The Republican Tax Bill Exacerbated Tesla's Drop Yesterday

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In addition to disappointing earnings, shares of Tesla (NASDAQ: TSLA) also fell on Thursday after Republicans unveiled a tax bill that would promptly kill off the federal tax incentive that maxes out at $7,500 for electric vehicles (EVs) at the end of 2017 -- less than two months away. The federal incentive applies to all EVs and manufacturers, and is not specific to Tesla. Manufacturers do not directly receive the credit, which consumers can claim on their federal tax returns.

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It's too early to say if the bill will pass, but it has some possible implications for Tesla's business.

The end was already nigh

Most importantly, Tesla is already rapidly approaching the volume threshold that would trigger the credit's phase out, which begins once a manufacturer has reached 200,000 units sold in the U.S. Tesla does not disclose U.S. sales figures on a regular basis, but was widely expected to hit this threshold in early 2018. Once triggered, the credit phases out over subsequent quarters.

Even though Tesla was expected to hit the 200,000 threshold soon, the phase-out period lasts five to six quarters, and eliminating that phase-out period would hurt demand for EVs categorically, including Tesla.

The U.S. is just one country on Earth, but a massively important one

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As we've seen play out in other jurisdictions throughout the world, eliminating EV incentives can potentially pull forward demand from prospective customers that want to take advantage of those incentives while they still exist. For example, Tesla vehicle registrations in Hong Kong saw a significant spike in March of this year, ahead of incentives expiring in April. Registrations are a rough proxy for sales, since customers register their vehicles shortly after purchase. Tesla registrations in Hong Kong have remained minuscule ever since.

At the time, CEO Elon Musk downplayed the concerns, pointing out that Hong Kong is just "one city on Earth." The U.S. also happens to be just one country on Earth, but it is by far Tesla's most important market. Musk will have no way to similarly downplay the potential negative impact if the incentive gets killed.

Tesla started providing quarterly disclosures regarding the geographical breakdown of revenue starting this year; it had previously only provided annual updates. The U.S. comprised 47% of sales in the first quarter and 55% of sales in the second quarter. Tesla will disclose this mix for the third quarter when it files its 10-Q in coming days.

Killing the EV incentive would be a net negative for the entire EV industry

If the bill passes, it will be a major blow to the nascent EV market that is finally starting to gain some momentum as all automakers continue to embrace EVs. Unlike legacy automakers, Tesla has no internal combustion engine (ICE) vehicle business to fall back on. The whole point of governments supporting nascent technologies is to help offset the high costs associated with all new technologies, and removing that support threatens to hurt demand for all EVs.

Starting at $35,000, Model 3 doesn't necessarily require the incentive in order to be competitive since that price point is comparable to the average sales price of a new car in the U.S. ($34,861 in September, according to Kelley Blue Book). What's less clear is how many Model 3 reservation holders may be relying on or significantly factoring that incentive in to their purchase decisions. One thing is indisputable: killing the EV incentive won't help the burgeoning EV industry.

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Evan Niu, CFA owns shares of Tesla. The Motley Fool owns shares of and recommends Tesla. The Motley Fool has a disclosure policy.