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CRS SAYS GAS TAX HIKES WOULD SPEED UP ALTERNATIVE FUELS DEVELOPMENT.

OCT. 7, 1994

94-785E

DATED OCT. 7, 1994
DOCUMENT ATTRIBUTES
  • Authors
    Lazzari, Salvatore
  • Institutional Authors
    Congressional Research Service
  • Code Sections
  • Index Terms
    CRS
    fuel, alcohol, credit
    fuel, gasohol
    gasoline tax, gasohol
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 94-9482 (33 original pages)
  • Tax Analysts Electronic Citation
    94 TNT 205-15
Citations: 94-785E

                       CRS REPORT FOR CONGRESS

 

 

              ALCOHOL FUELS TAX INCENTIVES AND THE EPA

 

                   RENEWABLE OXYGENATE REQUIREMENT

 

 

                          Salvatore Lazzari

 

                    Specialist in Public Finance

 

                         Economics Division

 

 

                           October 7, 1994

 

 

SUMMARY

The Federal tax code contains five tax incentives that benefit alcohol fuels: the 5.4 cents excise tax exemption, the 54 cents per gallon blender's tax credits, the 10 cents per gallon small ethanol producers' credit, the income tax deduction for alcohol-fueled vehicles, and the alternative fuels production tax credit. These tax incentives were enacted to encourage substitution of renewable alcohol fuels for gasoline and diesel, to conserve petroleum in the transportation sector, and reduce dependence on petroleum imports. The blender's tax credits were specifically enacted to complement the excise tax exemptions, so as to help support farm incomes by finding another market for corn, sugar, and other agricultural products that are the basic raw materials for alcohol production. More recently, proponents of expanding the alcohol fuels tax incentives argue that they reduce smog and improve air quality.

The alcohol fuels tax incentives -- particularly the 5.4 cents exemption -- are anticipated to receive greater scrutiny by the Congress as a result of a recent Environmental Protection Agency mandate that 30 percent of the oxygenate in reformulated gasoline must be made from renewables. The EPA mandate, if implemented, will result in a larger aggregate Federal subsidy for ethanol when tax subsidies (which are equivalent to $23 per barrel of oil displaced) are taken into account. The mandate will stimulate production of ethanol, increase ethanol's fraction of the future oxygenates market, and increase revenue losses from existing tax incentives. Revenue losses from the 5.4 cents exemption are currently averaging about $500 million per year, and might increase to nearly $1 billion by the year 2000 without the mandate. To date, a total of about $5 billion in Federal tax revenue has been lost from this incentive alone. Another $1 billion per year in revenue could be lost by the year 2000 as a result of the mandate, bringing the total alcohol fuels revenue loss to nearly $2 billion per year. This is tax revenue that would otherwise go to the highway trust fund.

Of all of the existing tax incentives, the 5.4 cents per gallon exemption from the motor fuels excise taxes has been the most effective in stimulating alcohol fuels development. Also, tax incentives are a more efficient way to stimulate alcohol fuels development than mandates. For four reasons, however, the alcohol fuels tax incentives are economically less efficient than alternative energy tax policies: (1) they provide subsidies to alcohol fuel producers when economic principles suggest that no subsidy, and maybe even a tax, should be imposed; (2) they fail to fully tax users of alcohol fuels in transportation on a par with users of gasoline and commensurate with the benefits received from the system of national highways; (3) the tax component that corrects for the negative environmental externalities from the combustion and evaporation of alcohol in vehicles is the same as gasoline when theory and evidence suggests that it be less than for gasoline; and (4) as a policy to stimulate alternative fuels targeting alcohol subsidizes more expensive fuel when economic theory suggests that the market will determine the least expensive fuels to use. Inefficiency leads to lower national income by distorting resource allocation. Raising the price of gasoline by increasing the excise tax on gasoline would be more economically efficient tax policy.

                          TABLE OF CONTENTS

 

 

THE FIVE TAX INCENTIVES FOR ALCOHOL FUELS

 

 

     EXCISE TAX EXEMPTIONS

 

          Structure of Motor Fuels Excise Taxes

 

          Structure of Excise Tax Exemptions for Alcohol Fuels

 

          Major Limitations

 

          Legislative History

 

          The Special Case of Methanol

 

     INCOME TAX CREDIT FOR ALCOHOL USED AS A FUEL

 

          Structure of the Credits

 

          Major Limitations

 

          Legislative History

 

          The Role of ETBE

 

     ETHANOL TAX CREDIT FOR SMALL PRODUCERS

 

          Structure of the Credit

 

          Major Limitations

 

          Legislative History

 

     TAX DEDUCTION FOR CLEAN FUEL VEHICLES

 

          Structure of the Deduction

 

          Major Limitations

 

          Legislative History

 

     THE ALTERNATIVE FUELS PRODUCTION TAX CREDIT

 

          Structure of the Credit

 

          Major Limitations

 

          Legislative History

 

 

ECONOMIC ANALYSIS

 

 

     REVENUE LOSSES AND THE HIGHWAY TRUST FUND

 

     EFFECTIVENESS OF THE TAX INCENTIVES

 

     ARE THE ALCOHOL FUELS TAX INCENTIVES EFFICIENT?

 

          Inefficiency Due to Negative Production Externalities

 

          Inefficiencies Due to Negative Consumption Externalities

 

          Inefficiencies Due to Insufficient Charge to Highway Users

 

          Implications for Energy Tax Policy

 

 

APPENDIX A: MISCELLANEOUS TAX BENEFITS

 

 

     IMPORT LEVIES

 

 

APPENDIX B: EXPIRED TAX PROVISIONS

 

 

     THE BUSINESS ENERGY TAX CREDIT

 

     TAX EXEMPT INTEREST ON INDUSTRIAL DEVELOPMENT BONDS

 

 

ALCOHOL FUELS TAX INCENTIVES AND THE EPA OXYGENATE REQUIREMENT

In response to the two energy crises of the 1970s, a variety of Federal tax incentives (and many regulatory incentives) have been enacted to stimulate production of alternative (nonconventional) energy resources. Some of these incentives have focused on alternative motor fuels in the transportation sector. As the single largest petroleum consuming sector, transportation contributes to dependence upon imported petroleum and to a variety of environmental problems, such as hazardous waste generation and disposal from petroleum refinery operations, and the increased risk of environmental damage due to oil spills into the Nation's waters and land. Moreover, mobile source emissions from gasoline and diesel combustion and evaporation are a major source of deteriorating air quality in urban areas and of greenhouse gases.

Since 1978, several tax incentives have been enacted to promote alternative motor fuels. Most of these have focused on the alcohol- based fuels, particularly ethanol from biomass. Over the years questions have been raised whether these tax incentives have been effective and appropriate or efficient energy tax policy. The Environmental Protection Agency ruling of June 30, 1994, mandating the use of the renewable alcohol as an oxygenate in reformulated gasoline, has provided an additional impetus for Congress to examine these incentives. The ruling guarantees ethanol an increased share of the future oxygenates market. The increased production and use of alcohol fuels in response to the ruling will increase the tax subsidies to alcohol fuels, which will increase revenue losses.

This report examines the current alcohol fuels Federal tax incentives. 1 Part I describes the statutory provisions of each of the five incentives. Part II examines the major public policy and economic issues of concern to policymakers: potential revenue effects, effectiveness, and economic efficiency.

THE FIVE TAX INCENTIVES FOR ALCOHOL FUELS

There are basically five Federal tax incentives or subsidies for alcohol fuels in the current tax code. In order of importance to alcohol fuels development, they are: (1) the excise tax exemptions; (2) the blender's tax credits; (3) the small ethanol producer's tax credit; (4) the tax deduction for clean-fuel burning vehicles; and (5) the alternative fuels production tax credit. Each of these is discussed below. In addition to a detailed discussion of the statute, each section discusses major limitations to the tax incentive, legislative history, and any other special issues concerning that particular provision. Readers familiar with these provisions might choose to go directly to the economic analysis discussion on p. 15.

EXCISE TAX EXEMPTIONS

The most important tax incentive for alcohol fuels, the one most responsible for the development of the alcohol fuels market, is the exemption from the various motor fuels excise taxes. In order to understand the structure of the exemption it is useful to first discuss the structure of the motor fuels excise taxes.

Structure of Motor Fuels Excise Taxes

The Internal Revenue Code (IRC) imposes excise taxes on a variety of motor fuels used in highway transportation, with the tax rates varying by type of fuel and its use. The traditional fuels, gasoline and diesel used in highway motor vehicles, are taxed at 18.4 cents per gallon and 24.4 cents per gallon, respectively [IRC section 4081 and 4091]. These tax rates have several components. The 18.4 cents rate comprises an 11.5 cents highway trust fund rate (which finances the Federal Highway Trust Fund), a 6.8 cents deficit reduction rate (which is designated to the general fund for deficit reduction), and a 0.1 cents Leaking Underground Storage Tank (LUST) trust fund rate. 2 The 11.5 cents highway trust fund rate is itself composed of 10.5 cents that finances the interstate highway infrastructure, and 1.0 cents that helps finance mass transit. The 24.4 cents diesel tax rate comprises a 17.5 cents highway trust fund rate (with 1.0 cents used for mass transit), a 6.8 cents deficit reduction rate, and a 0.1 cents LUST trust fund rate [section 4091 and section 4041(a)].

Diesel used in trains is taxed at 6.9 cents per gallon, and reflects levies only for deficit reduction rate and LUST fund. Fuel used for transportation on inland waterways by commercial cargo vessels is taxed at 21.4 cents per gallon, rising to 24.4 cents by 1995 [section 4042]. Fuels used in noncommercial aviation are taxed at either 19.4 cents per gallon [in the case of gasoline, section 4041(c) and section 4081] or 21.9 cents per gallon for jet fuel [section 4041(c) and section 4091]. Jet fuel used in commercial aviation only pays the 0.1 cents LUST fund tax. The 18.4 cents tax rate on gasoline and special motor fuels generally applies to fuels used in noncommercial motorboats.

