Subsidy fraud leads to reforms for China’s EV market

As the largest auto market in the world, China has been committed to promoting electric vehicles (EVs) since 2009; the country aims to have 5 million EVs on Chinese roads by 2020. To reach this ambitious target, the Chinese government offers substantial fiscal subsidies, at both the national and local levels. By the end of 2015, the Chinese national government had poured 33.4 billion yuan (~$4.87 billion) into its EV market, and EV sales skyrocketed from 2,300 in 2009 to 507,000 in 2016. As many as a third of these sales were electric commercial vehicles (including buses, coaches, trucks, and vocational vehicles), while electric passenger car sales hit a record of 336,000 in 2016. However, good intentions do not always bring good results, and a nationwide investigation conducted by the Chinese government in early 2016 found that some manufacturers had cheated to receive the subsidies.

Manufacturers fraud occurred through three main “tricks”:

• Registering vehicles illegally. In China, manufacturers receive subsidies based on their EV sales. To verify the sales volumes reported by manufacturers, local government entities typically check the number of vehicle operation licenses issued. Certain manufacturers obtained the licenses via bribing or deceiving the local vehicle registration authorities without actually producing the vehicles, or by producing them with key parts (e.g., batteries, motor controllers) missing. As a result, some subsidized vehicles exist only on paper, rather than on the road.
• Using smaller batteries in production. China’s subsidy amounts for electric passenger cars are tied to the driving range, which largely depends on battery size. Cars with longer driving ranges may receive higher subsides. For certain types of commercial vehicles, the magnitude of the subsidy is calculated directly based on battery size. Some manufacturers equipped their test vehicles with large batteries during the type-approval process, but in actual production, they switched to smaller batteries. Because of a lack of effective enforcement, the vehicles equipped with these smaller batteries, which were less valuable, received subsidies equivalent to the more valuable type-approval vehicles with larger batteries.
• Falsifying clients. In China, subsidies are paid to manufacturers only for EVs that are actually sold (not just produced). However, the investigation discovered that certain manufacturers sold their vehicles to themselves rather than to end-users to receive the subsidies. The result is that some subsidized vehicles were produced and “sold,” but never reached consumers.

The 2016 national investigation covered 90 companies and 401,000 electric vehicles sold during 2013–2015. To date, 8,015 vehicles (2% of the total sales covered) produced by 12 companies were officially disclosed and confirmed by the Chinese government to be involved in this scandal; over 80% were commercial vehicles (see here and here). However, the Chinese government has not yet released the complete investigation report, so it is too early to conclude how many vehicles were actually involved.

The subsidy fraud scandal led to much criticism on China’s EV policies—and the question was raised whether China should continue the EV subsidies at all. To be fair, using fiscal subsidies as an incentive is not an action to be blamed in and of itself; fiscal subsidies are a key driver of EV uptake in both the United States and Europe, and the same is likely true in China. However, the subsidy fraud occurred mainly because of loopholes in policy design and implementation, and these need to be addressed.

One major loophole is that the subsidy amounts are too high and apply to vehicles regardless of their level of technical sophistication. For example, a 6-m-long battery electric bus could receive subsidies totaling as much as 0.6 million yuan (~$87K; half from the national and half from the local government). This generous subsidy actually exceeds the total cost of a bus equipped with low-cost technologies—an enticing reason for manufacturers to deceive the government to receive the subsidy. Another loophole is the lack of valid enforcement measures, which increases opportunities for manufacturers to play the tricks described above.

The Chinese government has recognized these loopholes and has shown determination to address them. On December 29, 2016, the Chinese government announced its decision to reconstruct the EV subsidy policies as of January 1, 2017 (see our policy update here), with some important adjustments:

1. A phase-down of fiscal incentives is included in the new policy. The per-vehicle subsidy from 2017 to 2020 ramps down by 20% every 2 years from the 2016 levels before the national fiscal incentive program ends in 2021. Because battery costs keep dropping, committing to a phase-down of fiscal incentives is a smart policy.
2. Tightened technical requirements are introduced for vehicles to qualify for subsidies. The previous universal incentive system will no longer exist. Subsidies will be graded, favoring electric vehicles with advanced technologies.
3. Robust anti-fraud and enforcement measures have been added to the new policy. The government will verify proof of sale before releasing any subsidy and will perform regular or random checks to make sure vehicles are eligible. All new EVs will be equipped with onboard monitoring systems to allow for real-time monitoring. Non-private EVs will not receive any subsidies until mileage accumulates to 30,000 km. Both manufacturers and government staff implicated in fraudulent activities will be subject to severe penalties.

In addition, the Chinese government has been developing an EV credit system to compensate for the phase-out of national subsidies; the proposal for this system was released for public comments on September 22, 2016. The final rule is scheduled to be released after the proposal is refined and completed, according to Miao Wei, the Chinese Minister of Industry and Information Technology.

These policy adjustments, created largely in response to the high-profile subsidy fraud scandal, mark major reforms for China’s EV market. As an old Chinese saying goes, “A loss may turn out to be a gain.” After being struck by this scandal, China’s EV market may find the right path toward a prosperous future.

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