Papers

Introduction

Few federal policies have as long a history of poor results than those targeted toward energy. In 1973, Richard Nixon announced a program to make the United States energy independent by 1980. In 1975, Gerald Ford signed legislation establishing federal energy efficiency standards for new automobiles. In 1977, Jimmy Carter created the Department of Energy, and a number of other programs, in an effort to cut America's use of imported oil. In 1991, George H.W. Bush proposed the U.S. Advanced Battery Consortium. In 1992, Bill Clinton proposed a carbon tax in the hopes of cutting oil usage. Despite the lackluster track record of these programs, George W. Bush announced additional funding for energy research, including ethanol, during his 2006 State of the Union address.

While Bush's promise seemingly amounts to mere seed money to help a struggling new industry, ethanol has actually been putting down roots in taxpayers' wallets for decades. During the 1970s, ethanol was billed as the answer to America's energy crisis. During the 1980s, it was expected to save the family farm from financial ruin. During the 1990s, ethanol was touted for its environmental benefits. The 30 years that the fuel's proponents have spent cultivating popular and political support are starting to bear fruit. Today, ethanol is viewed not as the solution to just one of these decades-old problems, but rather as the solution to all of them. While going "yellow" does indeed have certain benefits for those who grow corn and distill it into alcohol, ethanol appears to be another in a series of highly-subsidized but ineffective energy programs that are costly for consumers and are bad "investments" for taxpayers. Rather than letting ethanol develop even deeper roots, Congress should end the massive chain of subsidies that supports the fuel program and allow market forces, rather than politicians, to determine which energy technologies will survive and grow.

Ethanol Basics

Ethanol is made by fermenting and distilling simple sugars into alcohol. In the U.S., 90 percent of ethanol is derived from corn. Sorghum, barley, wheat, and potatoes comprise the other 10 percent.[1] Ethanol can also be produced from switch grass, rice straw, and sugar cane waste (Brazil's ethanol industry relies upon sugar cane). Ethanol is then added to gasoline to create E10 (gasoline with up to 10 percent ethanol) or E85 (85 percent ethanol and 15 percent gasoline). Most vehicles can use E10. However, only flexible fuel vehicles (FFVs), approximately 2 percent of today's automotive fleet, can run on E85.

The Congressional Research Service (CRS) estimates that nearly 15 percent of America's expected 10.7 billion bushels of corn (approximately 1.6 billion bushels) from the 2005-2006 corn marketing year will be converted into ethanol.[2] One bushel of corn will create 2.7 gallons of ethanol. In 2004, nearly 3.4 billion gallons of ethanol were produced, which was 2.5 percent of the 140 billion gallons of gasoline consumed that year. According to industry data, the 101 ethanol refineries that are currently online can produce more than 4.7 billion gallons annually, with 32 additional plants and 8 plant expansions expected to add another 2 billion gallons of capacity.[3]

Costly for Consumers

Direct Costs

Despite 30 years of nurturing and development, ethanol still imposes significant direct and indirect costs on consumers. First, unsubsidized ethanol is more expensive to make and sell than gasoline. This is especially true for consumers outside of the five Midwestern states (Illinois, Iowa, Nebraska, Minnesota, and Indiana) that produce approximately 80 percent of the country's ethanol. Second, unlike other varieties of gasoline, ethanol absorbs water and therefore carries a risk of separating. Thus, it cannot travel through conventional gasoline pipelines due to the likelihood of cracks caused by the freezing of the water component. Instead, ethanol must be carried on trucks, trains, or barges. Bob Dinneen, President of the Renewable Fuels Association (RFA), calls this transport system a "virtual pipeline."[4] Regardless of how "futuristic" the distribution mechanism may sound, it results in increased prices at the pump for consumers. According to a report in The Toledo Blade, "The cost of transporting 5.1 billion gallons of ethanol will be about 8 cents a gallon compared with 1.5 cents for gasoline shipped by pipeline or 2 to 4 cents for gas shipped by tanker."[5] The Lundberg Letter estimates that California's shift to ethanol added 10 cents to the retail price of gasoline in the state.[6] Expanded ethanol use will likely lighten drivers' wallets as they fill up.

Not only will motorists have to pay more for each gallon, they will likely find themselves making more frequent trips to fill up as well. While ethanol may burn hotter than gasoline, which results in cleaner engines, a gallon of ethanol also has a lower energy content than does a gallon of gasoline. CRS reports, "This energy loss leads to a 2% - 3% decrease in miles-per-gallon vehicle fuel economy with 10% [ethanol]."[7] Essentially, drivers will not be able to go as far on each gallon of ethanol as they currently do on gasoline.

