The current fuel price shock has renewed focus on decarbonising Australia’s transport sector. But while calls to encourage electric vehicle (EV) take-up have intensified, the government’s flagship EV policy – a fringe benefit tax (FBT) exemption for EVs – has come under increased scrutiny with estimated annual costs blowing out from an initial $90 million to $1.4 billion in 2025-26, and expected to rise to $3 billion by 2028-29.
With a decision on the policy’s future expected in the upcoming federal Budget, policymakers should take this chance to consider whether its design remains fit for its intended purpose – reducing carbon emissions.
The FBT exemption for EVs
Carbon emissions from driving petrol or diesel vehicles are a classic case of what economists call a negative externality – a cost imposed on others by a person’s actions. Addressing this externality means reducing the use of fossil fuel-powered cars.
Switching to EVs is one solution to this problem, and it is this logic that motivates some subsidy for EVs to replace petrol or diesel alternatives. To incentivise the uptake of EVs, the government has exempted new EVs from FBT, which is normally paid when an employer provides an employee with a car for personal use, either directly or through a novated lease (akin to a new purchase).
There are two ways to think about the effectiveness of such an emissions abatement subsidy. First, does it accurately price the externality associated with emissions? Second, how does the cost of the subsidy compare to available alternatives? On both measures the EV FBT exemption comes up short.
Pricing the externality
The size of a subsidy that aims to price an externality should be calibrated to the size of the externality itself. But two key design flaws mean that the EV FBT subsidy fails in this regard.
The first flaw is that the policy provides very different levels of subsidy for the same EV purchase. This is because the policy operates by reducing an individual’s or business’s tax liability.
That means an individual earning $200,000 a year – and facing a marginal tax rate of 47 per cent – will get more than twice the subsidy for purchasing a $60,000 EV than someone earning $50,000, who purchases the exact same EV but faces a lower marginal tax rate of 32 per cent.
The second flaw is that the size of the subsidy increases with the cost of the car purchased.
If two people earn the same income (say, $120,000), the subsidy provided could be over 50 per cent higher if they purchase an EV worth $90,000 compared to purchasing one worth $60,000, with no clear correlation between EV price and emissions abated.
Combined, these two design flaws mean that the subsidy for a similar level of emissions abatement varies widely depending on your income and the cost of the car you purchase, even though the negative externality attempting to be priced doesn’t.
It’s also plausible that even at the average value of subsidy, the EV FBT exemption over-subsidises EV purchases relative to the negative externality it’s targeting. EVs themselves do not produce zero emissions, with many utilising electricity from a grid still powered in part by fossil fuels. And the uptake of EVs may not be decreasing petrol and diesel vehicle usage as much as we think – the subsidy may lead to increased vehicle purchases, with kilometres driven by EVs not offsetting one-for-one kilometres previously driven by petrol and diesel vehicles.
Procuring emissions abatement
To address some externalities, governments use direct pricing interventions like a carbon tax (reflecting the negative externality of carbon emissions) or an R&D subsidy (to reflect the positive spillover of new ideas). In these cases, policymakers attempt to equate the tax or subsidy to the size of the externality across all units of the relevant activity.
In other cases, policy is less about pricing the externality and more about procurement – paying people for desired outcomes – in this case, actions that reduce emissions. In those cases, analysis tends to focus on the cost of the program per additional unit of emissions abatement – the abatement that would not have happened in the absence of the policy.
From 2014 onwards, Australia has shifted from an emissions reduction policy primarily based on pricing (a carbon tax) to one based on procurement (like EV subsidies). In many cases, this leads to very high costs per tonne of abatement and is particularly sensitive to the amount of additionality the policy buys.
This was highlighted by estimates from the Productivity Commission (PC) on the cost of the EV FBT exemption. In the best-case scenario for additional EVs from the policy, the PC estimates the policy costs at least $987 per tonne of CO2-equivalent abated – at least 4.7 times the subsidy that underpins the government’s popular Cheaper Home Batteries program ($209). Under less rosy assumptions, the cost could be as high as $20,084 per tonne according to the PC, 96 times the cost of battery subsidies.
And it’s unclear how much of the recent take-off in EV sales in Australia is additional due to the EV policy. Growth in Australian EV sales has tracked trajectories in other advanced economies, suggesting global factors, such as falling battery costs, may be playing a key role.
So, what can policymakers do?
A policy lever already exists that is well placed to reflect the negative externality from petrol and diesel vehicles – the fuel excise, a per-unit tax on fuel. A reformed fuel excise could be calibrated alongside the mooted EV road user charge, so that the difference between the two reflects the negative externality from fuel-based carbon emissions. This would take us back to pricing the externality directly. It is the simplest and most efficient way to deal with carbon emissions from land transport.
If government chooses to retain the current EV subsidy in some form, then it should be removed from the FBT system to address the fundamental issues in its design. Tinkering with the policy (such as by capping the maximum subsidy) may limit some of these issues but won’t remove them, with underlying fairness concerns around who can access the subsidy remaining.
If there are concerns around needing increased EV demand to induce accelerated rollout of charging infrastructure, then re-prioritising money to expand incentives for such infrastructure directly would be more effective.
The Government has promised the 12 May budget will be big on reform. Repairing the way we currently subsidise EVs is a good place to start.
Amy Tramontozzi
Amy Tramontozzi is a Pre-doctorate Economist at the e61 Institute. She is a master’s student in Applied Data Science at the University of Chicago and recently graduated from the University of Edinburgh with First Class Honours in Economics with Environmental Studies. Amy is interested in analysing climate change effects on regional economies and applying machine learning techniques to economic forecasting.
Lachlan Vass
Lachlan is a Research Manager at the e61 Institute. He leads work at the intersection of economics, data, and public policy, with a current focus on immigration, productivity, and firm dynamics. Lachlan’s work experience spans the private and public sectors, both in Australia and internationally, across a range of policy areas, including social policy, financial markets, trade, and labour markets. Lachlan holds a Honours in Economics from the University of Melbourne. He is currently undertaking a PhD (Economics) at the Australian National University.