Liquid gasoline-substitute motor fuels such as naphtha, benzene, benzol, casinghead gasoline, and natural gasoline are taxed at 18.4 cents per gallon if the fuel is used in a highway vehicle for purposes that are not specifically tax-exempt [section 4041(a)(2)]. Liquefied petroleum gas (LPG) is taxed at 18.3 cents per gallon since it is the only gasoline substitute not subject to the 0.1 cents LUST tax. 3

Many non-highway uses of motor fuels, such as farm uses or commercial uses in stationary motors, and some highway uses of motor fuels, such as uses by school districts or State and local governments, are tax-exempt. Some non-highway uses of motor fuels are, however, taxed at varying rates.

The expiration dates for the motor fuels excise taxes vary depending on the component of the tax in question. The 11.5 cents component of the gasoline tax and the 17.5 cents portion of the diesel tax expire on October 1, 1999. The 6.8 cents deficit reduction rate comprises a permanent 4.3 cents and a temporary 2.5 cents that also expires on Oct. 1, 1999. The 0.1 cents LUST tax expires on January 1, 1996. Thus, under current law, the tax rates on gasoline and special fuels will be as follows: 18.4 cents from Oct. 1, 1993, through Dec. 31, 1995; 18.3 cents from Jan. 1, 1996, through Sept. 30, 1999; and 4.3 cents thereafter. The total tax on diesel will be as follows: 24.4 cents from Oct. 1, 1993 through Dec. 31, 1995; 24.3 cents from Jan. 1, 1996 through Sept. 30, 1999; and 4.3 cents thereafter. It should be noted that the various motor fuels taxes have always had expiration dates, which have always been extended prior to the actual expiration.

Structure of Excise Tax Exemptions for Alcohol Fuels

The excise tax exemptions for alcohol fuels apply to both blended fuels and straight alcohol fuels.

Mixtures of motor fuels and biomass-derived alcohols (either methanol or ethanol produced from plants and other renewables) are partially exempt from the 18.4 cents tax, with the amount of the exemption depending upon the fraction of alcohol that is in the mixture and the type of alcohol. Gasohol mixtures -- blends of gasoline and ethanol 4 that are 10 percent ethanol -- are taxed at 13.0 cents per gallon (or are exempt from 5.4 cents of the tax). Table 1 compares the various components of the tax on gasoline and gasohol.

     TABLE 1. HIGHWAY USER CHARGE COMPONENT OF THE EXCISE TAXES ON

 

                 GASOLINE AND 10 PERCENT ALCOHOL FUEL

 

 

  GASOLINE                                   ALCOHOL FUEL

 

 

  Tax Rate        Component           Tax Rate       Component

 

  ________        _________           ________________________

 

 

 10.5 cents     highway user           5.1 cents    highway user

 

                   charge                              charge

 

  6.8 cents     general fund           6.8 cents    general fund

 

  1.0 cents     mass transit           1.0 cents    mass transit

 

  0.1 cents         LUST               0.1 cents       LUST

 

 18.4 cents                           13.0 cents

 

 ____________________________________________________________________

 

 

      Source: Internal Revenue Code.

 

 

Mixtures that are 7.7 percent ethanol are taxed at 14.24 cents per gallon (or are exempt from 4.16 cents of the tax). And finally, mixtures that are 5.7 percent ethanol are taxed at 15.32 cents per gallon (or are exempt from 3.08 cents of the tax). 5 The 5.7 percent and 7.7 percent blend correspond, respectively, to the 2.0 percent and 2.7 percent oxygen content standard for gasoline sold in ozone nonattainment areas and carbon monoxide nonattainment areas under the Clean Air Act. 6

Technically, the exemption for alcohol fuels mixtures also applies to blends of diesel and biomass-derived alcohol -- sometimes called "dieselhol" -- and other blends of a special motor fuel and biomass-derived alcohol, although these blends are not actually produced in great quantities. Alcohol blended with diesel is exempt from 5.4 cents of the 24.4 cents tax. Alcohol blended with one of the special motor fuels is assessed at a 13.0 cents tax rate (the exemption is again 5.4 cents). There is no tax exemption or lower tax rate on alcohol fuel blends which are used in commercial vessels on inland waterways.

Straight alcohol fuels -- mixtures that contain a minimum of 85 percent alcohol -- also qualify for the excise tax exemptions at varying rates. There are three categories. For biomass-ethanol the tax rate is 12.35 cents consisting of a 5.5 cents highway trust fund rate (a 6.0 cents exemption), the 6.8 cents deficit reduction rate, and a 0.05 cents LUST fund rate. For biomass-methanol the tax rate is 12.95 cents per gallon, consisting of a 6.1 cents highway trust fund rate (a 5.4 cents exemption), the 6.8 cents deficit reduction rate, and the 0.05 cents LUST fund rate. In the case of 85 percent alcohol (ethanol or methanol) derived from natural gas, there is a separate motor fuels tax exemption of 7.0 cents per gallon [the tax rate is 11.4 cents per gallon (section 4041(m))]. 7 (Note that the LUST fund rate on these 85 percent mixtures is one-half the rate that applies to all other taxable fuels [4041(b)(2)].)

The excise tax exemption for gasohol is provided to a registered purchaser (usually the wholesaler) of gasoline from a terminal operator or refiner. The exemption is realized at the time of the removal of the blending stocks of gasoline and alcohol from the terminal. This is an exception to the general rule that a wholesaler pays the gasoline tax to the terminal or refiner, who remits the amounts to the Treasury. Both the blender and the ultimate seller of the gasohol must comply with registration, reporting, and recordkeeping requirements. 8

The excise tax exemptions for alcohol fuels expire on October 1, 2000.

MAJOR LIMITATIONS

There are two major restrictions or limitations to the excise tax exemptions for alcohol fuels. First, the alcohol must be at least 190 proof (95 percent pure alcohol, determined without regard to any denaturants). Second, for the 10 percent blended fuels, the alcohol cannot be derived from petroleum, natural gas, or coal (including peat). Nominally, both ethanol (alcohol from grain) and methanol (alcohol from wood) qualify for the exemption. In effect, however, only ethanol is tax exempt because most of the economically feasible methanol is derived either from natural gas or coal, which does not qualify for the exemption for blended fuels. Thus, methanol produced from wood, urban waste, and other biomass would qualify for the exemption, but very little methanol is actually produced from these sources because it is generally uneconomic. 9 Third, in the case of the 85 percent (straight) alcohol fuels, the mixture must consist of at least 85 percent alcohol. As before, the alcohol cannot be derived from petroleum or natural gas. However, in this case the alcohol may be derived from coal.

LEGISLATIVE HISTORY

The excise tax exemptions for alcohol fuels were adopted in the Energy Tax Act of 1978 (P.L. 95-618), one part of President Carter's National Energy Plan, intended to address what was perceived as severe problems in the country's energy markets. 10

The original exemption was for the full amount of the gasoline tax: 4 cents per gallon. The Crude Oil Windfall Profits Tax (P.L. 96- 223) extended the 4 cents exemption from October 1, 1984, to December 31, 1992. The Surface Transportation Assistance Act of 1982 (P.L. 97- 424) raised the gasoline tax from 4 cents to 9 cents per gallon and also raised the gasohol exemption to 5 cents per gallon. Thus, the total exemption became only a partial exemption, meaning that gasohol would be taxed at 4 cents per gallon instead of the regular 9 cents per gallon. The Tax Reform Act of 1984 (P.L. 98-369) raised the gasohol exemption from 5 to 6 cents by reducing the tax rate for gasohol from 4 to 3 cents, retained the 9 cents exemption for "straight" alcohol fuels, and provided that alcohol produced from natural gas would also qualify for the exemption. This was part of a provision that raised the diesel fuel tax from 9 to 15 cents per gallon as part of a compromise for lowering the highway use taxes on trucks.

The Tax Reform Act of 1986 (P.L. 99-514) reduced the excise tax exemption for 85 percent alcohol fuels from 9 cents to 6 cents per gallon (for sales made beginning in 1987). The Technical and Miscellaneous Revenue Act of 1988 (P.L. 100-647) permitted gasohol blenders to purchase gasoline and alcohol at different locations provided that these purchases are made within 24 hours. Prior to 1988, registered gasohol blenders were permitted to purchase gasoline at the lower tax rate if the blending occurred at the terminal. But if the blending occurred after the purchase from the terminal, the purchaser would pay the tax and file a claim for a credit or refund. The Omnibus Budget Reconciliation Act of 1990 reduced the exemption for gasohol to 5.4 cents per gallon. Finally, the last amendments to the excise tax exemptions for alcohol fuels were in the Energy Policy Act of 1992 (P.L. 102-486) which extended the exemption to gasohol that contained 7.7 percent and 5.7 percent alcohol.

Table 2 shows the exemption for the 10 percent alcohol blends (gasohol) since it first became effective beginning in 1979. The exemption is shown both in absolute terms and relative to the gasoline tax and the price of gasoline.

    TABLE 2. EXCISE TAX EXEMPTION FOR 10 PERCENT ALCOHOL (ETHANOL)

 

                             FUELS BLENDS

 

 

 Year     Exemption     Gasoline    Exemption    Price of    Exemption

 

           Amount         Tax       as Percent   Gasoline   as Percent

 

          (per gal)    (cents per   of Gas Tax  ($ per gal)   of Gas

 

                       gal)                                    Price

 

 ____________________________________________________________________

 

 

 1978       0            4 cents         0        67.0 cents       0%

 

 1-1-79     4 cents      4 cents       100%       90.3 cents     4.4%

 

 1980       4 cents      4 cents       100%      124.5 cents     3.2%

 

 1981       4 cents      4 cents       100%      137.8 cents     2.9%

 

 1982       4 cents      4 cents       100%      129.6 cents     3.1%

 

 4-1-83     5 cents      9 cents        56%      124.1 cents     4.0%

 

 1984       5 cents      9 cents        56%      121.2 cents     4.1%

 

 1-1-85     6 cents      9 cents        67%      120.2 cents     5.0%

 

 1986       6 cents      9 cents        67%       92.7 cents     6.5%

 

 1-1-87     6 cents      9.1 cents      66%       94.8 cents     6.3%

 

 1988       6 cents      9.1 cents      66%       94.6 cents     6.3%

 

 1989       6 cents      9.1 cents      66%      102.1 cents     5.9%

 

 12-1-90    5.4 cents   14.1 cents      38%      116.4 cents     4.7%

 

 1991       5.4 cents   14.1 cents      38%      114.0 cents     4.7%

 

 1992       5.4 cents   14.1 cents      38%      112.7 cents     4.8%

 

 10-1-93    5.4 cents   18.4 cents      29%      110.8 cents     4.9%

 

 _____________________________________________________________________

 

 

      Source: Tax rates are from Internal Revenue Code, various annual

 

 issues. Gasoline prices are from: U.S. Department of Energy. Energy

 

 Information Administration. Monthly Energy Review. July, 1994.

