Using Biofuel Tax Credits to Achieve Energy and Environmental Policy Goals

The federal government supports the use of biofuels—transportation fuel produced usually from renewable plant matter, such as corn—in the pursuit of national energy, environmental, and agricultural policy goals. Tax credits encourage the production and sale of biofuels in the United States, while federal mandates specify minimum amounts and types of biofuel usage each year through 2022. Tax credits effectively lower the private costs of producing biofuels relative to the costs of producing their substitutes, gasoline and diesel fuel. Together, the credits and mandates increase domestic supplies of energy and reduce U.S. emissions of greenhouse gases, albeit at a cost to taxpayers and consumers. For example, in fiscal year 2009, the biofuel tax credits reduced federal excise tax collections by about $6 billion below what they would have been if the credits had not been in effect.

Roughly 11 billion gallons of biofuels were produced and sold in the United States in 2009, and ethanol produced from corn accounted for nearly all of that total. Blenders of transportation fuels receive a tax credit of 45 cents for each gallon of ethanol that is combined with gasoline and sold. Although the credit is provided to blenders, most of it ultimately flows to producers of ethanol and to corn farmers—in the form of higher prices received for their products.

Most of the rest of the biofuel sold in the United States consists of biodiesel, which is made largely from soybean oil but is also produced from animal fats and recycled plant oils. Until recently, the producers of such biodiesel received a tax credit of $1 per gallon. Although that credit expired in December 2009, CBO included it in the analysis to provide information about the value of the credit should policymakers decide to reinstate it. In the future, cellulosic ethanol—made from plant wastes such as corn stalks—could account for a significant share of domestic production of biofuels. Its producers are eligible for a tax credit of $1.01 per gallon if it is produced and blended with gasoline; even with that credit, however, cellulosic ethanol is not commercially viable today and is produced in very limited quantities.

In a study prepared at the request of the Chairman of the Subcommittee on Energy, Natural Resources, and Infrastructure of the Senate Committee on Finance, CBO assesses the incentives provided by the biofuel tax credits for producing different types of biofuels and analyzes whether they favor one type of biofuel over others. In addition, we estimate the cost to U.S. taxpayers of reducing the use of petroleum fuels and emissions of greenhouse gases through those tax credits; we also analyze the interaction of the credits and the biofuel mandates. CBO’s main conclusions are the following:

• The incentives that the tax credits provide to producers of biofuels differ among the fuels. After adjustments for the different energy contents of the various biofuels and the petroleum fuel used to produce them, producers of ethanol made from corn or other similar feedstocks receive 73 cents to provide an amount of biofuel with the energy equivalent to that in one gallon of gasoline. On a similar basis, producers of cellulosic ethanol receive $1.62, and producers of biodiesel would receive $1.08 (if that credit were extended).
• The costs to taxpayers of reducing consumption of petroleum fuels differ by biofuel. Such costs depend on the size of the tax credit for each fuel, the changes in federal revenues that result from the difference in the excise taxes collected on sales of gasoline and sales of biofuels, and the amount of biofuels that would have been produced if the credits had not been available. The costs to taxpayers of using a biofuel to reduce gasoline consumption by one gallon are $1.78 for ethanol and $3.00 for cellulosic ethanol. The cost of reducing an equivalent amount of diesel fuel (that is, a quantity having the same amount of energy as a gallon of gasoline) using biodiesel is $2.55, based on the tax policy in place through last year.
• Similarly, the costs to taxpayers of reducing greenhouse gas emissions through the biofuel tax credits vary by fuel: about $750 per metric ton of CO₂e (that is, per metric ton of greenhouse gases measured in terms of an equivalent amount of carbon dioxide) for ethanol, about $275 per metric ton of CO₂e for cellulosic ethanol, and about $300 per metric ton of CO₂e for biodiesel. Those estimates do not reflect any emissions of carbon dioxide that occur when production of biofuels causes forests or grasslands to be converted to farmland for growing the fuels’ feedstocks (the raw material for making the fuel). If those emissions were taken into account, such changes in land use would raise the cost of reducing emissions and change the relative costs of reducing emissions through the use of different biofuels—in some cases, by a substantial amount.

Federal biofuel mandates require vendors of motor fuels to produce or blend specified minimum volumes of the different fuels with gasoline and diesel fuel; the annual targets are scheduled to rise through 2022. In the past, those requirements have not directly increased the quantity of biofuels sold in the United States because the combination of underlying economic conditions and the biofuel tax credits has caused the use of biofuels to exceed the mandated quantities. In the future, the scheduled rise in mandated volumes would require the production of biofuels in amounts that are probably beyond what the market would produce even if the effects of the tax credits were included.