As auto manufacturers attempt to sell consumers on the "green" benefits of running an FFV on "yellow," drivers should be aware that running on E85 may cost them more than using straight gasoline. Since it takes 1.4 gallons of E85 to equal the energy content of 1 gallon of gasoline, FFV owners can expect a 5 to 15 percent reduction in fuel economy.[8] It has been suggested that E85's lower price at the pump may offset this drawback.[9] The Department of Energy's FFV cost calculator, however, shows that even with a lower per-gallon cost than regular gasoline, consumers using E85 will pay more to drive their vehicles.

The following table compares the cost of driving two E85 vehicles (a Chrysler Sebring and a Dodge Durango) in the five largest ethanol-producing states (Illinois, Iowa, Nebraska, Minnesota, and Indiana) and the four most populated states (California, Texas, New York, and Florida). Even though 65 percent of the 600 service stations that sell E85 are located in the "ethanol belt," which should provide a significant cost savings relative to gasoline, a driver in the region would still spend $295 a year more to fill up the Sebring and $414 more to fuel the Durango. For residents of states outside the Midwest, the average cost difference is even more substantial: $782 for the Sebring and $1,250 for the Durango.

Consumers should be aware that government edicts forcing them to increase ethanol use could dramatically affect their family's fuel expenditures.

Indirect Costs

Consumers may also confront higher prices at the grocery store as ethanol use expands. The National Center for Policy Analysis points out that each dollar spent subsidizing ethanol costs consumers more than $4, observing that:

A study conducted by the Center for International Economics for Meat & Livestock Australia Ltd. found that "mandatory blending of ethanol at 10 percent for gasoline and 15 percent for diesel would sharply boost demand for feedgrains, and permanently increase the average price of grains in Australia by more than 25 percent."[11] Dan Basse, President of the economic forecasting firm AgResources, told The New York Times, "As the corn price reaches up above $3 a bushel, the livestock industry will be forced to raise prices or reduce their herds. At that point the U.S. consumer will start to see rising food prices or food inflation."[12] Upward price pressures could certainly ripple through agricultural and commodities markets and lead to higher food bills for American consumers.

An additional concern for consumers is whether ethanol is an efficient use of natural resources. Does it take more energy to produce a gallon of ethanol than one obtains from burning it? This question is extremely controversial, with Professors David Pimentel of Cornell University and Tad Patzek of the University of California arguing that corn-based ethanol requires 29 percent more energy to produce than fuel ethanol creates.[13] The Energy Department's web site counters that Pimentel's and Patzek's claims were addressed and refuted when the National Corn Growers Association hosted "The Debate on the Net Energy Balance of Ethanol" on August 23, 2005.[14] The Toledo Blade found five other researchers who agree with Pimentel and Patzek, while, "Thirteen other studies, including one paid for by the Department of Energy, show the opposite."[15] While this paper in no way seeks to resolve this debate, the significant level of scientific dissent suggests that the question of ethanol's efficiency is at least not fully resolved. Such uncertainty is not likely to reassure consumers.

Costly for Taxpayers

Subsidizing Overproduction

For over two decades, ethanol has been portrayed as the way to save the family farm and rural America. Iowa Senator Tom Harkin believes that ethanol will be "the next place to look for income for farmers."[16] And, it's easy to see why. Ethanol's supporters are quick to point out that a new refinery in an area will typically cause corn prices to rise 5 to 10 cents per bushel. According to the industry, ethanol generated $32 billion in economic activity and created 153,725 jobs in 2005.[17] Almost $6 billion of that $32 billion accrued to more than 300,000 growers and producers as farm income.[18] Writing in The Des Moines Register, Editorial Page Editor Carol Hunter highlights the benefits of these jobs for Iowa – and by extension all of rural America – declaring: "Those jobs help keep communities viable and offer new career opportunities for Iowa's young people – and older Iowans, too."[19]

While these jobs give the appearance of stability and vitality, they are in fact an artificial outgrowth of the subsidies that support the growing of corn and the making of ethanol. There are, in general, only two ways to increase farmers' incomes: (1) engage in labor activities off the farm, or (2) increase yields for every planted acre. The motivation at the farm level to secure additional income through additional output leads to an aggregate level of overproduction. As The Salt Lake Tribune observed, "We don't make ethanol from corn because it is efficient.… We make ethanol mostly out of corn because it is astoundingly plentiful, thanks to decades of heavy federal subsidies."[20] Author Michael Pollan estimates that taxpayers spend $5 billion a year – almost half of net farm income – to subsidize the growing of 10 billion bushels of cheap corn.[21] As a result, the U.S. sits on a two billion-bushel surplus of corn. According to Pollan, "Ecology teaches that whenever an excess of organic matter arises anywhere in nature, creatures large and small inevitably step forward to consume it, sometimes creating whole new food chains in the process."[22] In this instance, the need to deal with all of that excess corn – which results in large part from government subsidies – and in turn raise farm incomes is used as a justification for the creation and maintenance of the ethanol industry. It is reasonable, therefore, to question how much of this should come at taxpayers' expense.

