Scrapping corn ethanol subsidies for a smarter biofuels policy

As 2011 expired, so did a U.S. government program that for over three decades appeared politically untouchable: the federal tax credit and domestic tariff for ethanol. From its first appearance in 1978 to this past December 31st, the policy provided over $20 billion in subsidies to American ethanol producers, costing the U.S. taxpayer almost $6 billion in 2011 alone. Enacted in the spirit of “energy independence,” ethanol subsidies became a redoubt for the agricultural lobby and a lighting rod for criticism from environmentalists and sustainability advocates. But with their sudden demise, which came from an eclectic coalition of green lawmakers and budget hawks, opportunity beckons to remake American biofuels policy along greener, more efficient lines.

The boom and its costs

Subsidies for ethanol first emerged from the energy crises of the 1970s, when two major disruptions to Middle East oil imports spurred politicians to declare energy independence a major policy priority in Washington; nearly four decades later that policy has seen far more rhetorical than substantive success (I’ll leave it to Jon Stewart to provide a more vivid explanation). Ethanol processed and distilled from corn, of which the U.S. is easily the world’s largest producer, seemed to meet the goal of developing a renewable, domestically-produced energy source, winning it powerful backers in Washington. Over the last decade in particular, the growth of corn ethanol as an additive to gasoline exploded (see chart), thanks to such laws as the Energy Policy Act of 2005, which mandated an annual production of 7.5 billion gallons in renewable fuel by 2007, and the Energy Independence and Security Act of 2007, which upped that target figure to 36 billion gallons by 2022. Also introduced in the last ten years was the Volumetric Ethanol Excise Tax Credit (VEETC) or “blender’s credit,” which awarded gasoline refiners a 45-cent tax break for each gallon of gasoline they blended with ethanol.

However, the growth in federal support for ethanol and the consequent surge in corn ethanol production have attracted no small amount of criticism, and for good reason. Corn ethanol production is, for the most part, energy intensive and inefficient. Sasha Lyutse of the National Resources Defense Council (NRDC) has demonstrated that when the direct and indirect effects are taken into account, the life-cycle greenhouse gas emissions of corn ethanol can easily exceed those of conventional gasoline. A 2008 study from the Proceedings of the National Academy of Sciences (PNAS) concluded that the combined climate-change and health costs, for every billion gallons of fuel produced, ranged from $472-952 million for corn ethanol as opposed to $469 million for gasoline. Also harmful are the indirect land use effects of expanded ethanol production, which can include nitrogen runoff from crop fertilizers, soil degradation, and a loss of biodiversity. Furthermore, the federal subsidy and tariff regime has barred more energy-efficient forms of ethanol from competing with corn, such as Brazil’s sugar-derived variety.

To add to the environmental cost of U.S. corn ethanol is the potential of its expanded production to raise global food prices, potentially increasing the likelihood of social unrest and instability worldwide. Some 40 percent of the American corn crop is now distilled into fuel, and The Economist has estimated that if that amount of corn were used as food instead, global food supplies of corn would grow by 14 percent. Both the U.S. Government Accountability Office and the U.N. Food and Agriculture Organization have noted the positive link between U.S. corn ethanol production and rising corn prices. Because of America’s position as the leading corn producer and the status of Chicago-traded corn prices as a benchmark for global ones, the U.S. can have an outsize impact on worldwide food prices. Indeed, corn prices have more than tripled in the last ten years, in no small part due to the ethanol boom.

Taking these negative factors into consideration, it’s no surprise that NRDC researcher Nathanael Greene called the scrapping of the corn ethanol subsidy a “victory for average Americans and common sense.” But ethanol isn’t going away anytime soon. The Renewable Fuel Standard requiring a certain percentage of ethanol-blended fuel production is still in place – the Environmental Protection Agency even raised the permissible blend ratio of ethanol to gasoline last year – and the growth of the industry under the subsidies and tariffs regime has made it confident that it will survive the expiration of these programs with minimal damage; at present, ethanol is even trading at a significant discount to conventional gasoline.

Reconfiguring biofuels subsidies

Yet the removal of subsidies for corn-based ethanol should not blind policymakers to the merits of using tax credits to jump-start the development of other renewable energy technologies or even more efficient biofuels. At the NRDC, Greene has outlined a Greener Biofuels Tax Credit that would accomplish the latter through a variety of incentives. Critically, it would subsidize not blenders of gasoline and biofuels but the biorefineries that actually produce the biofuels themselves, thereby removing the incentive to choose cheap biofuel without regard for environmental impact. Biorefiners would be eligible depending on the environmental standards of their production process and supply chain, and environmentally-friendlier cellulosic ethanol (produced from less energy-intensive crops such as switchgrasses) would be favored over corn (though even corn could be eligible for the subsidy if it is produced using conservation measures minimizing fertilizer runoff and soil degradation). The revamped tax credit would also be designed to kick-start companies developing processing technologies to minimize carbon emissions or utilize greener biofuel sources. This new subsidy regime could be coupled with the existing Renewable Fuel Standard, which, though a boon to corn ethanol, has actually been critical to developing cellolosic biofuels.

In replacing one set of subsidies with another, Greene’s proposal would simply reconfigure U.S. biofuels policy to account for the environmental externalities of the production process. Encouraging the production of cellulosic ethanol could not only minimize those externalities compared with corn, but reduce the risk of food price instability. It would also help to achieve some of the original objectives behind biofuels tax credits such as the VEETC, namely to help balance energy usage away from crude oil by employing renewable forms of energy.

In last week’s podcast, Professor Jeffrey Sachs noted that a successful market economy depended upon the twin pillars of the market system for innovation and the state for public goods provision and the control of externalities. A reconfigured biofuels policy would utilize both of these pillars to develop a more sustainable source of ethanol. Bringing policymakers to adopt such a policy may be difficult in today’s political climate, but if the pursuit of energy independence launched the first ethanol subsidies, it’s entirely possible that this goal could be invoked to bring about a new and improved round, especially while oil prices hover around $100 a barrel. And if doubts remain in Washington about the ability of government to foster incentives for the private sector, consider that the VEETC regime turned an otherwise minor fuel additive into a $45 billion industry. Imagine the effects that a smarter biofuels policy could have on both renewable energy development and environmental conservation.