Bailout Watch

ETHANOL CONTINUES TO REAP SUBSIDY WINDFALL
Gloria Lee
June 28, 2002

Since 1978, the United States government has granted a multitude of tax incentives and subsidies to promote the growth of a domestic ethanol industry¹. At the beginning, the industry and its supporters maintained that ethanol is an effective substitute for gasoline, and promised that the fuel switch would reduce U.S. dependence on imported oil. A successful campaign to save corn farmers carried the ethanol market through the early 1980s. From then on, an unlikely coalition, comprised of ethanol producers, the corn lobby and parts of the environmental lobby, has been using "save the environment" slogans to secure and extend the financial giveaways².

However, ethanol's proponents have failed to address issues tied to the completely artificial demand for ethanol created by huge subsidies that have been secured with the help of both ethanol producers and corn growers, often one and the same. Furthermore, ethanol's exalted benefits have been refuted. Critics argue that ethanol has not reduced U.S. dependence on foreign oil and studies conducted by the Congressional Research Service (CRS) and others reveal higher emissions of nitrogen oxides, an environmentally harmful gas that contributes to the formation of ozone³.

A substantial capital investment-typically between $30 million to $40 million-is required to construct plants that convert simple sugars, primarily from corn, into ethanol⁴. Approximately sixty U.S. distilleries produce 1.8 billion gallons of ethanol yearly, mainly for use as an additive in gasoline⁵. In areas with too much carbon monoxide or ozone pollution, the Clean Air Act requires gasoline to be mixed with ethanol or other oxygenates to reduce vehicle emissions of volatile organic compounds. In 2000, 99.7% of fuel ethanol consumed in the United States was in the form of blends of gasoline with up to 10% ethanol, dubbed "gasohol" or "E10"⁶.

Ethanol got its first big break with the 1978 Energy Tax Act, which allowed for a 4-cents-per-gallon exemption for ethanol fuel from federal fuel excise taxes as a temporary measure to reduce U.S. dependence on imported petroleum. The rate was raised to 6-cents-per-gallon during the 1980s, but the Omnibus Budget Reconciliation Act of 1990 reduced the exemption to 5.4 cents of the 18.4-cents-per-gallon federal excise tax. Since 1978, the federal Treasury on average lost $770 million in revenue every year from the partial tax exemptions alone⁷. Current estimates of lost revenue now exceed $1 billion per year. Over the past two decades, the tax exemptions have cost American taxpayers more than $7.1 billion dollars.

The 1998 Transportation Equity Act for the 21st Century (TEA-21) extended the costly excise tax exemption through 2007. In addition to the tax exemptions, three income tax credits are provided for alcohol fuels that are biomass derivatives (renewable resources) and used as fuel: the alcohol mixtures credit, the pure alcohol fuel credit, and the small ethanol producer's credit⁸. The tax exemptions have cost the Highway Trust Fund about $10.4 billion in needed revenues⁹. Balances in both the highway and mass transit accounts will be depleted between 2003 and 2015, according to estimates by the Congressional Budget Office¹⁰.

Without ethanol subsidies, the ethanol industry would quickly cease to exist¹¹. Wholesale ethanol prices, before financial incentives, are about twice that of wholesale gasoline prices¹². Without various price supports and financial incentives for ethanol and corn crops by the federal government, ethanol would be so expensive it would not be able to compete with other gasoline additives.

Because corn is the biggest input into ethanol production, Congress further augments the cost to taxpayers by also subsidizing corn production. Corn producers are guaranteed a minimum national average price of $1.89 per bushel¹³. Ethanol producers, therefore, spend a lot of money to pay for the artificially high price of corn. To offset the high price of producing ethanol, lawmakers then subsidize ethanol producers to compensate them for the premium they paid. By negatively distorting not just either the corn or ethanol markets, but also both, these subsidies wind up costing American taxpayers billions of dollars every year.

To a certain extent, market inefficiencies are tolerable, or even necessary, if there are substantial positive externalities. However, in the case of ethanol, such benefits are either negligible, or are canceled out by the costs involved. Each gallon of ethanol contains only two-thirds of the energy content of gasoline¹⁴. Gasohol is also not as efficient to burn. Says Cornell Professor David Pimentel, "The growers and processors can't afford to burn ethanol to make ethanol. U.S. drivers couldn't afford it either, if it weren't for government subsidies to artificially lower the price."¹⁵

Supporters of ethanol subsidies point to environmental benefits as the chief reason why Americans should continue encouraging ethanol production despite the high costs. However, evidence supporting their claims is muddy. A report published by the U.S. General Accounting Office (GAO) indicates that ethanol tax incentives have had little effect on the environment, primarily because fuel ethanol makes up only 1.2% of the 125 billion gallons of gasoline Americans consume annually¹⁶. Furthermore, without the Environment Protection Agency's renewable oxygenate requirement, an ethanol market really would not exist because ethanol cleans the air no better than non-renewable oxygenates¹⁷.

Although oxygenates have been proven to reduce some harmful emissions, they can also lead to higher levels of others, particularly nitrogen oxide, a precursor to ozone formation¹⁸. Blending ethanol with gasoline can also result in more smog¹⁹. Moreover, combustion of ethanol necessarily results in emissions of carbon dioxide, the primary greenhouse gas²⁰.

Subsidizing increased use of gasohol has not reduced U.S. dependence on imported petroleum. Ethanol accounts for 0.7% of energy consumed by the U.S. Because the energy needed to produce ethanol is relatively equal to the energy produced by combustion, little or no reductions in fossil energy use follow. "Thus, if the energy used in ethanol production is petroleum-based, ethanol would do nothing to contribute to energy security," reports the Congressional Research Service²¹. Since ethanol production is so heavily dependent on corn, any threats to corn supply or increases in corn prices would negatively affect the cost and/or supply of ethanol²². Critics note that without significant new domestic energy sources or reductions in fossil fuel demand, ethanol will not lessen the country's dependence on foreign oil.

Recently, the Senate passed an energy bill that contains a provision that would mandate the use of ethanol in gasoline, and increase the use of ethanol to five billion gallons by the year 2012. The Joint Committee on Taxation has estimated that this provision will cost taxpayers $5 billion over the next ten years.²³

"A program so bereft of public benefit as the ethanol subsidy exists only because it has powerful friends," remarked Doug Bandow in Investor's Business Daily²⁴. Only five companies account for sixty percent of ethanol production capacity²⁵. Subsequently, the tax incentives are effectively direct handouts to these five companies, including mega-agribusiness player Archer Daniels Midland (ADM), which controls 41% of the ethanol industry²⁶. The ethanol giant, which made $1 billion in profit in the past two decades, is a big-time political contributor to both Republican and Democratic national parties, donating more than $3 million in soft money since 1988²⁷. Although ADM does not maintain a lobby office, it does help finance trade associations, such as the National Corn Growers Association and the Corn Refiners Association, that do lobby in favor of ethanol subsidies.²⁸

James Bovard of the Cato Institute commented that even if corn were to be free, ethanol would not reap profits without subsidies²⁹. The subsidies are a corporate bailout for huge agribusiness conglomerates. The small ethanol producer's tax credit is exactly that - small. Without substantial benefits and with significant losses, it is clear that American taxpayers are paying for Congress' shameful habits.

Gloria Lee is an intern at TCS. She will be a sophomore at Wesleyan University in the fall.