 

 Washington. p. 120.

 

 

THE SPECIAL CASE OF METHANOL

As was discussed, in all these cases of alcohol blends qualifying for the tax exemption, the tax code specifically provides that the alcohol can be either ethanol or methanol as long as it is biomass derived. In general, it cannot be derived from petroleum, natural gas, or coal (including peat). The latter limitation means, in effect, that exempt alcohol is currently derived from plants and other renewable energy resources. Thus, while both methanol and ethanol nominally qualify for the exemption, methanol blends are in effect disqualified because the economically feasible blends are currently produced from natural gas.

INCOME TAX CREDIT FOR ALCOHOL USED AS A FUEL

In addition to the excise tax exemptions, the current Federal tax code provides for an income tax credit for alcohol used or sold as a fuel. This credit is available for both alcohol blended with a motor fuels (mixture) and for straight alcohol used a fuel.

STRUCTURE OF THE CREDITS

The alcohol mixture credit (blender's) credit is a tax credit to the blender for alcohol blended with gasoline or any other liquid motor fuel. The amount of the credit depends upon whether the alcohol is ethanol or methanol and the proof of the alcohol. The credit is 60 cents per gallon of alcohol if the alcohol is methanol and if the alcohol is at least 190 proof, and 45 cents if the methanol is between 150 and 190 proof. No credit is available for methanol that is less than 150 proof. If the alcohol is ethanol, the credit is 54 cents per gallon if the alcohol is at least 190 proof, and 40 cents if the alcohol is between 150 and 190 proof. This mixtures or "blender's" credit is available only to the blender, who must not only produce the mixture but must either use the mixture as a motor fuel in a trade or business or sell it for use as a fuel. The blender may be either the producer, the terminal operator or the wholesaler.

The alcohol mixtures tax credit is available for alcohol mixed with gasoline or any other special motor fuel. 11 The alcohol fuels tax credit is also available for straight (NONBLENDED) or neat alcohol fuels. The amount of the credit is the same as above depending upon whether ethanol or methanol and depending upon the proof of the alcohol. This alcohol fuels tax credit is a credit to either the user of the fuel in a trade or business or to the retail seller of straight alcohol fuels, as long as it is placed in the fuel tank of the buyer's vehicle.

The alcohol fuels tax credits apply to most types of ethanol (i.e., alcohol derived from renewable energy resources such as vegetative matter, crops, and other biomass) including methanol derived from wood and other biomass sources. However, the alcohol cannot be derived from petroleum, natural gas, or coal (including peat).

The two blender's tax credits have been available continuously since 1980 and they are scheduled to expire on January 1, 2001.

MAJOR LIMITATIONS

There are several limitations to the two alcohol fuels tax credits. First, as was just noted, the alcohol cannot be derived from petroleum, coal, or natural gas. This limitation means that the credits are currently available only to ethanol, since most economically feasible methanol is made from natural gas, which does not qualify for the credits. Second, and most important, the credits are offset by any excise tax exemptions claimed on the same fuel. Taxpayers must choose between the exemption or the credit; they cannot claim both incentive on the same quantity of blended fuel. Third, under IRC section 87, the alcohol fuels tax credit is itself taxable as gross income for the tax year in which the credit is earned. Thus a taxpayer that claims the credit has to add it back as income subject to tax and the net value of the credit is reduced below the gross value. Fourth, the alcohol fuels tax credit is a component of the general business credit under IRC section 38, which includes the jobs tax credit, research and development tax credit, low-income housing tax credit, and other credits. The general business tax credit is limited to the taxpayer's net income tax less the larger of either 25 percent of net regular tax liability above $25,000 or the tentative alternative minimum tax. 12 Fifth, the credits are not refundable; they may be used only against a positive tax liability; they are of no value if the producer has no tax liability.

LEGISLATIVE HISTORY

The alcohol fuels tax credits were enacted as part of the Crude Oil Windfall Profit Tax of 1980. They were one of several provision in the law intended to support the production and use of alcohol motor fuels. The amounts of the credits were raised by the Surface Transportation Assistance Act of 1982 from 40 cents to 50 cents per gallon for 190 proof and from 30 cents to 37.5 cents per gallon for alcohol between 150 and 190 proof. The Tax Reform Act of 1984 raised the credits further to 60 cents and 45 cents for the two aforementioned alcohol strengths, respectively, and also made the credits refundable. This law also introduced the provision that alcohol produced from peat, like coal, would not qualify for the credits. The Omnibus Budget Reconciliation Act of 1990 (P.L. 101-508) reduced the credits from 60 cents to 54 cents, and from 45 cents to 40 cents.

THE ROLE OF ETBE

In 1990 the IRS ruled that blends of ETBE and gasoline (or other motor fuels) would be treated as alcohol fuels mixtures and, therefore, would qualify for the income tax credit. This was after two years of a rather heated controversy over whether ETBE should qualify for the tax credits. 13

ETBE (Ethyl Tertiary Butyl Ether) is a chemical compound derived from ethanol. It is the result of a chemical reaction between ethanol (which may be produced from renewables) and isobutylene, a byproduct of both the petroleum refining process and natural gas liquids. In this reaction, the ethanol is chemically transformed and is not present as ethanol in the final product.

Since the mandatory lead phase-out in the 1970s, refiners have been using MTBE (Methyl Tertiary Butyl Ether) an alternate oxygenate made from natural gas, as an octane enhancer. ETBE may also be further blended with gasoline to produce a fuel mixture which enhances the octane level of the resulting fuel. As an octane enhancer MTBE is basically the same as ETBE except that the alcohol is methanol instead of ethanol. 14 Being made of methanol, however, MTBE is statutorily excluded from qualifying for the alcohol fuels mixtures tax credit.

ETBE may also be used as an oxygenate according to EPA rules. ETBE, which is no longer an alcohol after its chemical reaction, may be used as a substitute for MTBE -- Methyl Tertiary Butyl Ether -- in reformulated gasoline mentioned under the Clean Air Act of 1990, as amended, for use in designated ozone nonattainment areas, as discussed below (see p. 15). As an oxygenate, refiners and blenders might use ETBE instead of ethanol during the summer months because ETBE is less volatile than ethanol (see p. 17 below).

Allowing ETBE to qualify for the blender's tax credit is designed to stimulate the production of ethanol for use in reformulated gasoline, which would reduce the growth of MTBE production. This would increase the share of the U.S. corn crop allocated to ethanol production above the current 4-5 percent. It would also significantly increase Federal revenue losses from the alcohol fuels credits, which heretofore have been negligible due to blender's use of the exemption over the credit.

ETHANOL TAX CREDIT FOR SMALL PRODUCERS

An additional tax incentive for biofuels is targeted specifically for biomass produced ethanol: the small ethanol-producer credit. This credit is part of the same section of the Internal Revenue Code (IRC section 40) that contains the blenders' tax credits, although it is a separate credit available only to small producers.

Structure of the Credit

Current law provides for an income tax credit of 10 cents per gallon ($4.20 per barrel) for up to 15 million gallons of annual ethanol production by a small ethanol producer. A "small producer" is defined as one with ethanol production capacity of less than 30 million gallons per year (about 2,000 barrels per day). This credit is strictly a production tax credit available only to the manufacturer who sells the alcohol to another person for blending into a qualified mixture in the buyer's trade or business, for use as a fuel in the buyer's trade or business, or for sale at retail where such fuel is placed in the fuel tank of the retail customer. Casual off-farm production of ethanol does not qualify for this credit.

Major Limitations

The small ethanol producer credit is limited in the same way as the blender's tax credit. In addition, the tax credit is limited to small producers, and aggregation rules are provided to prevent the credit from benefiting producers with a capacity in excess of the 30 million gallons per year limit, or from going to production in excess of the 15 million gallon limit. The amount of the credit is reduced to take into account any excise tax exemption claimed on ethanol output and sales.

Legislative History

The small-producers credit was added by the Omnibus Budget Reconciliation Act of 1990 (P.L. 101-508); it has not been amended.

TAX DEDUCTION FOR CLEAN FUEL VEHICLES

One of the more recent Federal tax incentives for alcohol fuels is part of a more general tax incentive for clean-fuel-burning automobiles introduced as part of a package of environmental and energy tax incentives and taxes in the Energy Policy Act 1992. 15

Structure of the Deduction

As a tax incentive, the tax deduction for vehicles that run on alcohol fuels and other clean burning fuels has two components: a tax deduction for individuals or businesses that purchase vehicles that run on alternative fuels, and a tax deduction for businesses that invest in equipment for storing and dispensing the clean fuel and otherwise refueling the clean fuel burning vehicle.

In the first incentive, taxpayers can deduct from adjusted gross income a portion of the costs associated with the purchase of dedicated alternative fuel vehicles (AFV's), or the costs of converting vehicles so that they can operate on clean-burning alternative fuels (dual-purpose vehicles AFVs) in addition to gasoline. Dedicated AFV's are new vehicles designed to run on an alternative fuel only. For dedicated AFVs, costs up to $2,000 for qualified property can be deducted for a vehicle up to 10,000 lbs., up to $5,000 for a truck or van of 10,000 to 26,000 lbs., and up to $50,000 for a truck or van over 26,000 lbs. Qualified property for a dedicated AFV includes the full cost of the engine, the fuel delivery system, and the exhaust system. For a dual-fuel vehicle, the qualified cost is limited to the incremental cost of the same components compared with the systems for conventional fuels.

