The Incidence of Tax Credits for Hybrid Vehicles

A variety of state and federal tax incentives have been used to subsidize gas electric hybrid vehicles. In this paper, I estimate the incidence of these tax incentives using microdata on sales of the Toyota Prius, in order to determine who benefits from these policies. I focus on three sharp changes in federal subsidies stemming from the Energy Policy Act of 2005 and assemble several pieces of evidence which indicate that consumers captured nearly all of the benefit. First, subsidy exclusive transaction prices do not jump in the anticipated direction in response to large changes in federal tax incentives. Second, estimates that account for consumer heterogeneity indicate that consumers captured the majority of the gains. Third, a state panel regression on state tax incentives shows that state tax incentives have little or no effect on transaction prices, which is consistent with the federal result. The conclusion that consumers captured the subsidy poses a challenge to standard models of tax incidence. Toyota faced a binding capacity constraint when the credit was introduced. Given a fixed supply, standard models predict that Toyota would capture the subsidy. I argue that consumers gained instead because Toyota believed that raising prices to clear the market would lower future demand for hybrids. I outline a stylized model in which current prices influence future demand and show that a capacity constraint can generate the tax incidence observed in the data. I then discuss factors that could give rise to such a demand system, drawing on the theory of search among alternatives and the behavioral literature on fairness. Finally, I draw lessons for the study of tax incidence in other markets.