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WebMemo #1074 on Energy and Environment

May 12, 2006

Lift Tariffs on Foreign Ethanol

By

The federal government has done much to boost the domestic ethanol industry and is largely responsible for the use of this costly fuel additive. Now Congress should do something for America's drivers by removing the tariffs that limit imports of cheaper ethanol and drive up prices at the pump. Several bills now before Congress would repeal these tariffs, either temporarily or permanently.

 

Good for Special Interests, Bad for Drivers

Even by the standards of special interest-driven Washington, the ethanol industry gets an unusually sweet deal. Domestic ethanol, produced mostly from Midwestern corn, is the recipient of special tax breaks, a mandate, and trade protection.

 

Each gallon of ethanol that is blended with gasoline receives a 51-cent tax credit, along with other tax code inducements. Even with these tax breaks, corn ethanol remains more expensive than gasoline.

 

The energy bill passed last year actually requires ethanol use. In 2006, 4 billion gallons of this fuel additive must be blended into the gasoline supply, and that amount will increase to 7.5 billion gallons by 2012. This ethanol mandate has contributed significantly to rising gasoline prices this year. Both the costs of ethanol itself (even with the tax credits) and the logistical difficulties of incorporating it into the fuel supply have proven greater than expected. The mandate will continue to pose challenges as the high-demand summer months near.

 

As if preferential tax treatment and a product mandate were not enough, the domestic ethanol industry also enjoys protectionist tariffs that keep it from having to compete with foreign providers. Foreign ethanol is subject to a 54-cents-per-gallon tariff and a 2.5 percent duty. This discourages imports, such as potentially cheaper sugar cane-based ethanol from Brazil and other countries, that could undercut domestic producers.

 

There is an exception to the tariffs. Under the Caribbean Basin Initiative (CBI) and other laws, ethanol produced or processed in certain Caribbean and Central American nations comes into the country duty- and tariff-free. But the total exempted amount cannot exceed 7 percent of total domestic use. Brazilian ethanol could qualify up to that limit, but only if it is first sent to a CBI nation for processing before coming to America.

 

In past years, the 7-percent import cap has not been reached. For one thing, current ethanol production in some nations just meets their domestic consumption, leaving only small quantities for export. Also, the costs of diverting Brazilian or other supplies to CBI nations has discouraged full use of the tariff exemption, especially given the relatively low ethanol prices that prevailed in the U.S. until this year. If the tariff were dropped, foreign producers would now face a strong incentive to export to the U.S. Allowing this ethanol into the country without penalties or special requirements would, over time, act as a catalyst for increased global production.

 

End the Protectionist Tariffs

Several recently introduced bills would either temporarily or permanently repeal the tariff and allow free trade in ethanol. Temporary repeal, as proposed in S. 2763 and H.R. 5170, is designed to help alleviate the current impact of the ethanol mandate on prices. Additional foreign competition in the U.S. fuel ethanol market would diversify sources of supply and reduce the cost of the mandate for many years to come. Both the exporting and importing nations would benefit. While permanent repeal is better, because it would signal that the American market is open to the world's ethanol production over the long term, even temporary repeal would bring these other benefits.

 

Needless to say, agribusiness giant Archer Daniels Midland and the rest of the ethanol lobby, which is strongly supported by Midwestern legislators, oppose to these measures. Proposals to repeal the tariff definitely face an uphill battle.

 

The best solution for consumers would be to end ethanol's special treatment entirely. Proponents of domestic ethanol have claimed that increased use could reduce pump prices, displace oil imports, and help clean the air, but others seriously doubt the merits of this alternative to gasoline. Beyond the fuel's high cost, the substantial amounts of fossil energy used to produce both the corn and the ethanol itself weaken the energy security rationale for the mandate because the amount of oil imports displaced by ethanol use turns out to be less than proponents claimed. In addition, studies have shown that that ethanol's putative environmental benefits have been exaggerated.

 

For these reasons, the preferential tax treatment and mandate should be abolished along with the protectionist tariffs. Fuel ethanol ought to succeed or fail on its own merits. Until this happens, Congress should at least end the tariffs and let global competition to serve this market and drive down prices.

 

Conclusion

If ethanol is to succeed as a motor fuel, it will have to be the cheapest ethanol globally available. Consumers would benefit if the market-not special-interest politics-decided how much ethanol to use and where it should come from. For these reasons, Congress should repeal the laws that keep foreign ethanol out of the U.S. and allow free trade in this alternative fuel.

 

Ben Lieberman is Senior Policy Analyst in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation. 

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