Ethanol, Gasohol and Tax Subsidies--Time-to-Go

There is so much news and events out there, it almost makes my head explode. I wanted to write something about the recent remarks of Treasury Secretary Tim Geithner on the Federal Debt limit. His politically misread of the situation and cavalier attitude on federal spending is astounding. However, I am attracted to the news that the federal tax credit for ethanol- one of the more egregious and biggest boondoggles of all time-- is seriously on the chopping block.

I am interested in ethanol because as a Congressional staffer I was deeply involved in creating the initial boost for the industry. The Federal ethanol subsidy can be traced back to the Energy Tax Act of 1978. Senator Robert Dole (R-KS) supported by a few others on the Senate Finance Committee spearheaded legislation to help the ethanol industry and at the same time help agriculture. For the good Senator, it was always about agriculture whether it was Commodity Credit Corporation credits, food stamps or child nutrition. Had to keep those farmers in business. Of course, there were also the two oil shocks and the disastrous energy plans of President Carter, to push the support along. 

The initial subsidy had a value of $0.40 cents per gallon of ethanol by providing an exemption from the 4 cents per gallon federal fuel excise tax on gasoline for fuel blended with at least 10 percent ethanol. A relatively simple idea but, in retrospect, not very effective. Not rich enough. While there are now about 45 different blends of car fuels, (I am not sure if old frying oil from McDonald’s is classified as fuel) this 10 percent blend was called “Gasohol”.

In 1982 Congress raised the gasoline excise tax from 4 cents per gallon to 9 cents per gallon and increased the exemption for 10-percent ethanol blended gas to 5 cents per gallon. In 1984, the Tax Reform Act increased the exemption again, to 6 cents per gallon. In 1990, Congress extended the ethanol tax incentive from 1992 to 2000 but decreased the incentive from 6 cents per gallon to 5.4 cents per gallon.

There is now a move on Capitol Hill supported by both Democrats and Republicans to remove the current subsidy, which has been transformed from the gas tax exemption into a 45-cent tax credit for blenders of gasoline and ethanol. The credit is valued at about $6 billion dollars per year.

I am not a huge believer in government subsidies, tax or otherwise. In some cases they may be necessary but need a very compelling rationale. The government either tries to tell us what to do and how to do it or tries to influence conduct by paying us to do something it deems important. In this case the ethanol subsidy is bad economic, tax and environmental policy. It should go. Let it be phased out but get rid of it.

Ethanol has been under attack for some time but farm state Congressmen and environmentalist have fought vigorously preserved it. The political muscle is and has been impressive.  However, it has always been tan elephant in the corner.  I knew when Vice President Al Gore confessed last year he supported the tax breaks on ethanol for self-serving political ambitions, the ethanol party was coming to an end even though it was recently extended in the tax deal enacted last December. But the subsidy is set to expire again. Probably, it is on its last legs.

There have been many studies, hearings, papers, panels and lobbying on this issue. In order to be fair and present both sides, checklist on the pro’s and cons is in order:

Against the ethanol subsidy

o      Ethanol subsidies don't reduce our dependence on foreign oil

o      Does not reduce carbon emissions

o      Taxes water resources

o      A large portion of the subsidy benefits multibillion-dollar corporations.

o      Use of massive amounts of corn as the feedstock increases the use of polluting fertilizer, 

o      Farmers shifts away from other naturally viable crops to grow corn for ethanol. This artificially driven shift limits the supply grown for food and caused food prices to rise

o      Manufacturing ethanol consumes more energy than the fuel produces.

o      Cost the Government about $6 billion a year when the deficit is at all time records

I could go on but lets go to the other side

For the ethanol subsidy

o      Increases the price of corn by creating artificial demand

o  Preserving the subsidy provides incredible political campaign contributions

There you have it: A primer on ethanol. I did not even have to go into the acreage planted, the detailed economics and food price inflation.  The tax subsidy for ethanol is a case study on government intervention to help a product that is not otherwise economically viable. (Sound familiar?) Over the years the subsidies have helped create the industry but to what end is a debatable question and has it been worth it in terms of costs and environmental degradation? What is clear to me is that the time to support this tax break has long time past. There are better ways to address the energy issues in the country.