A 2024 rule change could crush Tesla shares

Tesla‘s (Tesla 0.49%) Pricing power may become a thing of the past.

The leading electric vehicle (EV) company has reduced the prices of its cars several times this year in an attempt to remain the best in the industry and increase sales. In the third quarter, Tesla’s average vehicle selling price fell by about $9,000 to just over $45,000.

CEO Elon Musk spent much of his third-quarter earnings call arguing about how important it is for Tesla to be competitive on price. Musk explained that most car buyers use some form of financing, so the company reduced prices on its cars to combat rising interest rates and keep monthly payments from rising.

Musk also said “there is very significant price elasticity” in the auto sector and with Tesla, which may surprise some investors, who assume Tesla is able to charge higher prices because it is seen as having better technology or a better brand.

However, in its struggle to reach price parity with mainstream cars, Tesla may face another hurdle in 2024.

Tesla’s tax credit incentives are shrinking

Musk also acknowledged the $7,500 tax credit on the call, but said it wasn’t as big of an incentive as it might seem because it’s a burden for some Tesla buyers to wait until tax season to collect the credit.

However, Tesla is now warning customers on its website that some of its cars will no longer be eligible for the full $7,500 credit. According to Tesla, the rear-wheel drive (RWD) Model 3 and long-range Model 3 options will only qualify for the $3,750 tax credit, rather than the full $7,500 credit, because some of their components come from China.

The Department of Energy adjusted the tax credit at the beginning of December, and the Tesla Model 3 trim levels that will be affected by the move are Tesla’s cheapest, meaning it could dissuade some of Tesla’s more price-sensitive customers.

Tesla is using the rule change to try to incentivize purchases of these vehicles before the end of 2023, but this announcement also appears to be an acknowledgment that the reduced incentive could be a challenge to selling those cars.

Will the change hurt Tesla?

The change in the tax incentive will only affect a minority of Tesla buyers, as most of its car sales come from outside the United States. Furthermore, the Model Y outsells the Model 3, even though the Model 3 is its second best-selling vehicle.

The tax incentive change also applies to only two of the three trim levels offered by the Model 3. The more expensive Model 3 was not affected. It is unclear what percentage of Model 3 sales come from the affected trim levels, but one can assume that about 10% of Tesla’s sales come from the Model 3 rear-wheel drive and long-range models sold in the United States, as about 40% of Tesla’s sales come from the United States and the Model 3 is the second most popular model in the United States.

If we take Musk’s comments seriously, it appears that a large percentage of the affected Model 3s could become too expensive for Tesla customers. Before certification, the Model 3 RWD starts at $38,990, while the Long Range model starts at $45,990. Adding nearly $4,000 to the cost of the vehicle will likely turn away some customers.

While losing a few percentage points of revenue may not seem like a big deal, Tesla’s stock is priced at an ideal, and the company is currently struggling with slowing revenue growth and declining profits, as well as signs that the broader electric vehicle market is weak.

In other words, the timing of the tax credit change is not right for Tesla, and is likely contributing to its challenges. Given its expensive valuation and broader macroeconomic pressures, that could lead to a sharp sell-off in Tesla shares next year.