The second tax incentive is for the installation of refueling equipment for alternative fuels. Up to $100,000 of the cost of installing alternative fuel storage and dispensing equipment could be deductible per year. Qualifying property includes equipment usually purchased by retail service stations and associated with the storage and dispensing of the alternative fuel into the AFVs.

For both of these two tax incentives alternative fuels are defined as compressed natural gas, liquefied petroleum gas, liquefied natural gas, hydrogen, electricity, and any other fuel that includes 85 percent alcohol fuels, ether, or any combination of these.

Major Limitations

In addition to the above limitations, all of the property that qualifies for the deduction -- either the new vehicle, the conversions equipment, or the refueling equipment -- must be new. Qualifying vehicles must meet any applicable Federal and State environmental standards. For business taxpayers, the basis of the property for purposes of the depreciation deduction is reduced by the amount of clean-fuel-vehicle deduction.

In general, each of these deductions terminates at the end of 2004. But there is a phase-out provision in the case of new clean fuel burning vehicles or retrofit equipment. The deduction is phased- out evenly over a three year period beginning in January, 2002.

Legislative History

The tax deductions for clean fuel vehicles, retrofits, and refueling equipment was added by the Energy Policy Act of 1992 (P.L. 102-486). They have not been amended.

THE ALTERNATIVE FUELS PRODUCTION TAX CREDIT

Production of alcohol fuels may qualify for a non-refundable income tax credit that is also available for a broad variety of fuels derived from various alternative (to oil and conventional natural gas) energy resources. This is the alternative fuels production tax credit, also known as the section 29 tax credit.

Structure of the Credit

The alternative fuels production tax credit is a credit against the producer's income tax for the production and sale of fuels derived from alternative energy resources. Unlike the alcohol fuels tax credits, this tax credit is not targeted for alcohol fuels alone. It is available for oil produced from such nonconventional sources as tar sands and shale rock. It is also available for gas produced from biomass, or from unconventional locations such as geopressurized brine, Devonian shale, coalbeds, or tight formations. Certain types of alcohol fuels -- alcohol produced from coal and lignite -- could qualify for this credit. THUS BOTH ETHANOL AND METHANOL COULD TECHNICALLY QUALIFY FOR THIS CREDIT, ALTHOUGH IN REALITY THERE IS LITTLE IF ANY PRODUCTION OF SYNTHETIC FUELS FROM COAL. Moreover, alcohol fuels produced from coal or lignite may be used as feedstocks, unlike other fuels, without invalidating the tax credit. Alcohol fuels produced from biomass do not qualify for this credit.

Every barrel of qualifying fuels (including alcohol fuels) receives a credit of $3.00 in real terms (using 1979 as the base year and the GNP deflator as the price index). 16 The availability of the credit depends on the price of oil. In general, when oil prices are high, the credit is not available; when prices are low it becomes available. More specifically, the tax credit is determined by comparing the average wellhead price of domestic crude oil (called the reference price) with a trigger price. In real terms, when the reference price of oil is below $23.50 (in real terms) the tax credit becomes available; when the price of oil is between $23.50 and $29.50, the credit is phased-out proportionately; when the price of oil is above $29.50, no credit is available. These trigger or threshold prices are adjusted for inflation so that a comparison may be made with the reference price in nominal terms. For example, in 1987 the market price of crude oil (the reference price in nominal terms) was $15.41 per barrel, well below the $35.13 ($23.50 times the inflation adjustment factor of 1.4949). Thus the alternative fuels credit was available. The $3.00 real credit amount increases with inflation, which makes the current credit about $5.70 per barrel. In nominal dollars the credit was about $4.50 per barrel in 1987 and $5.35 per barrel in 1993.

The alternative fuels production credit is generally available for fuels produced before 2002. However, for all fuels except biomass gas and synthetic fuels, the production facilities (or wells) must be placed in service (or drilled) after 1979 and before 1993. This is the placed-in-service rule. For biomass gas and synthetic fuels, fuel production must be placed in service before 1996. Thus, prospective producers of these two types of fuels will have through December 31, 1995, to build a facility and begin production provided that there is a binding contract to that effect.

Major Limitations

This credit is reduced in proportion to any subsidized energy financing (grants, loans, tax-exempt financing) which may be used. This is done to prevent "double dipping." This credit is also reduced "dollar-for-dollar" by the enhanced oil recovery credit of section 43 and by any business energy tax credits claimed for equipment which is used to produce the fuel to the extent that this credit is still being claimed. 17

Legislative History

The alternative fuels production tax credit was enacted as part of the 1980 windfall profit tax. And there have been several relatively minor amendments such as those in the 1988 Technical and Miscellaneous Revenue Act (P.L. 100-647) that extended the "placed in service" rule by one year. This means that the fuels must be produced from a facility placed in service (or wells drilled) before January 1, 1991. Under prior law this deadline was January 1, 1990. Also, the 1988 tax legislation allowed unused fuels credits to be credited against the alternative minimum tax.

The most important amendments to the credits came under the Energy Policy Act of 1992. For biomass gas and for synthetic fuels (either liquid, gaseous, or solid synthetic fuels) produced from coal (including lignite) fuels production tax credit, Title XIX of the Act provided a three year extension of the placed-in-service rule for purposes of qualifying for the credit. Prior to the Act, the deadline for placing a facility in service was December 31, 1992, and there was no binding contract rule. As was discussed above, this deadline still applies to all other fuels that qualify for the credit. Thus, production of qualifying fuels from facilities placed in service after that date will not qualify for this tax credit.

The second amendment made by Title XIX is an extension of the time period during which the credit would be available by an additional five years, from December 31, 2002, to December 31, 2007. This extension applies only to biomass gas and to synthetic fuels. The 2002 expiration date for all other fuels continues to apply.

ECONOMIC ANALYSIS

The five Federal tax incentives or subsidies for alcohol fuels just described are anticipated to receive greater scrutiny by the Congress as a result of a recent ruling by the Environmental Protection Agency (EPA) mandating the use of alcohol fuels to meet the oxygenate requirements of the Clean Air Act of 1970 (P.L.91-604) as amended by the Clean Air Amendments Act of 1990 (P.L. 101-549). 18 As amended, the Clean Air Act makes two oxygenate requirements: (1) during the four winter months, the gasoline used in the 40 CO (Carbon Monoxide) non-attainment areas must contain 2.7 percent oxygen; 19 and (2) reformulated gasoline containing at least 2.0 percent oxygen must be used year-round in the 9 worst ozone non- attainment areas and in other ozone nonattainment areas that have opted into the program. If the area is both a carbon monoxide nonattainment area and an ozone nonattainment area, the reformulated gasoline must contain 2.7 percent oxygen during the winter season and 2.0 percent oxygen the rest of the year. Reformulated gasoline is basically cleaner burning and is required in areas with the worst air pollution. 20

The EPA believes that the Act gives it discretionary authority to require that a portion of the oxygenates used be derived from renewable resources. The agency settled on 30 percent of the oxygenate to be renewable, after a first-year phase-in at 15 percent. The American Petroleum Institute and National Petroleum Refiners Association argue that the EPA requirement goes beyond its statutory authority and have instituted suit to block its implementation. 21

EPAs renewable oxygenate requirement ("ROR") states that, in the first year, 15 percent of the oxygenates in reformulated gasoline must be made from renewable (biomass) resources. 22 In 1996 and beyond 30 percent must be derived from renewable resources. 23 While this mandate does not rule out the use of methanol from biomass to meet the standards, it basically favors ethanol since the technology for producing methanol from biomass is experimental and uneconomic at the present time. Consequently, the requirement has been interpreted as a mandate for increased production and use of ethanol as an oxygenate in reformulated gasoline.

The EPA mandate is a regulation that artificially increases the demand for ethanol. As such, the mandate amounts to a "regulatory subsidy" for ethanol and can be viewed as an expansion of the overall Federal subsidy for ethanol when tax subsidies are taken into account. At 54 cents per gallon, the tax subsidy alone is equal to nearly $23 per barrel of alcohol, about $5 per barrel more than the current oil price. And this does not consider additional profits to the ethanol industry as a result of the various regulatory subsidies for ethanol production and use.

The mandate will increase ethanol's fraction of the future oxygenates market, engender a variety of economic effects, and raise several economic issues. A fundamental economic issue is whether government policy should dictate the use of ethanol when competitive market factors would likely dictate the use of other less costly oxygenates, such as MTBE. Another concern will undoubtedly touch on revenue losses. The EPA mandate would, by stimulating production and use of ethanol, increase revenue losses significantly from existing tax incentives. In addition to these fiscal concerns, the EPA mandate raises questions of the effectiveness, and economic efficiency of the various alcohol fuels tax incentives.

Finally, Congress may review the size of the overall subsidy to alcohol fuels in relation to oil and gas tax subsidies. Historically, oil and gas benefitted from enormous tax incentives. But current evidence suggests that the subsidies to alcohol fuels are relatively larger than for oil and gas, which is also subject to large regulatory costs. In any event, the current oil and gas tax subsidies do not adversely affect development of alternative forms of energy such as alcohol fuels because they do not affect oil prices, which are determined in a world market. 24

REVENUE LOSSES AND THE HIGHWAY TRUST FUND

The EPA renewable oxygenate regulation, if it becomes effective, will force refiners and blenders to substitute ethanol or ETBE, which are tax subsidized, for other oxygenates such as MTBE, which are fully taxed and receive no tax subsidies. This substitution will reduce Federal tax revenue, particularly excise tax revenue, which would otherwise go into the highway trust fund. 25

Table 3 shows estimates of revenue losses from the alcohol fuels tax exemption from 1979, the year the exemption became effective, through 1993. Actual revenue losses resulting from the remaining four alcohol fuels tax incentives are not shown separately because either the data are not available or the incentives are relatively recent additions to the tax code. 26 In any event, indications are that these revenue losses are small compared to the excise tax exemption, although they are projected to increase in the future. Over $4.5 billion in revenue has been foregone due to the gasohol exemption through FY 1993. Adding an estimated $500 million for FY 1994, nearly $5.0 billion has been lost. This is revenue that would otherwise have gone into the highway trust fund and been allocated to the States for spending on the interstate highways, bridges, and other highway infrastructure.