Subsidizing Production

Prior to 2004, producers of E10 received a 5.2-cent-per-gallon exemption from the 18.4-cent federal motor fuels excise tax.[23] But as CRS notes, "Because the exemption applied to blended fuel, of which ethanol comprises only 10%, the exemption provided for an effective subsidy of 52’ per gallon of pure ethanol."[24] In 1997, the then-General Accounting Office found that the excise tax exemption had the effect of reducing the Highway Trust Fund by $7.5 billion to $11 billion over the period from FY1979 to FY2000.[25]

Concerns over ethanol's drain on transportation funds led the 108^th Congress to replace the excise tax exemption with an income tax credit. Producers can now receive a 51-cent-a-gallon credit for pure ethanol that is used for blending purposes. This subsidy was troubling when it was originally confined to motorists. It is even more so now that it has become embedded in the general Tax Code. In an interview with the Detroit Free Press, ExxonMobil Chairman and CEO Rex Tillerson expresses the skepticism of many, saying, "What the government has done is stick a filter between the signals of the market and consumers. The fact that the subsidies exist shows it's not a viable alternative."[26]

The industry is also receiving support at the state level. Data from the RFA shows that 15 states offer some type of producer incentive program. Table 2 highlights some of these programs. Yet, Pete Geddes of the Foundation for Research on Economics and the Environment questions the efficacy of such programs by pointing out, "Since 1983, Montana taxpayers have provided subsidies for ethanol production. And there is not a single ethanol plant in Montana."[27]

Minnesota's taxpayers have the opposite problem: subsidizing 11 privately owned plants to the tune of $26 million a year. The NBC affiliate in Minneapolis-St. Paul obtained financial reports from the state's ethanol plants and found that pre-tax profits had risen 300 percent in the past year, from $31 million in 2004 to $131 million in 2005. The Duluth News Tribune reports that Minnesota Governor Tim Pawlenty tried to terminate the subsidy program in 2003 but backed down in the face of opposition from the farmers who owned the plants.[28] David Strom of the Taxpayers League of Minnesota rightly calls this "a giant taxpayer rip off."[29]

Cost to Taxpayers

Calculating the amount of taxpayer subsidies transferred to the ethanol industry is difficult to determine, as estimates vary. An analysis from the Cato Institute suggests that ethanol received "a de facto subsidy of nearly $10 billion" between 1980 and 1995.[30] Writing in The Detroit News, Henry Payne suggests ethanol subsidies are costing taxpayers $4.1 billion a year.[31] The Lundberg Letter provides a lower estimate, calculating the amount of federal tax forgiveness in 2005 to be nearly $2 billion, with the subsidy growing to $5 billion by 2025. The $2 billion figure has been reported in several publications. However, it is important to remember that it represents subsidies at the federal level only. The following graph shows the increase in federal subsidies over time using the Lundberg estimates.

Since taxpayers may never know exactly how many of their dollars have gone to subsidize ethanol, it is appropriate to ask how ethanol has survived this long given its limitations. Ethanol is supposed to lead to reduced foreign oil consumption, but former Federal Reserve Chairman Alan Greenspan says, "Its ability to displace gasoline is modest at best."[32] The fuel is supposed to help ensure America's energy independence, but the Government Accountability Office has concluded that the tax incentives given to the ethanol industry have done little to promote energy security.[33] Why then does ethanol exist? One word: politics. During the debate on the 2005 energy bill, New York Senator Charles Schumer – not someone known for his defense of free markets or taxpayers – expressed his frustration regarding this matter saying, "There is no sound public policy reason for mandating the use of ethanol, other than the political might of the ethanol lobby."[34] The Lundberg Letter concurs:

The political support that ethanol enjoys did not happen by chance, nor did it happen overnight. The relationship between government and industry took special care and nurturing over the past thirty years. It is a relationship that entangles both political parties, both ends of Pennsylvania Avenue, as well as a number of state capitals.

The ethanol industry owes its rather comfortable relationship with politicians to the efforts of Archer Daniels Midland (ADM) and its then-Chairman Dwayne Andreas. Andreas spent the 1970s and 1980s convincing politicians that ethanol was good for America. It just happened that ethanol was also good for ADM. Writing for the Cato Institute, James Bovard lays out in great detail the connections between ADM and a number of powerful Washington politicians – names such as Carter, Dole (Bob and Elizabeth), Daschle, Clinton, Bush, Harkin, and Gingrich. By toiling away in the halls of Congress and spreading generous campaign contributions to both political parties, ADM – and to some measure the entire industry – has been able to reap a taxpayer-funded windfall. Bovard estimates that "every dollar of ADM ethanol profits is costing the American public more than $30."[36] One estimate places ADM's earnings from ethanol in fiscal year 2007 at $1.3 billion.[37] If even a portion of Bovard's ratio remains valid today, then ADM can still expect to do very well for itself at taxpayers' expense.

