The incentive, which allows employers to avoid paying fringe benefits tax on EVs under $91,387 purchased through a novated lease, will be transitioned to a 25 per cent discount, Treasurer Jim Chalmers and Energy Minister Chris Bowen will announce on Tuesday.
The cost of the tax break to the federal budget has blown out in recent years from an initial $90 million to $1.35 billion in 2025/26 and had been expected to rise to $3 billion by 2028-29.
But a phased tightening of the incentive will save taxpayers $1.7 billion over four years from the 2026/27 budget.
From April 2027, the full tax discount will only apply to EVs costing $75,000 or less, while vehicles above $75,000 but below the luxury tax threshold will only receive a 25 per cent discount.
From April 2027, all EVs below the luxury tax threshold will only receive the 25 per cent discount.
The luxury tax threshold is $91,387 but rises each year with inflation.
EVs eligible for the discount will continue to be exempt from import tariffs.
The changes will deliver a fairer and more financially sustainable tax treatment for EVs, Dr Chalmers and Mr Bowen said in a joint statement.
Growth in the scheme has coincided with a rapid take-up in electric vehicles, which has accelerated since the conflict in the Middle East sent oil prices soaring.
EVs made up 14.6 per cent of all new car sales during March, up from 7.5 per cent in March 2025, according to figures from the Federal Chamber of Automotive Industries.
While the scheme has helped encourage EV uptake, the Productivity Commission found the incentive was the most costly of the government's current suite of policies to reduce carbon emissions, at $987 to $20,084 per tonne of CO2 abated.
Lachlan Vass and Amy Tramontozzi, researchers at independent think tank e61 Institute, identified two major flaws in the scheme.
The incentive increases with the cost of the vehicle, so encourages people to purchase more expensive EVs.
Secondly, the subsidy it provides increases in line with the buyer's income, so disproportionately benefits high income earners.
Reprioritising funds from the scheme to expand EV charging infrastructure would be more effective, Mr Vass and Ms Tramontozzi argued.
The changes come as Labor attempts to rein in a forecast $36.8 billion deficit in the 2025/26 budget, which will be released on May 12.
Dr Chalmers on Monday said the budget will be the government's most responsible yet.
The government will save more money than it spends and bank upward revisions to revenue, he said.