Table 4 estimates possible revenue losses in the long run from the alcohol fuels tax incentives in response to the EPA regulation under various scenarios described below. Estimates are made for the year 2000 and illustrate the point that the EPA ethanol regulation creates the potential for significant increases in Federal revenue losses under existing alcohol fuels tax incentives. The estimates assume that gasoline demand grows at 1 percent annually.

     TABLE 3. ESTIMATED REVENUE LOSSES (IN $MILLIONS) FROM ALCOHOL

 

                         FUELS TAX EXEMPTION,

 

                               1979-1993

 

 

           YEAR                          REVENUE LOSS

 

 

           1979                               $16

 

           1980                               $32

 

           1981                               $34

 

           1982                               $94

 

           1983                              $210

 

           1984                              $284

 

           1985                              $396

 

           1986                              $479

 

           1987                              $495

 

           1988                              $497

 

           1989                              $441

 

           1990                              $430

 

           1991                              $294

 

           1992                              $431

 

           1993                              $411

 

 

 Total                                     $4,544

 

 ____________________________________________________________________

 

 Source: CRS calculations based on IRS quarterly excise tax

 

 reports.

 

 

            TABLE 4. POSSIBLE REVENUE LOSS SCENARIOS UNDER

 

           EPA'S ETHANOL MANDATE PROJECTED FOR THE YEAR 2000

 

                             ($ millions)

 

 

      SCENARIOS: Scenario 1 Additional demand consists of demand from

 

 the 9 ozone nonattainment areas and the 13 opt-in areas. This demand

 

 is assumed to be satisfied from existing gasohol markets i.e., there

 

 is no new ethanol production.

 

 

      BASELINE /*/ REVENUE LOSS: 702

 

 

      ADDED REVENUE LOSS: 0

 

 

      TOTAL REVENUE LOSS: 702

 

 

      SCENARIOS: Scenario 2 Additional demand consists of demand from

 

 the 9 ozone nonattainment areas and the 13 opt-in areas. 20 percent

 

 of this demand is assumed to be satisfied from existing gasohol

 

 markets; 80 percent from new ethanol production.

 

 

      BASELINE /*/ REVENUE LOSS: 562

 

 

      ADDED REVENUE LOSS: 293

 

 

      TOTAL REVENUE LOSS: 855

 

 

      SCENARIOS: Scenario 3 Additional demand consists of demand from

 

 the 9 ozone nonattainment areas and the 13 opt-in areas. But this

 

 demand is assumed to be satisfied not from existing gasohol markets

 

 but from new ethanol production.

 

 

      BASELINE /*/ REVENUE LOSS: 702

 

 

      ADDED REVENUE LOSS: 293

 

 

      TOTAL REVENUE LOSS: 925

 

 

      SCENARIOS: Scenario 4 Entire U.S. demands additional ethanol to

 

 meet 2 percent oxygen requirement, to be satisfied not from existing

 

 gasohol markets but from new ethanol production.

 

 

      BASELINE /*/ REVENUE LOSS: 702

 

 

      ADDED REVENUE LOSS: 922

 

 

      TOTAL REVENUE LOSS: 1,624

 

 

      Source: CRS estimates.

 

 

                          FOOTNOTES TO TABLE

 

 

      /*/ From ethanol demand not affected by the new regulatory

 

 regime.

 

 

      /**/ From new ethanol demand resulting from EPAs renewable

 

 oxygenate regulation.

 

 

                           END OF FOOTNOTES

 

 

Potential additional revenue losses range from zero to nearly $1 billion per year by the year 2000, depending on the additional demand for alcohol fuels in response to the regulation, and the supply responses by alcohol producers, petroleum refiners, and marketers. The additional demand for alcohol fuels comes not only from the 9 ozone nonattainment areas, but from remaining areas of the U.S. in which ozone levels are below the standard: areas that have opted into the RFG program; and areas that have not yet opted into the program but that might in the future. Additional demand could also conceivably come from the 40 CO nonattainment areas required to use oxygenates during the winter months. 27

There are also many uncertainties regarding possible supply responses by producers. For example, the extent to which alcohol would be added as ethanol or as ETBE is unclear. Blenders might use ETBE instead of ethanol during the summer months because ETBE is less volatile than ethanol, (it emits relatively less volatile organic compounds (VOC's) than ethanol) and because they would get credit for such reductions. 28 As ethanol, the revenue loss would be the full 54 cents per gallon because producers and blenders would prefer to take the exemption; as ETBE, the revenue loss is smaller because of the limitations on claiming the 54 cents credit and because the credit is taxable as income to those who claim it (see p. 13). Also, as ethanol all of the revenue loss is to the Highway Trust Fund; as ETBE, the revenue loss is to the general fund. Each of the scenarios in table 4 assumes that none of the ethanol goes in as ETBE.

Potential revenue losses also depend on whether the ROR ethanol requirement is met from current production (i.e., for existing gasohol markets), or whether the mandated ethanol is new production. If the requirement is met from existing production, then there is no additional net revenue loss. Ethanol currently being used for gasohol -- which already qualifies for the tax exemption -- would be reallocated for use as an oxygenate. If, as seems more likely, the mandate were met by increasing production (both from existing capacity and by investment in new capacity) then the additional revenue loss is higher.

It is important to underscore that the estimates in table 4 are not projections of what the revenue losses are going to be, but of what might happen to revenue losses in the long run under various assumptions. Also the revenue losses ignore possible revenue gains from economic feedback effects. However, these are expected to be negligible since the revenue gains from the expanding ethanol industry would be offset by revenue losses in the contracting industries (probably the MTBE industry) which likely would have supplied an alternate oxygenate without the EPA rule.

Finally, the estimates in table 4 are of revenue effects only. A more complete budgetary analysis would take into account estimates of reduced Federal subsidy payments to farmers as a result of greater corn demand and higher corn prices.

EFFECTIVENESS OF THE TAX INCENTIVES

An examination of the various tax incentives for alcohol fuels, in the wake of the EPA ruling, might raise the issue of the effectiveness of the incentives -- the extent to which they have been successful in accomplishing their goal of stimulating increased production and use of alcohol-based motor fuels.

The alcohol fuels market has expanded from a few million gallons prior to 1978, to over a billion gallons today. Much of this growth occurred between 1978 and 1986. Between 1978 and 1986, alcohol fuels production and use increased dramatically, from 40 million gallons to about 800 million gallons, an increase of 1,900%. Between 1986 and 1994, alcohol fuels production has increased by about 300 million gallons, a nearly 40 percent increase, still impressive but significantly smaller than the earlier growth.

This development and growth in the alcohol fuels market is due to economic factors, such as the price of ethanol relative to gasoline and the price of inputs (primarily, the price of corn) and to government tax and regulatory policy. These factors affect the supply of and demand for alcohol fuels. Alcohol fuels are fairly good partial replacements for gasoline in the internal combustion engine. Most vehicles that run on gasoline also could be run on gasohol with minor or no modifications. Alcohol fuels have been added to gasoline engines for many years in certain areas of the country close to the main resources inputs, grain (particularly corn) and sugar. The demand for alcohol fuels and other substitutes for gasoline and diesel fuel is largely a function of relative prices. As the price of gasoline relative to alcohol fuels increases, the demand for gasoline decreases and the demand for substitutes increases. This factor explains much, but not all, of the early significant growth of alcohol motor fuels. The high and increasing real price of oil between the late 1970s and early 1980s when oil prices tripled and the world oil markets were in turmoil, raised the real price of gasoline relative to the price of alcohol fuels. For example, real gasoline prices increased from $1.11 in 1978 to $1.75 in 1981, the peak of the high real price of gasoline. 29 An increase in the price of gasoline made alcohol (including the subsidy) relatively less costly compared to gasoline and relatively more profitable to produce and market. These reduced costs translated into declines in the relative market prices and, therefore, greater consumer demand for gasohol.

More evidence of the powerful effect of oil prices (and by deduction, gasoline prices) comes from the trend of alcohol fuels production since 1986, when there was a marked drop in the price of oil and the price of gasoline. The average real price of gasoline has decreased by about 10 percent since 1986, from about $0.97 to about $0.88 (1987 dollars). Indeed, in real terms, the price of gasoline recently reached a historical low. This significant recent decline in the real price of gasoline relative to gasohol has increased the demand for gasoline and dampened the demand for gasohol (and other alternative fuels), which has inhibited the further development of alcohol fuels.

But oil prices alone do not explain the growth and development of the alcohol fuels industry. Based on the evidence we have so far, Federal tax and regulatory policy have been effective in stimulating demand and output of alcohol fuels, although this issue will require further study. Regarding tax policy, increases in motor fuels excise taxes, which have increased from 4 cents per gallon of gasoline to 18.4 cents per gallon of gasoline, have raised the price of gasoline and created economic incentives to substitute alcohol fuels for gasoline. The various Federal and State tax incentives have also played a role. Of the various tax incentives described, the excise tax exemptions for the 10% alcohol fuels mixtures, (currently at 5.4 cents per gallon of gasohol, equivalent to 5.4 cents per gallon of ethanol) have been the single most important Federal tax incentive to the development and growth of the alcohol fuels market, lowering the price of ethanol relative to the price of gasoline. Despite the turmoil in the oil markets due to the 1973 oil embargo, and the resulting sharp increase in oil prices, the alcohol fuels industry did not expand until after the tax exemptions were enacted in 1978.