Despite suggestions from Energy Secretary Samuel Bodman that ethanol does not need a federal subsidy, at least at this moment, it is unlikely that politicians will cut off "King Corn" anytime soon. Ken Cook, President of the Environmental Working Group, tells The New York Times, "All incumbents and challengers in Midwestern farm country are by definition ethanolics."[38] The Lundberg Letter quotes an anonymous oil refiner who believes, "As long as you have 100 senators and 60 of them are from farm states, you will never overturn that tax credit, and now the sales mandate."[39] The Associated Press and The Wall Street Journal point out an important political coincidence in their reporting on New York Senator Hillary Clinton and former New York City Mayor Rudolph Giuliani's support for ethanol: both individuals are considered presidential candidates for 2008 and ethanol is extremely popular in Iowa, which hosts the nation's first presidential nominating caucus.[40]

Government Protection

The ethanol industry not only receives billions of dollars in subsidies each year, but governmental protection from international competitors as well. Ethanol imported into the U.S. is subject to a 54-cent-per-gallon tariff. This levy "has been a significant barrier to ethanol imports," according to CRS.[41]

The tariff deters most but not all imports. Ethanol from Caribbean Basin Initiative (CBI) countries is exempt from the duty. However, the exemption is capped at 7 percent of total domestic use. The Heritage Foundation points out that the 7 percent threshold has not been reached since ethanol production in most CBI countries barely exceeds demand and that diverting non-CBI produced ethanol to CBI countries for shipment to the U.S. is rather costly.[42] As such, domestic producers enjoy an effective monopoly thanks to the government protecting them from global market forces.

Regardless of what form the subsidy takes, taxpayers have spent substantial amounts of money to support and protect the ethanol industry.

Creating Markets by Fiat

Perhaps the most generous subsidy that the political system has presented to the ethanol industry was the Energy Policy Act of 2005. President Bush signed the bill into law on August 25, 2005. The law eliminated the oxygen requirements for reformulated gas (RFG) and with it one of the key reasons for using ethanol. In place of the RFG standard, however, the energy bill established a more clever rationale for ethanol use: a renewable fuels standard (RFS). The RFS requires the use of 4.0 billion gallons of renewable fuels in 2006. That requirement increases to 7.5 billion gallons by 2012. Table 3 below details the RFS thresholds for each year. While the RFS does not specify the use of ethanol, it is generally understood that ethanol is the only way to meet the standard. The legislation does require the use of 250 million gallons of cellulosic ethanol beginning in 2013. The law also gives cellulose-based ethanol an additional benefit on top of a guaranteed market. According to CRS, "a gallon of cellulosic ethanol counts as 2.5 gallons of renewable fuel under the RFS."[43]

Through the political wheeling and dealing that culminated in the 2005 energy bill, the federal government has created an artificial market for a product that would not likely exist without Washington's help.

Promoting E85

The federal government and several states seem determined to promote E85 even though only 2 percent of vehicles can use the fuel and fewer than 1 percent of gas stations (approximately 600 out of 170,000) are capable of selling it. While E85's lower fuel economy imposes an indirect cost upon consumers, its high alcohol content imposes a direct cost on gas station owners. E85 is highly corrosive and it cannot be dispensed through fueling systems that can handle gasoline and E10. To sell E85, gas station operators will have to pay for costly upgrades to their existing pumps or purchase new ones. New pumps cost about $100,000. The federal government is offering tax credits of up to $30,000 per station to offset some of this cost. Colorado and Kansas offer income tax credits, while Illinois offers a sales tax incentive. Hawaii, Idaho, Iowa, Maine, Minnesota, Pennsylvania, South Dakota, and Virginia all subsidize E85 by taxing it at a lower rate than gasoline.

