Why do Americans love their ethanol so much?
Growth of ethanol as a fuel source in the United States has resulted from tremendous subsidies at the federal, state, and local level. The biggest single item is the Volumetric Ethanol Excise Tax Credit, which grants a tax credit to blenders who combine ethanol with gasoline, in the amount of 51 cents per gallon of pure ethanol blended. But this is only part of the story, as detailed in a report released last October (hat tip: Cato Institute) by the International Institute for Sustainable Development. In addition to the direct subsidy from the VEETC, many states reduce motor fuel taxes on favored fuels, and there are numerous separate subsidies and tax breaks for investment in the infrastructure required for biofuel production. There is also a large implicit subsidy in the form of the mandate from the Energy Policy Act of 2005 that 4 billion gallons come from renewable fuels in 2006, rising to 7.5 billion in 2012. The impact of these mandates on the price of ethanol is greatly amplified by the 54-cents-per-gallon tariff currently in effect for imports of ethyl alcohol intended for use as a fuel. Finally, there are significant direct agricultural subsidies for farmers that reduce their water, fuel, and other costs below market. The IISD estimated that such subsidies currently sum to $1.05 to $1.38 per gallon of ethanol.
What this means is that the economic value of the resources that are used to produce a gallon of ethanol are nearly 50% greater than the value of the product to the consumers. Some have argued that ethanol is actually a net energy loss, requiring more energy in the various inputs than is contained in the final product, though the U.S. Department of Energy and a National Academy of Sciences study have endorsed the claim that there is some modest energy gain. But even assuming that ethanol does effectively add slightly to our net energy supplies, what sense does it make to pay attention only to the inputs of energy that are required in order to produce ethanol from corn, acting as if the inputs of land, labor, and capital can be valued at zero?
With 14% of the 2005 corn crop already going to ethanol production, devoting even more of the crop to making ethanol means higher prices for corn-dependent products ranging from soft drinks to bacon. The price of tortillas in Mexico rose 14% last year, a significant hardship for those who depend on corn as their dietary staple. Not to mention the fact that increased corn production also comes at the expense of other crops:
The NAS study claimed that even if 100% of the U.S. corn crop were devoted to ethanol production (leaving zero for exports, corn flakes, or whatever), it would only displace 12% of our gasoline consumption; (thanks again to Jerry Taylor for steering me to that estimate).
Although powering our cars with corn is vastly more expensive than other alternatives, this choice seems to be tremendously popular with most Americans. If an economist were asked to justify this attitude, the argument would have to be that the market cost of imported oil vastly understates its true cost to us in terms of geopolitical implications of U.S. dependence on foreign oil. But if that is the underlying rationale, the preferred economic solution would not be a subsidy to corn producers, but rather a tax on oil imports.
The subsidies and economic inefficiencies they create result in taxpayers and consumers paying more than they would under a simple, direct import tariff. A tariff would also produce strong incentives not just for ethanol production but also a variety of alternative energy sources and conservation, with the big advantage that market forces would guide us to the most efficient options on the table. But I guess the ethanol subsidies have the advantage that Americans can pretend that somebody else is footing this bill.