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Federal Ethanol Subsidies: Status and Benefits

Donald L. Van Dyne
Research Associate Professor, Agricultural Economics

Government subsidies for the production and use of ethanol from grain in the United States have always been controversial. Subsidy advocates describe the increase in jobs, personal income, tax base, reduction in petroleum imports, plus the cleaner air resulting from increasing ethanol production and use. Moreover, it provides an additional market for grain -- mostly corn. Those attacking the subsidy cite the large "drain" on the treasury, plus the fact that most of the financial benefit has gone to a few large agribusiness conglomerates. Both sides have good points. The purpose of this is to explain briefly how the federal subsidy works and some benefits of ethanol production and use.

First, the federal subsidy is a blender's tax credit of $0.54 per gallon of ethanol. Under current law, it is scheduled to expire at the end of the year 2000. The subsidy is not paid directly to those who produce the ethanol. Rather, it accrues to the business or company that blends ethanol with gasoline to form gasohol (10 percent ethanol and 90 percent unleaded gasoline). For example, each gallon of ethanol blended with gasoline by a petroleum distributor or retailer results in a $0.54 income tax credit from the tax owed to the federal government. If that company has an income tax obligation, the credit can benefit them directly. If they have no income tax obligation that year, the $0.54 per gallon credit cannot be used and is of no benefit.

In reality, the subsidy is divided between the ethanol producer and the blender by altering the ethanol price based on ethanol demand relative to supply. If the supply of ethanol is high relative to the demand for it, the bulk of the subsidy will be kept by the blender. Or, as ethanol supplies become tighter, the ethanol producer can demand a higher price and a larger portion of the subsidy.

Next, while all admit an ethanol subsidy results in payments from the federal treasury, some choose to ignore the benefits to a community, state or to the U.S. resulting from such an industry. These benefits are in various forms. First, ethanol produced from grain in Missouri would reduce gasoline imports. Missouri currently imports more than $10 billion of energy annually, with much of this expense being to import gasoline. Secondly, ethanol production in Missouri would increase jobs, personal income and tax base. A study conducted by Van Dyne and Braschler estimated that operating each of the two 15-million gallon ethanol plants proposed for North Missouri would result in slightly over 200 new jobs, plus an increase in personal income of almost $28 million annually. Some of these jobs and increased income would be for those working at the ethanol plant, but most would be for other businesses and sectors that would result from increased economic activity in the community. These benefits would be for operation of the ethanol plant. Additional jobs and income would also be realized during the plant construction.

Additional benefits include taxes that would be collected at the local, state and federal levels. Income taxes would be collected on at least some of the increased personal income by the state and federal governments. Sales taxes would be collected by local and state governments on expenditures resulting from much of the increased personal income. State sales tax rates are 4.225 percent, plus the local tax rate which is 2.75 percent in St. Joseph (the site of one of the proposed ethanol plants). Additional revenues would be collected in the form of excise taxes on increased gasoline and diesel fuel sold as the result of an ethanol plant. Excise taxes for both gasoline and diesel fuel in Missouri are $0.17 per gallon of fuel sold. Federal excise taxes for gasoline and diesel fuel are $0.184 and $0.244 per gallon, respectively. Finally, real and personal property taxes would be collected by local governments on the increased investment in the ethanol plant and other purchases such as automobiles, homes, etc. Van Dyne and Braschler estimated that tax collections (local and state, but not federal) could be up to $3 million annually from the increased income resulting from each of the two proposed ethanol plants in North Missouri.

Another benefit to the farm and agribusiness sectors would be the additional demand for grain, with the strengthening and stability of grain (primarily corn) prices directly related to the size of the ethanol industry. Other studies have estimated changes in grain prices that would result from introduction of an ethanol plant and/or an ethanol industry into an area.

One last potential benefit of an ethanol plant in Missouri is something economists call "economics of agglomeration." That is, if an ethanol plant is built and operated in a community, other businesses might be attracted to the area as the result of the ethanol plant. For instance, the wet milling ethanol plant operated by Cargill at Eddyville, Iowa, has attracted at least two additional plants that use output from the ethanol plant. These plants include one that produces lysine which is used as an additive for animal feeds and a plant that manufactures monosodium glutamate. Collectively, the wet milling ethanol plant, the lysine plant and the monosodium glutamate plants have provided a very significant economic stimulus to the Southeastern Iowa economy. Other potential industries that might be candidates for locating adjacent to an ethanol plant in Missouri include increased cattle feeding and/or a packing plant, primarily because of our large beef cattle industry and feed grain production in Missouri.

While this paper has not provided clear evidence of the value of subsidies for ethanol production, it does identify many issues that are critical in evaluating the societal value of such subsidies. It is fully expected that ethanol subsidies -- both state and federal, along with many other controversial issues, will continue to be debated well into the next century.