One attempt by the federal government to promote the use of E85 may have backfired by increasing oil consumption. As mentioned previously, users of E85 can expect a 5 to 15 percent drop in fuel economy. However, FFVs burning E85 perform very well under the government's Corporate Average Fuel Economy (CAFE) standard. The reason: a credit program created in 1988 designed to boost ethanol consumption and encourage the production of FFVs. In return for building FFVs, the auto industry receives a credit that helps keep their fuel economy numbers above the CAFE requirements. The issue here is that the program assumes that FFVs run on E85 at least half the time, which is rarely the case. A 2005 flex-fuel Chrysler Sebring running on straight gasoline gets less than 28 miles per gallon but is credited with 46 miles per gallon for CAFE purposes.[44] A 2005 Ford Explorer is rated at 32 miles per gallon for CAFE consideration even though it averages only 19 miles per gallon in other government tests.[45] A Chevy Tahoe's fuel economy while burning E85 is 14.6 miles per gallon but after recalculating for the dual-fuel credit, the Tahoe achieves 33 miles per gallon.[46] Even as the program has allowed auto manufacturers to inflate their CAFE numbers and avoid potentially costly fines,[‡] it has also led to higher oil usage. The Union of Concerned Scientists estimates that the dual-fuel credit increased U.S. oil consumption by 80,000 barrels per day in 2005.[47]

State Usage Mandates[†]

States are also working to create additional demand for ethanol through purchase requirements and RFS-style mandates of their own. At least four states require that ethanol be used to fuel state government vehicles. Data from the RFA shows that Illinois, Indiana, and Kansas had fleet fuel purchase requirements as of March 2006.[48] Ohio's Governor Bob Taft made his state the fourth practitioner when he signed biofuels legislation on July 6^th. The law would require the state to purchase renewable fuels when they are "reasonably available and reasonably priced."[49]

Not only are states requiring that their own vehicles run on ethanol, they are mandating its use by their citizens as well. Earlier this year, Iowa's Governor Tom Vilsack signed legislation requiring that 25 percent of the state's automobile fuel come from renewable fuels by 2020.[50] Iowa is just one of four states to have passed such legislation in 2006. Louisiana, Missouri, and Washington state all adopted similar measures. They joined Minnesota and Montana, who already had ethanol mandates on the books.

State ethanol mandates may push fuel prices even higher by recreating problems associated with "boutique" fuels, whose production and distribution were triggered because state and local governments mandated different varieties of gasoline for use within an area. This often required shipping multiple types of fuel to a state or region. Oil companies are concerned that the same supply and transportation bottlenecks associated with "boutique" fuels will arise again as they attempt to meet state and local demands for ethanol.[51]

Unable to Survive Without Help

In testimony before the House Energy and Commerce Committee, RFA President Bob Dinneen said the RFS was a "clarion call to the ethanol industry and financial community that demand for ethanol and biodiesel was no longer uncertain."[52] With a guaranteed market and more plants coming online, ethanol producers have generated a significant buzz on Wall Street. According to CNN, "investors have expressed unabashed enthusiasm for ethanol companies – even those that aren't producing any supply."[53] For example, VeraSun Energy Corp., the second largest ethanol producer in the U.S., recently went public in the hopes of raising $350 million through its public offering. The Wall Street Journal reports that VeraSun's stock price jumped 30 percent on its first day of trading. Hawkeye Holdings, Inc. and Aventine Renewable Energy Holdings, Inc., the third and fourth largest producers in the country, are also planning public offerings. The interest in ethanol stocks has likewise extended to ADM. ADM's share price has doubled over the past year, while that of Pacific Ethanol Inc. – a firm whose investors include Bill Gates – has tripled.[54]

With 30 years of subsidies and now interest from private investors, it would be reasonable to conclude that ethanol should be able to support itself without taxpayer handouts – reasonable, perhaps, but not realistic. After boasting that the demand for ethanol was no longer uncertain, RFA's Dinneen stated, "continued government support will be critically important."[55] Not only will the industry need ongoing subsidies, but removing the tariff and forcing the industry to face international competitors "would send a chilling signal … at a critical time and potentially discourage further investment in this promising technology."[56]

Dinneen's fears are not unfounded, at least from his point of view. A 1998 report from the Food and Agriculture Policy Research Institute concluded that removing ethanol's federal fuels tax exemption would cause corn-based ethanol output to plummet nearly 80 percent from 1998's level.[57] Dinneen is probably hoping to avoid a replay of what happened to Louisiana's ethanol industry. In 1989, Louisiana state lawmakers repealed all state ethanol subsidies. By December 1990, all of the ethanol plants in the state had closed and all production had ceased.[58]

Despite federal and state subsidies, a guaranteed market that is protected from international competitors, and millions of dollars from private investors, it is abundantly clear that ethanol is not and may never be a truly competitive energy alternative.

For over 30 years, ethanol's supporters have been able to marshal political resources and public interest to perpetuate the program and insulate the industry from market forces. Fluctuating gas prices allow ethanol's adherents to portray the fuel as a renewable energy source that will allow the U.S. to achieve some measure of energy independence. Rick Tolman, CEO of the National Corn Growers Association, believes that if consumers are allowed to choose, "they will pick ethanol for its environmental benefits and reduction in foreign oil dependence."[59] Yet, consumers are not allowed to choose – the government chooses for them. Government has decided to shower ethanol with taxpayer dollars. Government has decided to force consumers to purchase ethanol, whether it is cost effective or not. It has been the government's policy to shield the industry from international competitors. And still, ethanol's future is uncertain without continued government support.

