Ethanol: Let Protectionism Expire

It’s high noon for ethanol subsidies and import tariffs, but not for the ethanol industry.
After more than three decades, the U.S. ethanol blenders’ tax credit and the ethanol-import tariff that was put in place to offset it are set to expire at the end of the year. The way things are looking, we may finally be rid of these indefensible and parochial market distortions. The ethanol tax credit alone costs taxpayers over $6 billion per year.

The expiration of these policies will have little, if any, impact on the U.S. ethanol industry, because the Renewable Fuel Standard requires Americans to consume an increasing amount of biofuels each year. The demand for ethanol will therefore not drop significantly even when the current tax credit (45 cents per gallon) and tariff (54 cents per gallon) expire. As a mandate, the standard acts as a built-in market for U.S. ethanol producers.

Still, Tea Party darlings Tom Coburn (R., Okla.) and Jim DeMint (R., S.C.) rightly began pushing the ethanol issue immediately after the election as a key test of whether congressional Republicans could get serious about fiscal discipline. Last week, a bipartisan group of 17 senators, led by the unlikely tandem of Dianne Feinstein (D., Calif.) and John Kyl (R., Ariz.), signed on to a letter calling for an end to ethanol price supports.

The letter was countered by a statement from Sens. Chuck Grassley (R., Iowa) and Kent Conrad (R., N.D) declaring that the U.S. would suffer catastrophic job losses and domestic ethanol production would plummet. Sen. Tom Harkin (D., Iowa) proclaimed, “They have to show me a valid economic reason why the 45 cents is not in the best interest of this country and our economy.”

This argument is exactly backwards: Harkin is unable to demonstrate that the tax credit does anything but subsidize domestic gasoline consumption and exports of ethanol.

Although tax credits by themselves encourage ethanol production, they drive down the cost of gasoline when a mandate controls the price of ethanol. A tax credit gives blenders the incentive to blend more gasoline than they would otherwise (and thereby derive more profits from the tax credit). This increases the supply, and thus decreases the price, of fuel. Because the ethanol market price is fixed by the mandate, when the fuel (ethanol plus gasoline) price has to decline, it does so in the form of lower gasoline prices.

Meanwhile, U.S. corn-ethanol production is at an all-time high of 38 million gallons a day (13.9 billion gallons a year), with exports exceeding even Brazil’s. Corn prices are near their record highs, and food-price-inflation concerns are rising. It is time for lawmakers to adjust to these new realities.

Redundancy and high costs are contributing to politicians’ reluctance to extend the tax credit — as is the growing uncertainty over the claimed environmental benefits and the bad publicity that accompanied the perception that biofuels were a primary culprit of the 2008 commodity price spike.

The waning public support in the U.S. for biofuel subsidies is taking many forms. A broad coalition of organizations, including value-added agricultural industries, environmental groups, and some in the oil industry, is lobbying strongly against extension of the tax credit and tariff. This in the face of divisions within the ethanol lobby, where some argue tax credits are no longer necessary while others propose a shift to a production tax credit, which would be paid to ethanol producers instead of fuel blenders.

If the economic rationale for the ethanol-import tariff is to offset the tax credit, then the tariff should expire along with the tax credit. Letting the tariff expire can provide more competition in the ethanol market and allow more environmentally friendly ethanol onto the market — such as Brazilian sugarcane ethanol. The primary reason sugarcane ethanol is, by far, the world’s lowest-carbon-intensity biofuel produced on a commercial scale is that one obtains twice the amount of ethanol per land unit from sugarcane as from corn. Furthermore, sugarcane is not a staple food crop and, unlike corn, has only an indirect effect on food prices. It is better for Brazil to produce ethanol and the U.S. to produce corn.

Brazil ended subsidies for ethanol over ten years ago and eliminated its ethanol tariff early this year. The U.S. should reciprocate. As the world’s top producers of ethanol, the U.S. and Brazil should collaborate in building an open and global biofuels marketplace for clean, renewable energy.

The best thing President Obama and Congress could do for ethanol policy this year is nothing — let the tax credit and tariff expire.

— Harry de Gorter is a professor at Cornell University and a visiting fellow at the Cato Institute, where Jerry Taylor is a senior fellow.

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