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The economics of U.S. ethanol policy

Brazil also is a player in the debate. The United States currently is the world’s leading ethanol producer, refining about 12 billion gallons of corn-based fuel last year. Brazil comes in second, producing around 7 billion gallons annually from sugar cane.

The South American country hopes to export more ethanol to the United States. Domestic manufacturers argue, however, that this would increase America’s dependency on foreign energy.

With so many competing claims and the Gulf oil disaster spurring greater interest in renewable fuels, two Iowa State University colleagues and I developed a new economic model to examine the likely consequences of changing U.S. ethanol policies.

Our model randomly “drew” corn yields and gasoline prices — the two key factors affecting the profitability of U.S. ethanol — and then calculated how the U.S. and Brazilian ethanol markets would react to each draw. We repeated the calculations 5,000 times to derive an average market response for each scenario.

Three government initiatives help shape the current U.S. market for ethanol: 1) mandates to increase the use of renewable fuels like ethanol from approximately 13 billion gallons today to 36 billion gallons by 2022, 2) a 45-cent-per-gallon tax credit for “blenders” who add ethanol to gasoline, and 3) a 54-cent-per-gallon tariff, which increases the price of foreign (mostly Brazilian) imports. After 30 years, the tax credit and tariff are due to expire at the end of this year, which has triggered an intense lobbying campaign.

Our research, financed by a grant from the Brazilian Sugarcane Industry Association, found that allowing the blenders credit and import tariff to expire would have neither the dramatic, adverse effect U.S. ethanol producers claim, nor create the export bonanza Brazilian producers hope for. Here’s what we found:

Production. Because of strong demand for ethanol in Brazil, elimination of the tax credit and tariffs would have little short-term impact on the U.S. corn and ethanol markets. U.S. ethanol production would increase to some 14.5 billion gallons by 2014 without subsidies and trade restrictions; U.S. imports of Brazilian ethanol would rise modestly to about 740 million gallons — less than 5 percent of the total U.S. ethanol market.

Jobs. There is no scenario under which 112,000 jobs — or anything remotely close to that number — would be lost. If the mandates are kept in place but the tax credits and trade protection are allowed to expire, we estimate the possible loss of no more than 300 jobs in the ethanol industry in 2014.

Fuel prices. Ending the tax credit and tariff would reduce ethanol prices by 12 cents per gallon in 2011 and 34 cents per gallon in 2014. Because most gas sold in the United States contains 10 percent ethanol — a limit the Environmental Protection Agency may increase to 15 percent this fall — lower ethanol prices lead to modest savings at the pump: a penny or two per gallon next year and 3 to 5 cents per gallon in 2014. Opening the U.S. market to all producers also would mean that in years when domestic ethanol production is low, imports would lower the consumer cost of meeting blending mandates.

Taxpayers. The tax credit prompts blenders to use about 900 million gallons of ethanol each year above mandated levels. This costs taxpayers some $6 billion annually (or almost $7 per gallon). Ending the subsidy would save that amount.

U.S. ethanol production and the demand for corn will continue to grow with or without the tax credit and tariff. U.S. drivers and taxpayers stand to benefit if they are allowed to lapse.

Bruce A. Babcock is professor of economics and director of the Center for Agricultural and Rural Development at Iowa State University.


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