Ethanol Subsidies: A Bad Policy that Refuses to Die

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US Ethanol Subsidies:A Bad Policy thatRefuses To Die

Posted December 19, 2010

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Posted Dec. 19, 2010 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com

Ethanol in the 2010 Year-end Tax Bill

In addition to extending income tax cuts and unemployment benefits, the tax bill passed by Congress in December, 2010, extends key elements of U.S. ethanol policy, otherwise set to expire

A $.45 per gallon tax credit for ethanol used as motor fuel (plus a $.10 bonus for small producers)

A $.54 per gallon tariff that applies to most ethanol imports

NEDAK Ethanol PlantAtkinson, Nebraska

Photo source: http://upload.wikimedia.org/wikipedia/commons/e/e3/Atkinson%2C_Nebraska_factory_to_SE.JPG


Stated Goals of the Policy

Enhance U.S. national security by reducing dependence on foreign oil

Improve the environment by encouraging substitution of ethanol for gasoline

An oil tanker loading at an offshore terminal in the Middle EastPhoto source: http://commons.wikimedia.org/wiki/File:Tanker_offshore_terminal.jpg


Negative Externalities and Social Cost

The logic of intervention in fuel markets is that pollution and national security concerns are “social costs” (externalities) that are not included in market costs

Because of them, the true opportunity cost of using petroleum-based fuels is higher than the market price

At the price P0 the quantity sold Q0 is greater than the efficient amount Q1 that would be sold at price P1.

However, it is doubtful that U.S. ethanol policy accomplishes its stated objective of offsetting harmful social costs


Problem 1: Net Energy Gains from Ethanol are Low

Producing ethanol from corn uses energy inputs in farming and distilling that are nearly as great, or greater, than the energy value of ethanol produced

Studies differ slightly because of assumptions about technology, energy value of by-products, land use effects, and so on

In addition to the net energy problem, other studies suggest that there is little or no net carbon gain from corn-based ethanol

Energy value of inputs

Energy value of ethanol

Energy value of corn

Source: Tad W. Patzek, “Thermodynamics of the Corn-Ethanol Fuel Cycle,” U.S. Berkeley , http://www.bio-nica.info/biblioteca/PatzekCornEthanol.pdf


Problem 2: Subsidies are Not the Best Corrective Policy

Even if corn-based ethanol were highly efficient, subsidies would be a bad way to correct the social cost problem

Instead, each fuel (gasoline, ethanol, natural gas, electricity, etc.) should bear a tax proportional to its social costs

Such a policy would encourage use of the most efficient fuels, and would also provide an incentive for reducing overall fuel use through choice of more efficient cars, moving closer to work, use of local products, and other lifestyle changes

Revenue could be returned through cuts in other taxes or used to reduce the deficit


Problem 3: Ethanol Tariff Blocks Efficient Trade

International trade operates most efficiently when products move from relatively low-cost to higher-cost producers (the principle of comparative advantage)

Brazilian sugarcane-based ethanol is the world’s lowest cost source

However, imports of Brazilian ethanol to the U.S. are blocked by a $.54 per gallon tariff Sugar cane harvesters in Brazil

Photo source: Mariordo, http://commons.wikimedia.org/wiki/File:Piracicaba_10_2008_Sugarcane_harvester_199.jpg


Problem 4: Ethanol Exports

International trade is further distorted by the combined effect of U.S. ethanol tariffs and tax credits

Rather than simply blocking ethanol imports, these policies have made the United States a net ethanol exporter, in direct contradiction to comparative advantage

The reversal of ethanol trade imposes costs on consumers and taxpayers that far exceed the increased profits to corn farmers and ethanol distillers


The Bottom Line: A Bad Policy that Refuses to Die

U.S. ethanol policy is ostensibly intended to improve environmental quality and national security

Its actual effects are the opposite—it does little or nothing for the environment and national security while imposing huge costs on taxpayers and consumers

It is a bad policy that deserves to die, but refuses to do so

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Ethanol Subsidies: A Bad Policy that Refuses to Die