The Welfare Economics of Biofuel Tax Credits and Mandates

Abstract

An ethanol consumption mandate is a tax on fuel consumers with a fixedoil price, but consumer fuel prices may decline with endogenous oilprices, putting the burden on oil producers. The ethanol consumptionmandate has an ambiguous effect on total fuel consumption, CO2emissions, and miles traveled. A tax credit increases fuel consumptionand miles traveled. But a tax credit subsidizes gasoline consumption inlieu of a binding mandate, contradicting energy and environmental policygoals while providing no extra support to farmers. A mandate of 36 bil.gallons by 2022 will cost taxpayers $28.7 bil., potentially generatingup to $37 bil. in annual social deadweight costs of increased CO2emissions, pollution, miles traveled, and dependence on foreign oil. Theintercept of the ethanol supply curve is above the gasoline price,implying part of the price premium due to ethanol policy is redundantand represents ``rectangular{''} deadweight costs that dwarf standardmeasures. Historically, corn subsidies were required for any ethanolproduction to occur; ethanol import tariffs, mandates, productionsubsidies, and tax credits were not enough. The claim by proponents thatethanol policy reduces tax costs of farm subsidy programs is thereforein doubt as farm subsidies make ethanol policy more inefficient andvice-versa.