Sugar & Biomass

The costs – direct and indirect – to consumers and ethanol's need for massive taxpayer subsidies have not kept some in Washington from suggesting that the U.S. can obtain "energy independence" by producing more ethanol from a variety of crops other than corn. Crops such as sugar (already heavily-subsidized) and dry biomass are the leading contenders.

The current yardstick for "energy dependence" is to replace one-third of the country's gasoline consumption with ethanol as Brazil has done. Yet, Brazil's fuel needs are rather different from those of the U.S. Brazil has approximately 100 vehicles per 1,000 people, which consume 15 billion gallons of fuel a year. The U.S. has approximately 765 vehicles per 1,000 people, which consume 150 billion gallons of fuel. In the U.S., ethanol represents 3 percent of the fuel pool. Ronald Bailey of Reason magazine estimates that doubling the 2004 corn harvest in the U.S. could get the country close to Brazil's level of ethanol use. He points out, however, that growing the additional 12 billion bushels of corn for ethanol "would require plowing up an additional area double the size of the entire state of Illinois."[60]

Yet, some lawmakers in Washington are pointing to Brazil and suggesting that the U.S. should begin producing sugar-based ethanol as well. Minnesota Senator Norm Coleman told the Associated Press, "It would be absurd in 10 years if we're doing 60 billion gallons of ethanol, and the only crop in America that's not participating is sugar."[61] As it happens, Minnesota is the top producer of sugar beets. Coleman is not alone in his support for sugar-based ethanol, as Senators Bill Nelson of Florida, which is the top producer of sugar cane, and Evan Bayh of Indiana, who is another 2008 presidential contender, want to mandate the eventual use of 100 million gallons of sugar ethanol annually. Table 4 shows the states that would benefit from using either sugar cane or sugar beets to produce ethanol and the size of their Congressional delegations.

A sugar-based ethanol mandate would almost certainly turn politicians from sugar-producing states into ethanol supporters. The one exception appears to be Congressman Collin Peterson of Minnesota, who has called sugar-based ethanol "one of the dumbest ideas I've heard around this town in awhile."[62] Producing ethanol from sugar certainly does not make sense from the taxpayers' perspective. Steve Williams, President of the American Sugar Beet Growers Association says, "I would say the economics are not going to be there. The food value is better for sugar than for ethanol."[63] In a recent report, the Department of Agriculture estimates that sugar-based ethanol might be profitable with spot prices near $4 per gallon.[64] However, there are not plants currently producing ethanol from sugar to take advantage of the spike in prices. The Department does not see sugar ethanol being profitable should prices return to their historical norms. To make ethanol derived from sugar economically viable, producers would need subsidies of between $1 and $2 a gallon, significantly higher than the subsidy for corn-based ethanol.[65] Table 5 provides the estimated costs of producing ethanol using various sugar feedstocks. Following Brazil's example of attaining "energy independence" by using ethanol made from sugar would be extremely costly for taxpayers.

Another alternative to corn-based ethanol is dry biomass, or cellulosic ethanol. This type of ethanol can be made from straw, switchgrass, crop residues, and according to researchers at Penn State University, "remnant trees" from Pennsylvania's forests.[66] The primary challenge to producing ethanol from biomass is breaking down the fibrous plant material into usable sugars. According to a report in The Wall Street Journal, private companies such as Abengoa Bioenergy, ADM, Chevron, DuPont, Iogen, Royal Dutch Shell, and Goldman Sachs are involved in a race to find "enzymes that can break down the cellulose into sugars and microorganisms that eat the sugars."[67]

Taxpayers have already spent $1 billion on cellulosic research since the 1980s.[68] The 2005 energy bill provides loan guarantees for cellulosic ethanol refineries. The Energy Department is spending $160 million on a contest to induce private firms to build a working pilot plant. Despite these previous commitments and the resources available to the private firms, taxpayers will likely be forced to provide even greater subsidies in the future. As The Wall Street Journal noted, DuPont considers the research too risky to consider without government backing. The Journal also reports that one of the nation's leading authorities on biomass, Michigan State Professor Bruce Dale, believes that the government needs to spend $2 billion on research in the next few years, effectively doubling the amount of subsidies that the ethanol industry receives from federal taxpayers. Cellulosic ethanol is a pricey alternative whose results are years away at best.

