Tuesday, July 20, 2010

CBO Study – BioFuel Tax Credit

The Congressional Budget Office (CBO) recently published a report entitled “Using Biofuel Tax Credits to Achieve Energy and Environmental Policy Goals” that focused on the cost to the US taxpayer of biofuels tax credits. The report focused on two policy goals: displacing the use of petroleum fuel and reducing greenhouse gas emissions. We have taken a quick look at the CBO’s analysis on the displacing of petroleum fuels by ethanol.

The CBO states that biofuels tax credits cost the US Treasury approximately $6 billion per year.

The CBO takes a reasoned approach in determining the cost of the tax credit per gallon of gasoline displaced by ethanol. The CBO converts the tax credit from a volumetric basis to an energy content basis. A gallon of petroleum based gasoline contains 125,000 btu/gallon and a gallon of ethanol has 85,000 btu/gallon energy content. Consequently, the 45 cpg tax credit for each gallon of ethanol is the same as paying blenders 67 cents for every 125,000 btus of ethanol blended with gasoline. Adding an addition correction for the 11,000 btus of petroleum fuels used to produce 125,000 btus of energy from ethanol yields a tax credit value of 73 cents per 125,000 btu of energy produced. This is a fair and reasoned approach to placing a value on the tax credit granted the ethanol industry.

The CBO report then attempts to assign a cause and effect relationship to the tax credit by using the results of a 2008 study by the Food and Agriculture Policy Research Institute (FAPRI) at the University of Missouri that concluded that if no other biofuels policies were in place, removing the tax credit would reduce ethanol production by 32%. The CBO then applied the entire $5.2 billion ethanol portion of the annual $6.0 billion tax credit cost and applied it to the 32% quantity identified in the FAPRI report yielding a final cost of 178 cpg. So in effect, the CBO report concludes that the government is paying $5.2 billion per year for approximately one third of US ethanol production. The size of this number is eye catching and will influence the tax credit renewal debate, but it is not an honest depiction of the regulatory landscape for ethanol in the US.

This is a faulty approach because there is a long term biofuels policy. The Energy Independence and Security Act of 2007 (EISA) with its RFS volumetric mandates will be government policy that remains in place until 2022. Congress is now questioning whether volume mandates take away the need for a tax credit by guaranteeing the industry a market for its product. The VEETC tax credit is paid to the blender of ethanol/gasoline and not paid to the ethanol producer making the effect an indirect incentive at best.

The debate is now being framed in Congress - does an industry that has a tax credit, a mandate carving out 10% of the gasoline market and a protective import tariff; does it still need this much support - or should it stand on its own or decline less government monetary support?

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