The US and the EU may be on the verge of another transatlantic trade war in 2023 as the two sides continue a dispute over new electric vehicle subsidies in the US.

Relations between the parties have been frosty since the US signed a major new spending package into law in August, with officials in Brussels highlighting a range of measures in the bill that they claim violate international trade rules.

So with the EU preparing its response as key provisions of the act are set to come into force in January, what does the dispute entail and what might the possible consequences be for trade across the Atlantic and beyond?

What is the dispute about?

At the heart of the disagreement are provisions in US president Joe Biden's flagship Inflation Reduction Act (IRA) - a $500 billion spending package that, while nominally aiming to tackle high inflation, also seeks to cut prescription drug prices, boost clean energy and support US manufacturing, among other goals.

The EU has raised objections to nine points within the act, but its biggest concerns relate to subsidies for electric vehicles. Under the IRA, consumers in the US who purchase a domestically-made electric car, SUV or pickup truck will be eligible for tax credits worth up to $7,500. In effect this offers a significant discount for vehicles manufactured in the US. 

However, the benefit is only available for electric vehicles with a final assembly point in North America (including Mexico and Canada due to the USMCA free trade agreement), and using a majority of domestically-sourced components, including the battery. Brussels is therefore worried this will put European manufacturers that import their products to the US at a significant disadvantage.

As well as having a direct impact on imports, a major concern is that it will also discourage future investment in the EU, as manufacturers are likely to shift operations across the Atlantic in order to take advantage of the consumer tax breaks. 

France, for example, has been especially concerned about this, with its government estimating it could cost the country as much as €8 billion in investment that will now go to the US.

What could the EU response include?

The impact of the subsidies was one of the main talking points at a recent EU-US summit known as the Trade and Technology Council (TTC) - which was itself launched last year to help reset relations following the range of tit-for-tat tariffs imposed during the administration of Donald Trump. Meanwhile, potential responses have also been the subject of much debate in Brussels.

One possible answer would be for the EU to draw up its own set of green subsidies in order to benefit European carmakers. However, this could prove divisive within the bloc, with smaller nations concerned they may be left behind their larger neighbors.

European Commission president Ursula von der Leyen stated that the EU should adjust its rules in response to the US subsidies. She said: "The Inflation Reduction Act should make us reflect on how we can improve our state-aid frameworks, and adapt them to a new global environment." Ms Von der Leyen added that the "assertive industrial policy of our competitors requires a structural answer".

Another avenue would be to negotiate an exemption in the IRA that would allow EU-built vehicles to benefit from the same status as those made in Canada and Mexico. EU Council President Charles Michel signaled at the TTC summit that this would be his preferred option. However, as the EU does not have a wide-ranging free trade deal with the US similar to the USMCA, this could prove difficult.

A formal complaint to the World Trade Organization could allow the EU to impose retaliatory tariffs on US imports to make up for any losses if the body's dispute panel finds in its favor. However, the panel is currently dealing with a large backlog that could take years to resolve, and new tariffs are seen very much as a last resort. 

The US is clearly continuing to pursue an aggressive approach to trade under the Biden administration and is showing no signs of backing down even when the WTO has ruled against it - as was the case recently with steel and aluminum tariffs. Therefore, even if some concessions are made, the dispute is likely to set the stage for EU-US relations for much of 2023.