The Law of Unintended Consequences: How the U.S. Biofuel Tax Credit with a Mandate Subsidizes Oil Consumption and Has No Impact on Ethanol Consumption

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  • 1 January 2007
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      • Published in RePEc
Abstract
With a mandate, U.S. policy of ethanol tax credits designed to reduce oil consumption does the exact opposite. A tax credit is a direct gasoline consumption subsidy with no effect on the ethanol price and therefore does not help either corn or ethanol producers. To understand this, consider first the effects of each policy alone (a mandate and a tax credit). Although market prices for ethanol increase under each policy, consumer fuel prices always decline with a tax credit and increase with a mandate except when gasoline supply is less elastic than ethanol supply. To achieve a given ethanol price, the gasoline price is always higher with a mandate compared to a tax credit. A tax credit alone is an ethanol consumption subsidy but most of the benefits go to ethanol producers because ethanol is typically a small share of total fuel consumption. Fuel consumers benefit indirectly to the extent gasoline prices decline with increased ethanol production. With a tax credit or mandate, gasoline consumption declines but more so with a mandate (for a given ethanol price and production level). However, a tax credit with a binding mandate always generates an increase in gasoline consumption, the extent to which depends on the type of mandate. If it is a blend mandate (as in most countries outside the United States), the tax credit acts as a fuel consumption subsidy. Ethanol producers only gain indirectly with the increased ethanol demand resulting from the increase in total fuel consumption. Most of the market effects are due to the mandate with the tax credit only exacerbating the ethanol price increase and causing an increase in the gasoline price but a decrease in the consumer fuel price. For a consumption mandate (as in the United States), the tax credit is even worse as it acts as a gasoline consumption subsidy. Market prices of ethanol do not change, even as the price paid by consumers for gasoline declines (while gasoline market prices rise). A tax credit is therefore a p
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