The Socially Optimal Import Tariff and Tax Credit for Ethanol with Farm Subsidies

Abstract

We determine how the U.S. ethanol tax credit and import tariff affect the corn-ethanol-gasoline markets and how farm subsidies interact with these policies. We show how the ethanol tax credit and import tariff each uniquely affect the ethanol and gasoline prices. The ethanol import tariff alone increases the terms of trade in ethanol imports and corn exports, but decreases the terms of trade in gasoline imports and the tax costs of farm price supports. With price-contingent farm subsidies in place, the optimal tariff and tax credit will depend on the price level. When farm subsidy expenditures are high, import subsidies for ethanol may increase social welfare due to the substantial size of the fuel market relative to the corn market.