November 30, 2010

Left and Right: Down With Ethanol Subsidies

In recent years, the US government has been subsidizing the ethanol industry, giving them tax breaks that have stimulated growth and production of ethanol in the United States. The underlying justification of subsidizing domestic ethanol production is that it strengthens US energy independence. But at what price?

According to this article, many groups, conservatives and liberals alike, disapprove of the current subsidies of this industry. Conservatives want to cut the subsidy program because they see it as a handout to private interest, and cutting it would reduce federal spending. Environmentalists feel that ethanol has no real effect on greenhouse emissions. Liberals feel the benefits of using corn as fuel are marginal, and they think that the subsidy of ethanol (which is corn-based) is driving up food prices. 1

While this article addresses some very important social issues, it really does not address the economic issues that can result from an industry subsidy such as this. Considering the market for ethanol, when the government has subsidized ethanol production, the supply curve for ethanol surely shifted outward, resulting in a larger quantity being supplied, at a lower cost. The impact of the subsidy is lower prices for consumers with higher prices received by producers; this results in both a surplus for consumers and a surplus for producers. While lower prices for consumers is nice, it is a direct result of the government subsidizing ethanol production, so while consumers may enjoy paying a lower price, they inevitably pay for this through their own taxes.

The total figure by which the ethanol industry is being subsidized by the US government is about $6.5 billion per year. According to a study by the Global Subsidies Initiative, if ethanol subsidies were eliminated, demand for ethanol would fall, resulting in corn commodity prices declining by $.30 per bushel. As the price of corn falls, other farm subsidy programs would go into effect, costing the government about $.57 billion per year. 2 The Renewable Fuels Association believes that eliminating the ethanol subsidy would result in a loss of $3 billion in net revenue of federal taxes.1

So, $6.5 billion per year in subsidies could be saved if the program were eliminated, but there would be an additional burden of $.57 billion on other farm subsidy programs. So eliminating the program would save $5.9 billion per year. I did not include the loss of net tax revenue into this calculation because this tax is not a benefit, but a transfer.

Based on preliminary observation, it appears that liberals, conservatives, and environmentalists may be on to something; whether they know it or not.



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