Lessons from Previous Failures

While the political system has invested heavily in ethanol over the past 30 years, elected officials have explored other avenues for energy independence. This section highlights three energy alternatives that have been favored in Washington at one time or another: synthetic fuels, alternative fuel vehicles, and wind energy. Americans have learned two lessons from each of these technologies that are applicable to ethanol: (1) the programs were extremely costly for taxpayers, and (2) the programs produced little if any return on the "investment" of tax dollars.

Synthetic Fuels

Taxpayers should be concerned that ethanol bears a striking resemblance to the federal government's synthetic fuels program of the 1980s. During the summer of 1979, President Jimmy Carter announced an initiative to spend $88 billion to develop synthetic fuels as an alternative to imported oil. Carter signed legislation creating the Synthetic Fuels Corporation (SFC) in June of 1980. The program was given $14.5 billion and instructed to subsidize new technologies, such as converting peat to methanol. SFC was projected to produce 500,000 barrels of fuel a day by 1987 and 2 million barrels a day by 1992.

SFC made significant "outreach efforts" to various industries and promised virtually-risk free government financing. Yet in 1984, CRS was issuing dramatically scaled-back forecasts, with output expected to be just 30,000 barrels per day in 1987 and 50,000 barrels a day in 1992. Despite the fact that many of the projects guaranteed by SFC were "riddled with huge cost overruns," the program was able to hang on until 1985, soaking up billions of dollars and producing very little benefit.[69]

The problem for SFC was that synthetic fuels were not commercially viable despite billions in taxpayer subsidies. If the federal government had not created, funded, and sustained it, the program would not have existed. The same can be said of ethanol. If Congress, and the states, were to remove the production incentives and the RFS, ethanol production would likely all but disappear as well. Rather than having politicians pick "winners and losers," market forces should determine which energy alternatives are available to meet consumer demand.

Alternative Fuel Vehicles

Just as some saw synthetic fuels as the means to energy independence during the late 1970s and early 1980s, some now see alternative fuel vehicles as the way to reduce America's use of imported oil. In 1993, the Clinton Administration created the Partnership for a New Generation of Vehicles (PNGV). This public-private collaboration was supposed to spur innovation in Detroit. The goal was to produce a "Supercar" that was capable of achieving 80 miles per gallon using diesel-fueled hybrids. A prototype was to be available by 2004, with "Supercars" in showrooms by 2008. Taxpayers spent $1.5 billion on PNGV and, as with synthetic fuels, saw little in the way of results.

In 2003, President Bush promised $720 million for hydrogen fuel research. This initiative was designed to complement the FreedomCAR (Cooperative Automotive Research) program that had been announced the year before. FreedomCAR replaced PNGV and shifted the focus to hydrogen as a fuel source. FreedomCAR and the hydrogen fuel program are "to produce hydrogen-fueled engine systems that achieve double to triple the efficiency of today's engines at a cost competitive with conventional engines."[70] Dariel Colella, an adjunct scholar at the National Taxpayers Union, asks two perceptive questions given the "success" of PNGV: "[H]ow many billions of dollars will be spent during those years, and will the cooperative produce a practical and affordable alternative? More importantly, what if the program is a complete failure?"[71]

As taxpayers await the answers to Colella's questions, consumers are choosing hybrid vehicles that are already on the market. Even though hybrids accounted for 1.2 percent of all vehicles sold in 2005, sales have almost doubled every year since the Honda Insight was introduced to Americans in 1999.[72] Depending upon the estimate, hybrids are expected to constitute 3 to 80 percent of the overall car market in the next 5 to 10 years.[73]

The Toyota Prius is the most popular hybrid in the U.S. Toyota – which sold 107,847 of the cars, or 52 percent of the hybrid market in 2005 – developed the Prius without significant input or subsidies from the Japanese government. Without the bureaucracy of a public-private partnership, Toyota has been able to bring a car to market that has found a consumer following. Writing for The American Enterprise, Eli Lehrer points out that "the Prius enjoys a four-year head start on similar products from America's auto makers."[74]

The lesson here is that some auto manufacturers are producing vehicles for which there is a market demand. Rather than subsidizing technologies, the federal government should allow car markers to innovate without interference or "help." Then consumers can decide which technologies best meet their needs.

Wind Energy

The third example is an expensive renewable energy source: wind energy. While demand for wind energy is expected to grow over the next one to two decades, that growth will be driven in large part by federal subsidies – the other driver is government mandates requiring the use of renewable resources. Tax credits for wind energy are expected to total at least $3.7 billion over the next five years.[75] If the subsidies are extended for at least 10 years, the U.S. might have 100,000 operating windmills by 2025.[76] The question is, will they be sustainable without taxpayer support?