The other four Federal tax incentives do not explain, for various reasons, the development and growth in the alcohol fuels market. Consider the income tax credits for alcohol fuels, which cannot be claimed if a taxpayer (typically a blender) is also claiming the tax exemption. These tax credits were intended to complement the excise tax exemptions for alcohol fuels that were enacted in 1978, which provide the maximum tax benefit when the gasohol mixture is 90% gasoline and 10% alcohol. Until 1992, there was no exemption for blends made with less than 10% alcohol. 30 The Congress wanted the income tax credits to provide incentives for the production and use of alcohol fuels in mixtures that contained less than 10 percent alcohol. Also, the Congress wanted to give tax-exempt users (such as farmers and State and local governments) who do not benefit from the exemption, an incentive to use alcohol fuel mixtures instead of gasoline and diesel.

For several reasons, however, blenders prefer the excise tax exemption over the income tax credit. First, the exemption is an immediate "up-front" tax benefit, which increases cash-flow, while the benefits from the tax credit must await the preparation of the business tax returns. Second, the alcohol fuels tax credits are not refundable; they may only be used against a positive tax liability; they are of no value if the producer has no tax liability. Third, the alcohol fuels tax credit is also subject to taxation under income tax section 87. Taxing the credits as income limits the net (after tax) benefits of the 54 cents credit to 35 cents per gallon, [54-.34(54)]. This makes the exemption even more profitable compared with the credit. Fourth, the limitations to the alcohol fuels "blenders" tax credit under IRC section 38 also could reduce the value of the credit. The amount of the alcohol fuels credit must be combined with other tax credits to determine the general business credit for the year. The general business credit is the combination of the alcohol fuels credit, jobs tax credit, research and development tax credit, low-income housing tax credit, and the investment tax credits (including carryovers). The general business tax credit is limited to the first $25,000 of the net tax liability for the year plus 75 percent of the remaining net tax liability. The alcohol fuels tax credit may not exceed the excess of the taxpayer's net income tax over the greater of either 25 percent of regular tax liability above $25,000 or the tentative minimum tax. Any unused credits may be carried forward 15 years or back 3 years.

The remaining three tax incentives available to alcohol fuels -- the alternative fuels production tax credit, the small ethanol producers credit, and the tax deductions for clean burning fuel vehicles -- have, for different reasons, also not been important factors in the development of the alcohol fuels market in the past. With respect to alcohol fuels, the alternative fuels production tax credit is basically available only to alcohol fuels produced synthetically from coal or lignite. In effect, the credit would seem to be available only to synthetic fuels. These fuels are so uneconomic at current market conditions, that even a significant tax credit -- amounting to nearly $6.00 per barrel of fuel produced -- is not enough incentive to stimulate output. 31 Alcohol fuels produced from biomass, which are more economical than from coal, but still uneconomical relative to gasoline, do not qualify for this tax credit.

The remaining two tax incentives were enacted only recently, and they have not been in effect long enough to have had significant incentive effects on alcohol output. The tax deduction for alternative fuel vehicles is intended to make those vehicles less unattractive economically to those required to buy them under the Energy Policy Act of 1992, effecting this by lowering the price of the vehicle that would run on the alternative fuel -- a capital stock incentive. Unless there are major technical improvements, however, which would lead to cost reduction, most mandated buyers will still not find the AFVs economic, except for high-mileage vehicles. Methanol and ethanol flexibly fueled vehicles will not significantly benefit from the income tax deduction, unless the costs of these fuels can be substantially reduced, a major objective of Title XII of the Energy Policy Act of 1992. 32

ARE THE ALCOHOL FUELS TAX INCENTIVES EFFICIENT?

The alcohol fuels tax incentives were enacted in order to counteract the forces of supply and demand in the fuels markets, which for a variety of economic and technological reasons, have tended to render alcohol fuels uneconomic and not competitive with gasoline. These economic forces established a much higher cost and price for ethanol fuels than for conventional motor fuels. The market for such fuels without these tax and regulatory incentives is limited. For most of the 16 years that the regulatory and tax subsidies for alcohol fuels have been in effect, ethanol has been favored over many others including methanol, liquified petroleum gas, compressed natural gas, and others. 33

It is possible that these incentives may have been effective but economically inefficient. Economic principles suggest that, in the absence of external costs and benefits, allocative efficiency takes place at the point where a commodity's market price equals its marginal costs. This allocation of scarce resources maximizes the total output produced nationally, and the economic well being of the population. In the presence of external costs, the commodity's price is generally too low, so that more is produced than is economically efficient. The solution favored by many economists is a TAX to increase the price to the point where it equals the marginal social cost, including the external costs. In the presence of external benefits, the commodity's market price is generally too high, so that less is produced than is economically efficient. Likewise the suggested solution is a SUBSIDY to reduce the market price to the point where it equals the marginal social costs, inclusive of the external benefits.

This section analyzes the various Federal tax subsidies provided in the form of incentives for alcohol fuels and finds that, although they are more efficient than mandates, they are less efficient than alternative energy tax policies. There are three sources of these inefficiencies. First, alcohol fuels PRODUCTION is characterized by external costs, rather than external benefits, and requires a tax, not a subsidy. Second, alcohol fuels consumption also generates negative environmental externalities. Should a system of taxes be imposed on motor fuels to correct for these external costs, the per unit tax on alcohol fuels should be less than for gasoline, not the same. Third, the user charge component of the total motor fuels taxes is smaller for alcohol fuels than for gasoline. Theory suggests that it be the same since users of alcohol fuels in transportation receive the same benefits from the system of national highways as users of gasoline.

Inefficiency Due to Negative Production Externalities

Externalities are unpriced effects from one economic agent to another. Positive (negative) production externalities are unpriced benefits (costs) from producers to society above and beyond what the market normally accounts for in its pricing and production decisions. When production of a commodity generates a negative production externality, the economically efficient policy is a tax on the commodity, not a subsidy. For example, in the case of production of either gasoline or diesel, the tax rate per gallon of output should reflect or equal the marginal external damages conferred on society. 34

Production and marketing of alcohol fuels generate negative environmental effects. First, most alcohol from biomass is produced from corn, which can generate pollution from the use of fertilizers. 35 Fermentation of grain in an ethanol plant generates carbon dioxide, a greenhouse gas. On the other hand, growing the grain recaptures the carbon dioxide. To the extent that the fermentation plants are powered by fossil fuels, there is net CO2 generated but this is relatively small. Second, production and marketing of alcohol fuels require the use of petroleum and other fossil fuels, which also generate pollution. In addition, while aggregate oil use decreases when ethanol is substituted for gasoline, ethanol production requires petroleum to grow the corn, power the fermentation plants, and market the final product. This also contributes to oil import dependence although substantially less than that which results from use of gasoline and diesel. 36 Excessive importation of petroleum is considered by some to be an external cost in the sense that dependence on unstable foreign oil producing countries increases the risks of supply cutoffs, embargoes, and price shocks. By themselves, these effects would suggest a tax, not a subsidy, although at lower rates than for refinery of gasoline and diesel, which generates even more pollution, and other external costs.

Inefficiencies Due to Negative Consumption Externalities

Economic efficiency in fuel use requires that the market price of the fuel reflect all of the cost to society of consuming that fuel, including the external costs in terms of air pollution, traffic congestion, and oil import dependence.

Although alcohol fuels are generally cleaner and less carcinogenic than gasoline and diesel, its combustion and evaporation does generate air pollution. 37 Ethanol fuel combustion is more complete and thus produces less CO, but it is more ozone forming than other oxygenates. Tailpipe emissions from ethanol combustion, for example, include acetaldehyde, which is toxic and possibly carcinogenic. Ethanol blended with gasoline reduces emissions of CO, but increases emissions of nitrogen oxide (NOx) and volatile organic compounds (VOCs). According to the EPA, ethanol blended with gasoline increases evaporative emissions that may actually increase smog (ozone) in the summertime. Methanol releases much more formaldehyde -- both a carcinogen and smog contributor -- than gasoline, and when produced from coal generates greenhouse gases, which contribute to possible global warming. These all suggest a tax rate less than the comparable tax on gasoline, not a subsidy.

Inefficiencies Due to Insufficient Charge to Highway Users

Drivers of alcohol-fuels-powered vehicles, receive comparable benefits from their use of interstate highway infrastructure as do drivers of petroleum powered vehicles. If this is the case, these drivers should pay the same price (excise tax) for these publicly provided benefits.

Drivers of gasoline powered vehicles currently pay an 18.4 cents tax per gallon of gasoline, of which 10.5 cents is considered to be a user charge or fee for the use of the interstate highways and is allocated into the Highway Trust Fund. 38 It is the price that drivers pay for the use of the highway infrastructure, with the price more or less reflecting the marginal benefits received. In contrast, drivers of gasohol powered vehicles currently pay a 5.1 cents user fee (table 1 p. 4). Alcohol fuel blends appear to be undertaxed by 5.4 cents per gallon.

Implications for Energy Tax Policy

Most economists believe that environmental problems associated with production and consumption of fossil fuels are more appropriately addressed with emissions taxes or a combination of emissions trading rights (as in the Clean Air Act) and energy taxes, not with tax credits and other subsidies. Economic efficiency in fuel use suggests a substantial tax on gasoline to make its market price fully reflect all of the social cost of producing that fuel, including the external costs in terms of the costs of air pollution, traffic congestion, and possibly oil import dependence. In the case of gasoline use, the market does not account for the pollution costs, crowding costs, or the full highway use costs of using gasoline. The result is that the market price is lower than the socially efficient price inclusive of external costs. (Recall the point made in an earlier section that the real price of gasoline recently was the lowest in history). Arguably, too much gasoline is consumed. The 6.8 cents component of the tax that goes into the general fund was enacted for fiscal reasons. From this perspective the tax on (and price of) gasoline should be increased to more fully reflect the external costs per gallon of gasoline.

An increase in the gasoline tax that substantially raised the price of gasoline and stabilized it at a fairly high level, would likely be the most economically efficient policy for promoting the development of alternative motor fuels. Raising the gasoline tax to fully reflect its external costs would raise the price of gasoline relative to alternative transportation fuels and increase the use of alternative motor fuels such as alcohol fuels. While this policy would not guarantee the development of alcohol fuels, or any other specific alternative fuel, it would guarantee the development of the lowest cost fuel alternatives, which is what an efficient tax policy would do. Assuming, however, that subsidies for alcohol fuels continue, a more efficient approach would be to enact targeted R & D tax incentives designed to reduce alcohol fuels production costs and improve the technical feasibility of using alcohol fuels in the internal combustion engine. 39 This would render alcohol fuel more competitive with gasoline.

