Ethanol's Bottom Line

Resident Scholar Robert W. Hahn
Resident Scholar
Robert W. Hahn
To hear the candidates tell it--especially those on the stump in Iowa--ethanol is the answer to America's energy-security woes. And back in Washington, politicians since 1978 have been putting your money where their mouths are: Ethanol is currently subsidized to the tune of 51 cents per gallon when blended with gasoline.

To make sure foreigners don't share the ride on the ethanol gravy train, moreover, Congress has imposed a 54-cent tariff on imported ethanol. President Bush, for his part, has targeted a 20% reduction in gasoline use, mostly by substituting the renewable fuel.

Farmers and refiners remain bullish on ethanol, even though market prices have dipped in recent months--and domestic production capacity will nearly double once refineries now under construction come on line. Yet in all the decades ethanol has been subsidized, Washington has never rigorously applied cost-benefit analysis to ethanol's myriad preferences.

Even if ways are found to make alcohol cost-effectively from otherwise worthless sources of carbon, the process would undermine local air quality as it slowed global warming.

A study I authored with Caroline Cecot, just released by the AEI-Brookings Joint Center, attempts to fill that gap. The results, based on a recent Environmental Protection Agency report on the economics of mandating the production of alternative fuels, strongly suggest that the case for ethanol is lacking.

We used EPA numbers to calculate the environmental benefits of ethanol, along with the security benefits linked to its potential to reduce oil imports. We then compared these benefits with the direct costs of producing and distributing ethanol, the environmental costs associated with its manufacture and combustion, and the cost of the slew of incentives offered to refiners and corn farmers.

If annual production increases by three billion gallons in 2012--a plausibly modest number when the EPA made its own calculations--we estimate that the costs will exceed the benefits by about $1 billion a year. If domestic production reaches the more "optimistic" Energy Department projection for that year, net economic costs would likely top $2 billion annually.

Our analysis is deliberately weighted to give ethanol the benefit of a doubt. For example, we assume that, on balance, ethanol from corn reduces greenhouse emissions, even though recent science suggests that substituting ethanol for gasoline might actually have a negative impact (it increases emissions of nitrous oxide, a more potent greenhouse gas than carbon dioxide). Ethanol distilled from grasses and waste materials has a better environmental payoff, but has much higher direct production costs.

Even if ways are found to make alcohol cost-effectively from otherwise worthless sources of carbon, the process would undermine local air quality as it slowed global warming. Though ethanol is likely to reduce tailpipe emissions of carbon monoxide and toxic hydrocarbons including benzene and formaldehyde, the extra nitrogen oxides react in sunlight to form smog.

The picture on the energy side is a little brighter. For each barrel of oil displaced by ethanol, there are benefits in the form of slightly lower oil prices and reduced potential for economic dislocation from oil-price spikes. We estimate these to be in the neighborhood of $500 million annually in 2012.

But the emphasis here should be on the word "little." In 2005, the ethanol program used about 15% of U.S. corn supplies but displaced less than 2% of gasoline use. Even if all corn produced in the U.S. were devoted to distilling ethanol, the renewable fuel would amount to about 12% of the gasoline demand in 2005. And the more corn used to make alcohol, the greater the potential for collateral damage. Beef producers, not to mention Mexico's tortilla makers, are already upset with high corn prices. Environmentalists, too, seem to be waking up to the fact that ethanol from corn is no panacea.

This growing opposition could open the door to a midcourse correction in Congress's commitment to preferences for corn-based alcohol. The first order of business: ax the tax credit and the tariff on imported ethanol. Instead, direct funds to research that might make a real difference in energy security and/or climate change, such as geoengineering the atmosphere to block solar radiation, or converting biomass to electricity on a large scale.

Congress should also begin using emissions taxes or market-based incentives to drive private innovation. If the tax route is taken, the revenue should enable equivalent reductions of efficiency draining taxes, such as the payroll tax.

Congress might never have bet so much of the taxpayers' money on corn-based ethanol if an unbiased accounting of the consequences had been available early on. We could use a separate agency, shielded in part from political considerations, whose sole mission would be to analyze the costs and benefits of regulations and government programs. Without such an agency, interest-group logrolling will continue to trump science and economics in major policy choices.

Robert W. Hahn is a resident scholar at AEI and executive director of the AEI-Brookings Joint Center for Regulatory Studies.

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