An analysis by William Koch in the May 22, 2006, Wall Street Journal provides a micro-level case study on the impracticality of wind power. Four years ago, Koch, the founder and President of Oxbow Corporation, was approached and asked to invest in a wind farm that would be built off Nantucket Sound. Koch analyzed the plans and estimated the project's operating costs to be $27.5 million per year, or 1.8 cents per kilowatt-hour (kwh). Assuming that the plant could sell electricity at 6.6 cents per kwh, then it would have an after-tax cash flow of nearly $54 million. This return, however, was dependent upon both federal and state credits. According to Koch "taxpayers would subsidize Cape Wind [the company building the wind farm] to the tune of $72 million a year."[77] Cape Cod residents could expect their electric bills to rise $440 a year as a result. Koch declined to invest in the venture.

Four years later, the windmills are still under consideration, and Koch finds the numbers even less impressive. Because of increased costs, Koch expects the project to have operating expenses of 9.3 cents per kwh. To obtain a 20 percent return, which is necessary for financing such a venture, the plant's owners would need to sell power at 18 cents per kwh, nearly double the market rate. If the plant was to sell electricity at market rates, it would earn just a 3 percent return and would need subsidies of 10 cents per kwh, approximately $100 million a year. Koch determined that without the tax credits the return would be negative. He concludes, "When you do the math, it is clear that every other form of power generation would be cheaper to build, produce more electricity at a consistent rate and save consumers more money."[78] Koch's comments affirm an observation that NTU Adjunct Scholar Glenn Schleede made in March of 2000: "State officials who are counting on wind energy and other non-hydro renewable energy sources when they create Τportfolio standards' may be unwittingly imposing huge costs on electricity consumers in their states."[79]

All three of these examples have been viewed as potential solutions. All required government support or mandates, yet none were truly economically viable. After spending billions of dollars on these technologies, taxpayers have seen very little for their "investments." It should be apparent that whether it is synthetic fuels, alternative fuel vehicles, wind energy, or ethanol, when government tries to pick "winners and losers," taxpayers always lose.

Long-run Risks for Taxpayers

Ethanol exposes taxpayers to significant long-run financial risks. The fuel is a combination of two commodities, corn and oil, whose production and prices are given to some volatility. CRS notes that "high corn prices caused by strong export demand in 1995 contributed to an 18% decline in production between 1995 and 1996."[80] It is reasonable to assume that unforeseen events will force taxpayers to increase subsidies for farmers, ethanol producers, or both. Consider these possible scenarios and their impact on taxpayers:

• Continued overproduction causes the price of corn to fall; taxpayers must increase subsidy payments to corn growers.

• Corn production falls due to bad weather and ethanol producers must pay more for corn; taxpayers shell out more in agricultural subsidies (or even disaster compensation) and more to the ethanol industry to offset the price spikes in corn.

• Continued high corn prices cause a shift in demand to other crops as ethanol input; taxpayers increase subsidy payments to corn growers to offset lower production, as well as to other farmers to increase production.

• The ethanol industry over-expands and has excess capacity; taxpayers increase subsidies to offset potential losses. (According to the Department of Agriculture, "projections indicate ethanol production will increase beyond the mandated minimum level of 7.5 billion gallons by 2012.)[81] In this scenario, it is possible that government would mandate the use of more ethanol, which would cost both taxpayers and consumers.

• Oil prices drop, making ethanol even less competitive relative to gasoline; taxpayers must increase subsidies to ethanol producers.

After 30 years of government sheltering, any notion that ethanol will be able to stand on its own, let alone weather the storms above (or any others) is rather naive.

Conclusion

Since the 1970s, ethanol has been billed as an all-encompassing solution capable of addressing America's energy, rural development, and environmental challenges. Ethanol's supporters have dutifully nurtured their industry and stalked the halls of government, securing billions in taxpayer subsidies. The industry claims that consumers choose ethanol because it's good for farmers or because it's good for the environment. Yet, after nearly 30 years of government help and protection, the industry is still not able to meet the test of the marketplace. As politicians look to add farm crops from their states to the list of subsidized sources of ethanol, taxpayers can expect to "invest" more and more in this disappointing technology. Washington needs to learn the lessons from its experience with synthetic fuels, alternative fuel vehicles, and wind energy. Politicians are not adept at picking successful technological innovations. Instead of pouring more of the public's money into ethanol, politicians should pull the program out by its roots – ending payments to both farmers and ethanol producers. By doing so, new technologies will emerge into the sunlight – allowing consumers to determine for themselves how to spend their own money to address their own energy needs. This would be a far happier harvest than America has ever reaped from ethanol.

About the Author

Jeff Dircksen is a Policy Analyst with the 350,000-member National Taxpayers Union (www.ntu.org), a non-profit, non-partisan citizen group founded in 1969 to work for lower taxes, smaller government, and economic freedom at all levels. Visit NTU's web site at www.ntu.org.