Another Blow to Ethanol Subsidies and Trade Protection from Iowa State

11/16/2010 06:21 pm ET | Updated May 25, 2011

As chatter increases inside the Beltway that some energy legislation may move forward during the lame-duck session, new research from the heart of the farm belt once again battered the economic case for extending the ethanol tariff and subsidies. A new report by Bruce A. Babcock, director of the Center for Agricultural and Rural Development (CARD) and a professor of economics at Iowa State University, finds that extension of the two policies would have stark consequences for taxpayers and food prices -- while allowing them to expire would have no significant impact on the ethanol economy.

Higher Feed Costs for Livestock Industry

The report, Impact on Ethanol, Corn, and Livestock from Imminent U.S. Ethanol Policy Decisions, finds that recent price increases for corn are a direct result of U.S. ethanol policies forcing demand adjustments on the livestock industry -- where need for feed rations is fixed -- rather than the ethanol industry which can more easily adjust to changing supplies. Babcock shows that the surge in corn prices (up nearly 50 percent since July) helped spur similar dramatic price increases in other crops like soybeans. The result has been significantly higher feed costs for U.S. livestock producers that are in turn raising the cost of producing Thanksgiving turkeys and other foods.

For instance, the cost of producing 100 pounds of milk has increased by almost $4.00, while the cost of producing meat has increased by about seven cents per pound for poultry to 24 cents per pound for beef. And Babcock predicts that food costs paid by consumers will eventually rise to reflect these increased production costs.

Marginal Impact on Ethanol Economy

In contrast, the report forecasts only modest impacts on the U.S. corn and ethanol industries if Congress does not extend the tax credit and import tariff. Because of a robust government mandate to blend ethanol with gasoline, the $6 billion dollar per year subsidy does very little to stimulate additional demand. Of the 5,000 random pricing scenarios analyzed, nearly half resulted in no change to ethanol consumption levels mandated by the government. That means there's a nearly 50 percent chance that allowing the ethanol tax credit and corresponding import tariff to expire as scheduled at the end of this year will have no impact on corn prices or America's ethanol consumption in 2011 at all!

The other half (i.e., the scenarios where extending the tax credit and tariff made a difference) showed an average increase in ethanol consumption of just 600 million gallons above the mandated level in 2011 - meaning taxpayers would be pay a staggering $10 per gallon of additional ethanol. Summing it all up, Babcock concludes:

The recent corn and soybean price increases have starkly revealed the economic consequences of U.S. ethanol policy. Congress will need to decide if it really makes a lot of sense to stimulate demand for domestic corn ethanol through subsidies and taxes on imported ethanol when corn prices are so already so high. If Congress decides that it does not make sense to stimulate demand when supply is short, then allowing the tax credit and import tariff to expire on schedule makes sense.

A decision to let the tax credit expire may not be that difficult politically because it does so little to stimulate demand. It will cost taxpayers about $10 for each additional gallon of ethanol that is stimulated by the tax credit. And there is no better time to let the import tariff expire because there is so little Brazilian ethanol available for export. Strong domestic demand in Brazil, high prices for sugar, and a strong Brazilian currency all have worked to limit the availability of Brazilian ethanol in export markets.

That last point underscores the value of competition we've been making all year. Commodity prices rise and fall for a host of reasons. But when Americans have access to multiple sources of ethanol, they can turn to the less expensive option -- whether it's corn, sugarcane or something else in the future -- to keep fuel prices in check.

A new paper by the U.S. Department of Agriculture Economic Research Service reached a similar conclusion, noting that in some U.S. markets today, ethanol produced from corn would be cheaper than imported Brazilian ethanol even if the tariff were removed. While sugarcane ethanol imports would likely remain low in the current market environment, fresh competition will ultimately benefit consumers with reduced prices at the pump in the long run.