The tax break on car loans is a sideshow

When Republicans passed their sprawling tax bill, one objective was to bolster American auto plants. The new tax deduction for interest on car loans is welcome. In terms of the Buy America agenda on dealer lots, however, it’s something of a sideshow. The White House and the Federal Reserve are the bigger factors here, not the IRS.

The new law allows new car buyers to deduct up to $10,000 of car loan interest payments when filing federal taxes each year through 2028, provided the vehicle is assembled in the U.S. and bought rather than leased. Given that financing constitutes the lion’s share of monthly car-running costs, and those have risen above $1,000 partly due to rising interest rates, tax relief looks well-targeted.

The problem is that it’s a Band-Aid, in part because of the limitations on how far such relief extends. About 80% of new passenger vehicle sales go to retail customers, of which about 60% buy using financing. Furthermore, only 56% of vehicles sold to retail customers in the U.S. are assembled here, according to Cox Automotive.

Now factor in tax brackets and income caps. The deduction phases out above earnings of $100,000 for individuals and $200,000 for joint filers, zeroing out at $250,000 for the latter. About 90% of households make $250,000 or less per year, so the net looks pretty wide at first. But for those in the lowest federal tax bracket, deductibility is of limited use since their income generally limits their choices to vehicles costing around $30,000 or less. (1) Roughly four-fifths of the vehicles in that segment are imported, according to Cox Automotive.

Assume, therefore, this benefit is most relevant to households in the next three tax brackets up, roughly 56%. Some rough calculations put the addressable market at about 15-20% of new vehicle sales, even assuming the proportion of US-assembled vehicles rises from here. That’s not nothing, but now consider the scale of the savings.

A salient point is that, as much as average vehicle prices have shot up since the pandemic, the average price of U.S.-assembled vehicles is even higher, at $54,000 according to Cars.com. The charts below summarize the tax shield for a vehicle costing that much at different federal tax brackets, both in terms of average monthly savings and as a percentage of the overall cost of the vehicle at the prevailing average rate of 6.73%. This assumes the vehicle is purchased in September 2025 and the tax shield ends in December 2028. Roughly 40% of the benefit accrues in the first 12 months due to the amortization schedule.

As one would expect with a tax deduction, this one is regressive, compounded by imports predominating among cheaper models.

Lower-income households would benefit far more from lower interest rates. In this example, a one percentage point cut would take about $1,200 off the overall cost of ownership, versus tax deductibility benefits of $683 and $820 for those paying 10% and 12% federal tax, respectively, at the current interest rate. For those in higher tax brackets, the deductibility benefit is more meaningful, equivalent to more like a 1.5 percentage point cut. Plus, of course, lower rates would show up immediately in lower monthly payments, rather than later after filing taxes, and would also extend beyond the law’s expiry in 2028.

Given ominous jobs readings — and ominous threats to Fed independence — lower rates look imminent. In that case, tax-deductibility benefits would shrink a little but still act as something of a force multiplier in reducing costs. For example, a 12% marginal rate taxpayer would see their effective first-year payments cut by $43 per month, split roughly half and half between reduced loan costs and deductibility.

That could offer domestic manufacturers a small edge, but must be set against the implications of slowing economic activity prompting such rate cuts in the first place. Moreover, the fundamental problem of affordability remains. The median household would still be reaching to pay for a $54,000 vehicle, even including a one point rate cut and tax deductibility.(2)This is why Detroit must rethink the prevailing strategy of leaning into bigger, pricier trucks and SUVs to support profits.

It is also why President Donald Trump’s trade war is a bigger factor than tax deductibility. A vehicle price increase of less than 3% would be enough to wipe out the benefits of tax deductibility, even for higher marginal rate payers, according to an analysis by the Institute on Taxation and Economic Policy, which fits with the chart above. There is an optimistic scenario in which a grand bargain on trade with Canada and Mexico removes this threat. For the majority of households, though, the combination of tariffs on imported cheaper models and the frictional costs of tariffs on parts will render the tax break a nice-to-have but will hardly make made-in-America a must-have.

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(1) Two rules of thumb for vehicle affordability are that the price is no more than half your annual take-home pay or that monthly car loan payments take 15% or less of take home pay. The upper bound of joint income in the 10% federal tax bracket, adjusted for the standard deduction, is $53,850. Estimated annual take home pay at that level in Pennsylvania is $43,616, using ADP’s salary paycheck calculator (I chose Pennsylvania because it is a relatively populous state that ranks around the middle in terms of individual tax burden). That take home pay would imply a vehicle price of between roughly $22,000 and $36,000, based on half the annual take home pay or 15% of monthly take-home pay, which is $545. The latter is roughly enough to cover the monthly charge for a 20%-down, 60-month loan, assuming the prevailing average interest rate of 6.73% and federal tax relief.

(2) Median household income in 2024 was $83,730, putting it in the 12% federal tax bracket. Assuming, again, a Pennsylvania taxpayer, take-home pay would be $64,661, per the ADP paycheck calculator. Assuming a reduction in the 60-month loan rate to 5.73% and tax deductibility benefits, the effective first-year payment would be $807 per month, or 15% of take-home pay, at the upper limit of the rule-of-thumb for affordability. In terms of the other affordability guidance, a $54,000 vehicle would still be significantly higher than half of gross income.

This column reflects the personal views of the author and does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners. Liam Denning is a Bloomberg Opinion columnist covering energy. A former banker, he edited The Wall Street Journal’s Heard on the Street column and wrote the Financial Times’s Lex column.