The Welfare Economics of Biofuel Tax Credits and Mandates

Abstract

An ethanol consumption mandate is a tax on fuel consumers with a fixed oil price, but consumer fuel prices may decline with endogenous oil prices, putting the burden on oil producers. The ethanol consumption mandate has an ambiguous effect on total fuel consumption, CO2 emissions, and miles traveled. A tax credit increases fuel consumption and miles traveled. But a tax credit subsidizes gasoline consumption in lieu of a binding mandate, contradicting energy and environmental policy goals while providing no extra support to farmers. A mandate of 36 bil. gallons by 2022 will cost taxpayers $28.7 bil., potentially generating up to $37 bil. in annual social deadweight costs of increased CO2 emissions, pollution, miles traveled, and dependence on foreign oil. The intercept of the ethanol supply curve is above the gasoline price, implying part of the price premium due to ethanol policy is redundant and represents “rectangular” deadweight costs that dwarf standard measures. Historically, corn subsidies were required for any ethanol production to occur; ethanol import tariffs, mandates, production subsidies, and tax credits were not enough. The claim by proponents that ethanol policy reduces tax costs of farm subsidy programs is therefore in doubt as farm subsidies make ethanol policy more inefficient and vice-versa.