Providing tax subsidies for one type of fuel over others, on the other hand, tends to distort market decisions and engender an inefficient allocation of resources, even if doing so produces some energy security and environmental benefits. This occurs when the subsidized fuel is more costly to produce than other fuels, and when other policy approaches more efficiently correct for preexisting market distortions. Both the concept underlying the alcohol fuels tax incentives, and the specific fuels that are eligible for the credits, make the tax code the arbiter of which alternative energy resources should and which should not be developed. Providing tax subsidies for alcohol fuels in order to increase farm sector incomes has also been questioned on grounds of economic efficiency. It would much more efficient to pay farmers a direct subsidy. 40

An increase in the gasoline excise tax would produce other benefits. Unlike the alcohol fuels tax subsidies which lose revenues and increase deficits, a higher gasoline tax would generate revenues and help to reduce Federal budget deficits. A larger gasoline tax would also tend to have beneficial environmental effects. Higher gas prices would reduce both gasoline consumption and vehicle miles traveled, both of which would reduce auto emissions. 41

Economists have also questioned the effectiveness of the alcohol fuels incentives as an energy tax policy to reduce imported petroleum and contribute toward energy independence. To the extent that the incentives induce a substitution of domestically produced ethanol for petroleum fuels, they would reduce petroleum imports, although not necessarily more than other alternative fuels. Alcohol fuel is not only higher in price, but also requires substantial energy to produce, thereby diminishing the net overall conservation effect. If the importation of oil imposes external costs, economic theory suggests a more efficient solution be considered, e.g., a tax on imported crude oil. 42

APPENDIX A: MISCELLANEOUS TAX BENEFITS

IMPORT LEVIES

Domestic production of fuel alcohol also benefits from customs duties or tariffs (types of import taxes) on imported alcohol used for fuel and other nonbeverage purposes. There are two types of duties: a permanent (no termination date) ad valorem duty assessed on price and an additional temporary specific duty assessed on a per liter basis. The rates for each of these two differ according to the type of alcohol and the country from which they are imported.

Consider ETHANOL used as a fuel (and other nonbeverage purposes) first. Generally, the permanent general ad valorem duty for such ethanol is 3 percent with the following exceptions: imports from Israel, Andean Pact countries, and Caribbean basin countries are duty free; imports from Canada and Mexico are assessed reduced rates; and imports from communist or former communist countries are assessed a 20 percent rate. An additional temporary duty is 14.27 cents per liter (54 cents per gallon or about $23 per barrel) with the following exceptions: imports from Israel, Caribbean basin countries, and Andean Pact countries are duty free; imports from Canada and Mexico are assessed lower rates. Note that imports from communist countries are assessed the general rate of 14.27 cents per liter. The additional temporary duty is set to expire on September 31, 2000 or in the event that the highway trust fund component of the gasoline tax expires (see table 4 above). 43

The additional temporary duty on ethanol, which was phased in over a period of three years, was introduced by the Omnibus Reconciliation Act of 1980 (P.L. 96-499) in order to offset the tax benefits (either the excise tax exemption or the blender's tax credits) claimed on imported ethanol. Ethanol imports, particularly from Brazil, reached significant levels in the early and mid 1980s. 44 Since 1983, when the full duty went into effect, the duty has always equaled the blender's tax credit. The Highway Improvement Act of 1982 (P.L. 97-424) raised the duty to 50 cents; the Tax Reform Act of 1984 (P.L. 98-369) raised the duty to 60 cents; and OBRA 90 reduced the duty to 54 cents.

Now consider METHANOL used as a fuel. There is no general permanent ad valorem duty or additional temporary specific duty for such methanol. The only exception is for imports of such methanol from communist or former communist countries, which are assessed a specific duty of 4.8 cents per liter (18 cents per gallon).

Finally, consider the ethers ETBE AND MTBE. Generally, the ad valorem duty on such ethers is 5.6 percent and no duty is assessed on imports from Israel, Andean pact countries, Caribbean basin countries, Canada, or Mex1co. Communist and former communist countries are assessed a 37 percent rate. An additional temporary duty, in effect during the same period as the additional duty on ethanol, is assessed on ETBE at a rate of 5.99 cents per liter (22.6 cents per gallon, $9.50 per barrel). Imports from Mexico are dutied at 5.3 cents per liter, while those from Israel, Andean Pact, Caribbean Basin countries, and Canada are duty free. For communist and former communist countries the additional temporary duty is also 5.99 cents per liter, the same as the general rate.

APPENDIX B: EXPIRED TAX PROVISIONS

The Federal tax code contained, at one time, two other energy tax incentives which became available in the 1970's but have since expired: the business energy tax credit and the provision to exempt from Federal tax the interest earned on certain types of Industrial Development Bonds. These incentives were available for alcohol fuels as one of a variety of qualifying types of alternative energy resources

THE BUSINESS ENERGY TAX CREDIT

The most important of these was the business energy tax credit, enacted as part of the Energy Tax Act of 1978. This was a tax credit for investment in a variety of capital equipment which produced alternative energy resources (broadly defined) and which also was used in conservation of energy and cogeneration. Generally, the credit rates ranged from 10 percent of the equipment costs for some types of property, to 11 percent and sometimes 15 percent. These credits were in addition to the regular 10 percent investment tax credit.

Two types of property for producing alcohol fuels, qualified for this tax credit: A 10 percent tax credit for alternative energy property and biomass property. The credit for alternative energy property covered equipment for producing synthetic fuels, including alcohol fuels, from substances other than oil and natural gas. Thus the equipment for producing alcohol from coal qualified for the credit. This expired at the end of 1982, except for certain long-term projects to which investors were committed. For these projects the credit was originally available until the end of 1990 but it has been phased out as part of the repeal of the investment tax credit by the Tax Reform Act of 1986.

The 10 percent energy credit for biomass property was originally available until the end of 1985, but was extended retroactively through 1987 by The Tax Reform Act of 1986 (at the rate of 15 percent for 1986 and 10 percent for 1987). This credit was generally limited to equipment for converting biomass into a fuel including alcohol fuels from biomass. Biomass was defined as any organic substance other than oil, natural gas, and coal. Thus equipment for producing methanol did not qualify for this credit. 45

TAX EXEMPT INTEREST ON INDUSTRIAL DEVELOPMENT BONDS

The second tax incentive which has expired is that which provided for tax-exempt financing of facilities which produced alcohol from biomass (IRC section 103(g)). THIS WAS FOR FACILITIES WHICH PRODUCED ETHANOL, NOT METHANOL. Tax exempt financing means that the interest on the bonds used to finance the construction of the facility for producing alcohol fuels was exempt from Federal income tax. This incentive was also part of the 1980 windfall profit tax law; it was repealed by the Tax Reform Act of 1986.

 

FOOTNOTES

 

 

1 Non-tax options to promote alcohol fuels have been examined in two CRS reports: U.S. Congress. Congressional Research Service. Legislative Options to Promote the Use of Alcohol Fuel. CRS Multidivisional Report, March 9, 1989. Washington. The regulatory incentives for alcohol fuels are discussed in: U.S. Congress. Congressional Research Service. Alternative Transportation Fuels: Oil Import and Highway Tax Issues. Issue Brief 93009, by David E. Gushee. August 18, 1994, (updated regularly). Washington.

2 The LUST trust fund is a Federal program that finances the cost of cleaning up spills from underground fuel tanks.

3 LPG is made up primarily of propane, with varying amounts of propenes, butane, and some minor constituents. Where LPG is sold by weight, the equivalent of a gallon for purposes of computing the motor fuels tax is 4.25 pounds per gallon (see Rev. Rul. 71-464, 1971-2 CB 357).

4 Although under the IRC blends of gasoline with biomass- derived methanol would also qualify, such blends are disqualified under the Clean Air Act because of the associated increase of emissions of ozone-forming pollutants.

5 In all these cases, the exemption equates to 54 cents per gallon of ethanol used.

6 The Clean Air Act, as amended, requires that all gasoline sold in the 40 carbon monoxide (CO) non-attainment areas contain 2.7 percent oxygenate; and that all reformulated gasoline sold in 9 ozone non-attainment areas (six of which are also CO non-attainment areas) contain 2 percent oxygenate. An oxygenate is a gasoline additive that adds oxygen to gasoline and makes the fuel burn more completely and more cleanly. Tailpipe emissions -- nitrogen oxides, carbon monoxide, particulate matter, and other hydrocarbons -- are a result of incomplete fuel combustion. Complete combustion of gasoline in pure oxygen would yield only carbon dioxide and water.

7 This partial exemption had the effect of equalizing the Federal tax rate for methanol to that of gasoline on an energy- content (Btu) basis prior to the Omnibus Budget Reconciliation Act of 1993 (OBRA). OBRA, however, increased the gasoline tax by 4.3 cents per gallon, which on a gasoline-equivalent basis would be 8.6 cents per gallon of methanol.

8 The literature contains no analysis of the question of benefit incidence --whose income is increased as a result of the alcohol fuels tax subsidies. According to a 1984 GAO study, however, ethanol producers set their prices to equal the price of unleaded gasoline plus the Federal and State tax subsidies. If the wholesale price of unleaded gasoline is 68 cents per gallon, the Federal ethanol exemption is 54 cents, and the State exemption is 40 cents, the wholesale price of ethanol would be set at P = 68 + 54 + 40 = $1.62 per gallon. If this is still the case, the producer, rather than the blender, is in effect receiving the economic benefits from the exemption. See U.S. General Accounting Office. Importance and Impact of Federal Alcohol Fuel Tax Incentives. GAO/RCED-84-1, June 6, 1984.

