Ending corn ethanol support

Posted January 13, 2012 | folder icon Print this page

A USAToday story on the expiration of federal government support of domestic corn ethanol demonstrates the media’s ability to shape a story while appearing to be objective. The reporter technically includes both sides of the story, but trumpets one side so that the average reader would be outraged at the policy change. In reality, federal government support for ethanol is an inefficient attempt at central planning of markets that spawned some terrible consequences.

What’s In a Headline?

Right from the start, we know where the story is coming from. Its headline blares: “End of ethanol subsidy will raise the price of gas.”

Yet this is just one of the points addressed in the article. For example, after reading the text of the piece the editor could have used any of the following alternative headlines:

1) “End of ethanol subsidy will allow Congress to give Americans huge tax cut.”

2) “End of ethanol subsidy will trim deficit by $60 billion over 10 years.”

3) “End of ethanol subsidy will lower food prices.”

4) “End of ethanol subsidy means Congress no longer picking winners and losers in energy markets.”

5) “End of ethanol subsidy without repeal of ethanol mandate means government makes consumers pay more for gasoline.”

Each of these five alternate headlines would be just as true as the one the editor went with. They have a different ring from talking about raising gas prices, don’t they?

As the article explains, the subsidy was a 45-cent-per-gallon tax credit given to refiners for blending ethanol into gasoline, which works out to 4.5 cents a gallon for “E-10.” The tax credit did two things: (1) It made it cheaper to produce ethanol thus increasing its supply and pushing down its price. (2) It increased the demand for ethanol and hence for corn, thus pushing up the price of all types of food. Furthermore, the tax credit meant the Treasury received $6 billion less than it otherwise would have.

With this context, now we can see how removing the 45-cent-per-gallon subsidy would yield the various effects described in the hypothetical headlines above.

This Was Never About Encouraging Ethanol Use

The irony in the ethanol program was that it has never been about the environment, or weaning Americans off of their “dependence” on oil, as supporters of the program claimed. Instead, the rationale for the tax credit—and the mandate that we put it in our gasoline — and the reason the program lasted for 30 years—was to provide a quite naked payoff to American corn growers.

This is obvious when we consider the other component of the program: A 54-cent-per-gallon tariff on imported ethanol. The tariff made Brazilian ethanol (produced from sugar cane) unable to compete in the United States with corn-based ethanol. This ensured that the generous tax credit given to refiners ended up boosting incomes of American farmers, rather than Brazilians.

Let the Market Decide

Federal ethanol policies have been a classic case of the far reaching consequences of federal policies. In recent years, with more and more of the corn crop getting diverted by federal mandate to ethanol, we have seen spiking commodity prices and global food riots, even ardent boosters of ethanol started having doubts.

The economist Ludwig von Mises demonstrated that once the government begins dabbling in one sector of the market, it leads to problems that invite yet more intervention. The government swells, with more money and more regulations being thrown as the problem evolves.

In this case, the government initially wanted to support domestic farmers while boosting the use of ethanol. To that end, it implemented a tax credit to refiners who were forced by law to incorporate ethanol. However, if that were the end of things, then the Treasury would effectively be creating a tax loophole to funnel money to Brazilian farmers, since they could produce ethanol more cheaply. Thus the need to implement the tariff, keeping Brazilian ethanol out.

Yet the extra demand for corn caused its price to rise, but also the prices of everything for which corn is used, including cattle feed (and hence beef prices), and chicken feed (and hence chicken prices). Moreover, by raising the price of corn, the ethanol support caused farmers to use more of their land growing corn, rather than other crops. The reduced supply made these agricultural products more expensive, too.

The government lacks the knowledge and judgment to decide whether refiners should be using more ethanol, or whether such ethanol should be produced domestically versus abroad. These are the types of decisions that a decentralized market makes, day in and day out. Central planning doesn’t work in North Korea, and it doesn’t work in US energy markets either.

Conclusion

Eliminating the tariff on imported ethanol removes an artificial barrier to the free movement of goods across borders, and hence can increase the standard of living of Americans and Brazilians. The elimination of the special tax credit for ethanol moves the tax code in the direction of simplicity and neutrality with respect to various energy sources. To prevent the change from being a net tax hike, the government could reduce tax rates across the board for all Americans. Lastly, the next thing to be repealed should be the ethanol mandate, which compels the use of one product and drives up gas prices. If the USAToday staff is concerned about rising gasoline prices, they should support IER’s calls for increased access to domestic oil resources.

Author:
Robert Murphy