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The End of Ethanol Subsidies

J. Mijin Cha

Here’s good news to start the year off: after more than thirty years, the federal tax credit for ethanol production has ended. The tax credit cost the government $6 billion last year. With nearly 40 percent of the corn produced going to ethanol and byproducts, the high demand for corn resulted in higher corn prices, which led to increased food prices. Not only does corn ethanol raise food prices, but its growth and production requires significant amounts of water and energy. In short, we can celebrate the end of subsidizing an inefficient alternative fuel that competed with a staple food source.

There is a very important lesson to learn from the story of the ethanol industry, however. Corn ethanol became so successful- to the point where more corn was used for ethanol production than for food or feed- due to deliberate government policy. One, a federal mandate required certain amounts of renewable fuels, like ethanol, to be blended into gasoline. This action created a steady, predictable level of demand so ethanol producers knew that there would be a guaranteed stable market. Two, refiners who blended ethanol into gasoline received a tax credit.  This tax credit helped offset any increased costs and provided necessary incentives to grow the sector. Finally, a tariff was imposed on imported ethanol, thereby giving the domestic industry a cost advantage and protecting domestic producers.

While corn ethanol did not turn out to be the miracle alternative energy, other forms of ethanol, like cellulosic biomass, are more promising. The point is that with strong government support, the industry was able to develop alternative fuels and explore new horizons to bring us closer to energy independence. If we applied the three-pronged government approach of mandate, tax incentives, and protection of domestic industries to renewable energy, we would be much closer to energy independence and make significant carbon emission reductions.

For one, a mandate would provide market demand stability for renewable energy that is currently sorely missing. If, for example, the federal government would pass a requirement that 20 percent of energy produced must come from renewables, there would be a guaranteed market for renewable energy that would provide stable market conditions.  Second, a guaranteed tax credit for renewables would provide predictability for producers. As we mentioned earlier, renewable energy producers have to fight for tax credits every year, as opposed to tax credits for fossil fuels, which are written into the tax code, leaving their financials with a sense of uncertainty year to year.

Finally, taxing imported renewable energy production and materials would allow the renewable energy market in the U.S. to flourish and create even more jobs than it already is doing. Renewable energy producers in the U.S. have filed several complaints for anti-competitive practices against China for flooding the market with cheap solar panels and wind towers with artificially low prices that put U.S. manufacturers at a steep disadvantage. The U.S. should not employ anti-competitive practices but there must be some protection for domestic producers against goods coming in that are artificially low in price due to huge Chinese government subsidies.

The ethanol requirement for fuel still remains, preserving its market demand. And, ethanol production is set to increase in 2012. Saying goodbye to its dedicated tax break is a good way to start the year.