Singapore does not manufacture anything. The U.S. does not have any free trade deals with countries that have a national automotive industry like Korea. The USMCA includes Mexico and Canada, of course, but those two countries do not have a native car industry. It’s all American, Italian, and Japanese.

Seeing how South Korea is the only one with an FTA that is being affected by the new EV tax credit law, there is a chance for a special trade agreement to remedy the situation. The Europeans, Japanese, and Chinese will just have to try their luck in the WTO.

Should the WTO say Biden’s inflation law is in breach of WTO rules, as it did with the Section 301 tariffs against China, which are still in place, either the White House does what it has been doing with them and ignore Geneva, or they scrap the EV rule altogether.  Given that Biden has not yet removed the Section 301 tariffs, despite enormous pressure to do so, it is likely that the White House will not want to give up on its North American-centric EV tax credit policy.

That tax credit is designed to make it more attractive to manufacture EVs in the U.S. (as well as Mexico and Canada). Worth noting, some half dozen U.S.-based EV start-ups have been created over the last three years alone. Rivian, with its attractive new trucks, has invested heavily in this space and gearing up for mass production.  Lucid Motors built an EV assembly plant in Arizona.

Thinking Beyond the EV Tax Credit

A straightforward fix to all of this is to renegotiate the U.S. tariff schedule in the WTO. Unless the U.S. wants to continually face floods of imported cars, then we need higher tariffs than the 2.5% tariff we currently offer every WTO member except China. Europe charges 10% on cars.

The WTO allows countries to have high tariffs. India’s average WTO-bound tariff rate is just over 50%. It really boils down to political will in Congress, which sees low tariffs as the symbol of free trade.

Last month, CPA trade counsel Charles Benoit warned in a long report about the inflation law’s impact on the new auto market that Europe and Asia weren’t going to accept it without a fight, and that we “looked like jerks” to Korea. The solution, he says, is to raise our tariffs at the WTO so that we can better manage trade volumes. This is preferable to agreeing to rules and then promptly violating them.

Korea accommodated our rules-based trade requests to ease up on their sovereign prerogative to manage environmental and safety standards for cars. We didn’t get the outcome we’d hoped, so now we just blew up the deal, stripping their EV exports of the $7,500 credit and denying them in the future while extending them to North American assembly. Officials in Korea’s Ministry of Trade are surely, rightfully, indignant.

When we signed the U.S.-Korea Free Trade Agreement in 2007, the perception was that U.S.-made cars did not sell well in Korea due to their taxes on engine size. In that trade agreement’s National Treatment chapter, the U.S. trade negotiators wrote in a unilateral obligation on Korea to ease up on their engine displacement taxes. That didn’t work.  Dissatisfied, the Trump Administration acted to preserve our 25% tariff on trucks until 2041 to limit further damage. In the renegotiation, we took an important first baby step to pivot towards managed trade: Korea promised that at least 50,000 U.S.-made vehicles annually could skip Korean safety standards and use American standards instead. That renegotiation included a further loosening of Korean environmental regulations in the hopes of accommodating more U.S. exports.

None of this worked. U.S. car imports from Korea in 2021 were 831,090 units while U.S. car exports to Korea in 2021 were 77,515 units.

With managed trade, the burgeoning EV market here avoids this mess of constantly having to contend with subsidies and other regulations abroad that often act as either an export subsidy for the foreign producer or a non-tariff barrier.

If the U.S. set expectations on EV import volumes like steel, there would be fewer auto disputes. This is the rule in its simplest form: you get 50,000 vehicles tariff-free each way. If you want to send more, this is the tariff.

“Both countries’ automakers could discover that there’s a viable market for their product, and then make the investments necessary to supply the other country’s market from within it,” Benoit said. “We get all the benefits of competition, without the downsides of hollowing out our domestic base.”

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