Study Finds Government Mandates Superior to All Other Biofuels Policies, But Mixing With Subsidies Causes Adverse Effects; The Argument for a Direct CO2 Tax
17 February 2010
A new cost-benefit analysis of biofuels policies by economists Harry de Gorter and David Just at Cornell University has concluded that government mandates for biofuels “are clearly superior to all other policies, with few tradeoffs arising.” However, they write in a paper published in the journal Applied Economics Perspectives and Policy (AEPP), as soon as different types of policies are combined, there can be negative economic interactions.
For example, adding a biofuel subsidy with a consumption mandate fails to increase ethanol consumption but instead subsidizes oil consumption. A more effective policy would rely on specific taxes and subsidies targeted directly at achieving specific environmental, energy and agricultural policy goals, according to the study.
When used in some combinations, biofuel policies can be contradictory, where the effects of a policy are reversed. These biofuel policies never complement each other, but can on rare occasions be complementary to energy or environmental policy. Rarely does a biofuel policy have a neutral effect.
The effects of each biofuel policy and their interaction with other policies (biofuel or otherwise) are very complex, the economics of which can seem impenetrable. This is due to the intricate interrelationships between energy and commodity markets and the varied environmental consequences. Nevertheless, in this paper we disentangle the key interactions in this byzantine system of policy instruments by analyzing each biofuel policy on its own merits, in relation to each other, as well as to other environmental, energy and agricultural policies. As complex as the economics are, however, once understood, a set of relatively clear policy implications emerge.
—de Gorter and Just
Foremost among those findings is that a quantity-based biofuel mandate is superior to a price-based consumption subsidy. While a mandate can potentially increase social welfare substantially, a consumption subsidy likely decreases welfare significantly, primarily because of the taxpayer burden but also because it encourages negative externalities related to vehicle miles traveled, local air pollution and CO2 emissions.
Other findings from the study include:
Ethanol policy can have a substantial impact on corn prices. However, production costs of US corn-ethanol are very high. The gap between the intercept of the ethanol supply curve and the oil price creates large deadweight costs that may overwhelm any external benefits.
Subsidies and mandates by themselves do not discriminate against international trade. However, production subsidies, import tariffs and sustainability standards do. These trade distorting policies can create huge inefficiencies; US production would otherwise be replaced by Brazilian production, resulting in far lower CO2 emissions.
Sustainability standards which set a maximum amount of CO2 emissions per gallon are ineffective because of leakage to other sectors or countries not covered by the standard. Further, the US standard is highly unlikely to survive a legal challenge in the WTO under the exception for the environment, because the latter requires a measure that is necessary and least trade-restrictive, and not discriminatory or arbitrary (criteria that a sustainability standard does not meet).
Historically, corn subsidies were also required in addition to ethanol policy for US ethanol production to occur. Because farm subsidies make ethanol policy more inefficient, and vice-versa, the claim that ethanol policy reduces the tax costs of farm subsidy programs may not be borne out.
Biofuel policies are clearly inferior to a portfolio of specific taxes and subsidies that directly target environmental, energy and agricultural policy goals.
Taxpayer costs of biofuel and renewable energy policies in general are very high, especially relative to their benefit (which can easily be negative and highly so).
Biofuel subsidies may be warranted in specific situations like compensation for volumetric fuel taxes that discriminate against biofuels because of lower miles per gallon obtained, or if lower CO2 emissions with ethanol due to sequestration occur while growing the crop.
These conclusions are extremely relevant to the current debate over how the United States can best reduce its dependence on fossil fuels while simultaneously improving the environment and reducing greenhouse gas emissions. In his remark on ethanol policy, Stephen Colbert, a comedian, may have anticipated the paradox uncovered in this article when he stated, “The ultimate sacrifice is sacrificing the idea of sacrifice itself.” Taxing CO2 directly will represent a sacrifice in productivity but using various renewable energy policies in its stead generates huge inefficiencies and exacerbates the exact situation it was intending to avoid. Surely, the increases in CO2 coupled with the staggering inefficiencies that accompany the cocktail of renewable energy policies together represent a sacrifice that is ultimately more pernicious than would be the sacrifice of directly taxing CO2.
...biofuel policies that attempt to curb CO2 without directly cutting energy use are clearly wasteful. This approach may have worked (or done little harm) for other economic issues in the past, but renewable energy policy is proving to be unique. We are implementing a lot of policies to find that in return, we are paying even more to achieve less.
—de Gorter and Just
Harry de Gorter and David R. Just (2010) The Social Costs and Benefits of Biofuels: The Intersection of Environmental, Energy and Agricultural Policy. Appl. Econ. Perspect. Pol.32 (1): 4-32 doi: 10.1093/aepp/ppp010
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