9 As a practical matter, there is little if any production capacity for methanol produced from biomass resources.

10 The other four components of Carter's National Energy Plan were: the Public Utilities and Regulatory Policies Act (P.L. 95-617); the National Energy Conservation Policy Act (P.L. 95-619); the Powerplant and Industrial Fuel Use Act (P.L. 95-620); and the Natural Gas Policy Act (P.L. 95-621). For biomass energy, the Energy Tax Act introduced the excise tax exemptions for alcohol fuels, the business energy investment tax credits, and the tax-exempt bond provisions to provide financing incentives. Each of these provisions is discussed in this paper. The Energy Tax Act also provided for the gas-guzzler tax, incentives for van pooling, and miscellaneous energy tax provisions.

11 A special fuel is defined as "any liquid fuel which is suitable for use in an internal combustion engine."

12 Any unused general business credits may generally be carried forward 15 years or carried back three years.

13 The Treasury Department was against the proposal. Sixty-one Senators, including fourteen Senators who were members of the Senate Finance Committee, petitioned the Treasury Department to have ETBE eligible for the alcohol fuels mixtures tax credit, then at 60 cents per gallon.

14 ETBE has a slightly higher octane rating and has a significantly lower vapor pressure, i.e., it is less volatile.

15 For a complete discussion of these provisions see: U.S. Library of Congress. Congressional Research Service. Energy Tax Provisions of the Energy Policy Act of 1992. CRS Report # 94-525E, June 22, 1994, by Salvatore Lazzari. Washington.

16 Technically, the amount of the credit is linked with the BTU (British Thermal Unit) content of oil. Each 5.8 million BTU's of fuel qualifies for the $3.00 credit.

17 These business energy tax credits have expired but they may still be available as carryovers of unused credits (see the appendix).

18 U.S. Congress. Congressional Research Service. EPA's Implementation of the Clean Air Amendments Act of 1990: The First Two Years. CRS Report # 93-268 ENR, by Susan L. Mayer. February, 1993. Washington.

19 This requirement became effective November 1, 1992.

20 Ozone nonattainment areas are metropolitan areas of the U.S. with the worst ozone pollution, which do not comply with air quality standards established under the Clean Air Act, as amended.

21 The EPA requirement was to become effective on January 1, 1995, but on Sept. 13, 1994 a Federal appeals court ruled in favor of the oil industry, issuing a stay that will, at least, delay implementation of the rule. See American Petroleum Institute, et. al., vs. EPA, U.S. Court of Appeals for the District of Columbia, Docket # 94-1502.

22 U.S. Library of Congress. Congressional Research Service. Ethanol and Reformulated Gasoline: The Renewable Oxygenate Standard. CRS Report # 94-613 ENR, by Susan L. Mayer. Washington.

23 Also called biomass, renewable energy resources in this context refers to anything organic -- basically plants. Broadly, biomass is defined as any organic material or substance other than oil, natural gas, coal, or any product or byproduct of oil, natural gas, and coal, Biomass includes plants, wood, crops, plant and animal waste, solid wastes, including municipal and industrial waste, sewage, and sludge.

24 See U.S. Library of Congress. Congressional Research Service. Energy Tax Subsidies: Biomass vs. Oil and Gas. CRS Report 93-19 E, by Salvatore Lazzari. January 5, 1993. Washington.

25 In addition, the regulation could also affect State revenues as many States also have preferential tax treatment of alcohol fuels. On the latter see U.S. Library of Congress. Congressional Research Service. Disparate Impacts of Federal and State Highway Taxes on Alternative Motor Fuels. CRS Report 93-330E, by David E. Gushee and Salvatore Lazzari, December 17, 1993. Washington.

26 The alcohol fuels tax credits are claimed as part of the general business credit and so they are not shown separately in the corporate statistics of income published by the IRS. The tax expenditure budget shows ex-ante PROJECTIONS of revenue losses from the alcohol fuels tax credit rather than ex-post or actual revenue losses. However, the annual issues of the tax expenditure budget show significant variation in these figures so they are not presented in table 3. In any event, the figures are small relative to the excise tax exemption -- under $100 million in all years, and under $50 million in most years -- although they are projected to increase to about $100 million per year beginning in FY 1995. The same tax expenditure estimates show a $100 million revenue loss from the clean-fuel vehicles deduction, but there are no data from which one can impute the amount to vehicles fueled by alcohol fuels only. With respect to the section 29 tax credit for alternative fuels, IRS data do show the aggregate amount claimed on all fuel produced, but data do not permit imputation to alcohol fuels.

27 Additional ethanol could also come from reduced exports (such as to Brazil), increased imports, or both.

28 The Clean Air Act requires that during the summer months only oxygenates that do not increase VOC's are acceptable.

29 Real magnitudes based on 1987 as the base year and the implicit price deflator for gross domestic product as the price index.

30 The pro rata provisions for alcohol fuel blends that are 7.7 percent and 5.7 percent alcohol, should make it possible for those blending ethanol into gasoline to get the immediate economic benefits of the highway tax exemption from ethanol use at the levels of ethanol in gasoline corresponding to the oxygen mandates. Heretofore, the immediate benefit was available only for 10 percent ethanol in gasoline, or gasohol; blenders at other concentrations had to claim the benefit under the Blender's Tax Credit provision, which required paying the highway tax and then getting it back later when income tax returns were filed.

31 Small quantities of alcohol synfuels output were generated in the early 1980s in response to the Carter Administration's synthetic fuels program.

32 It is likely that a significant number of propane-fueled vehicles and a small number of natural gas-fueled vehicles will become more economical to buyers not under mandate, so a nonfleet market may well develop for gaseous-fueled vehicles.

33 In recent years, the tax incentives have been gradually broadened to encompass a broader list of alternative fuels, but at lower values per gallon of those alternative fuels than ethanol has.

34 This does not mean to suggest that there is no benefit to consumers from the underpricing of gasoline. It means that this additional consumption imposes more costs on society than the price paid by consumers.

35 Currently, about 95 percent of ethanol production is derived from corn.

36 While petroleum accounts for 10-20 percent of total energy inputs into ethanol production, some studies suggest that every Btu of alcohol produced requires more than one Btu of petroleum, natural gas, and electricity. Wyman, E.E., R.L. Bain, N.D. Hinman, and D.J. Stevens. Ethanol and Methanol from Cellulosic Feedstocks. In Renewable Energy: Sources for Fuels and Electricity. Edited by T.B. Johansson, H. Kelly, A.K.N. Reddy, and R.H. Williams. Island Press, Washington D.C.. 1993. pp. 910-912.

37 Some analysts question whether, in its commercially available form, ethanol is less polluting than gasoline or diesel. This point is well made in: U.S. Congress. Congressional Research Service. Alternative Fuels for Automobiles: Are They Cleaner Than Gasoline. CRS Report #92-235S, by David E. Gushee. February, 1992. Washington. On p. 21, for example, he writes:

With respect to tailpipe emissions, it would appear that, if the emission standards are based on mass emissions unadjusted for ozone-forming tendency, alternative fuels have inherent air quality advantages over gasoline . . . Where tailpipe emission standards are set to control on the basis of ozone-forming tendency, however, alternative fuels by definition would have no advantage with respect to ozone formation, assuming that the vehicles are tuned to "Just meet" the standards.

38 In most prior years, all of the revenues from the gasoline excise tax was allocated into the highway trust fund, which rendered the entire gasoline tax a user charge. In recent years the non-user charge components of the tax have increased.

39 Market failures in research and development (R&D) of energy, and non-energy, technologies due to the fact that information from the research becomes public, suggests either an R&D tax credit or government expenditure on energy research. See U.S. Congress. Congressional Research Service. The Research and Experimentation Tax Credit. Issue Brief 92029, by David L. Brumbaugh. February 12, 1992. Washington.

40 This was essentially the conclusion of a 1986 U.S.D.A study. See U.S. Department of Agriculture. Fuel Ethanol and Agriculture: An Economic Assessment. August, 1986. Washington.

41 Increasing the gasoline tax would not be costless, however. A higher gasoline tax would hurt poor people relatively more than the rich; it would hurt the oil industry which has not fully recovered from the 1986 downturn; and would hurt certain regions of the country relatively more than others (large, rural, and sparsely populated States would be hurt relatively more than small, urbanized, and densely populated States where the driving distances are smaller). See: U.S. Library of Congress. Congressional Research Service. Gasoline Excise Tax: Economic Impacts of An Increase. Issue Brief 87078, August, 1994 (regularly updated) by Bernard Gelb and Salvatore Lazzari. In addition, the macroeconomic effects of an increase in the gasoline tax (especially a large tax which is not gradually phased in) would be largely negative. Gross national product (GNP) would tend to decelerate or decline depending upon the size of the tax increase and the stage of the business cycle. Employment growth would tend to slow and the unemployment rate would tend to increase. See U.S. Library of Congress. Congressional Research Service. Macroeconomic Effects of Increases in the Gasoline Tax. CRS Report #93-213E by Salvatore Lazzari and Brian Cashell. February 10, 1993. Washington.

42 Vulnerability to supply cutoffs and price shocks can be efficiently addressed by stockpiling oil, which the U.S. government does through it Strategic Petroleum Reserve. See: U.S. Library of Congress. Congressional Research Service. The Strategic Petroleum Reserve. Issue Brief 87050, by Robert Bamberger, regularly updated.

43 The gasoline tax has always been a temporary tax with a definite expiration date, but the tax has always been extended prior to its expiration.

44 U.S. Congress. Congressional Research Service. Alcohol Fuels. CRS Issue Brief # 74087, by Migdon R. Segal. March 13, 1989. Washington.

45 For more information on these credits see U.S. Library of Congress. Congressional Research Service. An Explanation of the Business Energy Investment Tax Credits. CRS Report No. 85-25 E, January 24, 1985, by Salvatore Lazzari. Washington, 1985. 40 p.

 

END OF FOOTNOTES
DOCUMENT ATTRIBUTES
  • Authors
    Lazzari, Salvatore
  • Institutional Authors
    Congressional Research Service
  • Code Sections
  • Index Terms
    CRS
    fuel, alcohol, credit
    fuel, gasohol
    gasoline tax, gasohol
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 94-9482 (33 original pages)
  • Tax Analysts Electronic Citation
    94 TNT 205-15
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