Toward an optimal U.S. ethanol fuel subsidy
Section snippets
Current ethanol tax exemption provisions and benefits
The force behind the recent rapid expansion of the ethanol–fuel market is the current phasing-out of MTBE (methyl–tertiary–butyl ether) as a fuel oxygenate and its replacement with ethanol. The ethanol–fuel market received a further boost from the 2005 Energy Bill which, while eliminating the oxygenate requirement, sets a new goal for expanding domestic fuel supplies with renewable fuels, mainly ethanol and biodiesel. In particular, the renewable fuels standard sets a national minimum usage
Theoretical model
As outlined by Parry and Small (2005) a number of previous studies have investigated the external costs of vehicle transportation in an attempt to develop an optimal gasoline tax. Parry and Small (2005) in their analysis identify a Pigovian and Ramsey tax along with congestion feedback as components of an optimal gasoline tax. Limited if any studies have attempted to model the optimal ethanol fuel subsidy. Using the past studies on deriving the optimal gasoline tax, in particular Parry and
Parameter values
Benchmark values and parameter ranges used for estimating the optimal ethanol subsidy (21) are summarized in Table 1. The proportion of ethanol fuel used was determined from U.S. FHWA (2003) using 2003 estimates of 2.75 billion total gallons of ethanol used, and dividing it by the total fuel consumed, 134.1 billion gallons.2
Results
Applying the benchmark parameter values from Table 1 directly to (21) yields an estimated optimal ethanol subsidy s⁎ = $0.22 per gallon of ethanol (Table 2), which is less than the current highway tax exemption of $0.51 per gallon. As indicated from Table 2, the negative marginal external benefits accounts for a large portion of this optimal/actual discrepancy. The ethanol fuel subsidy does yield positive benefits from increased share of renewable fuel in the form of reduction in greenhouse gases
Sensitivity analysis
The wide range of parameter values in Table 1 suggests the benchmark optimal subsidy in Table 2 has an associated rather large variance. In order to investigate the sensitivity of the optimal ethanol subsidy, s⁎, to ranges of the parameter values, both individual parameter variation and Monte Carlo analysis were implemented. Fig. 1, Fig. 2 illustrate the response of the optimal ethanol subsidy to a range of elasticities and external benefits and costs. As indicated from Fig. 1, the optimal
Implications
It is very important in public policy analysis to consider the market effects of such policies. The government providing market incentives for the establishment of a renewable fuels industry is a case in point. The objective of establishing a renewable fuel industry within the U.S. is to increase social welfare by improving air quality, reducing greenhouse gas emission, increasing energy security, and contributing to economic development. The U.S. 2005 Energy Bill takes a step in this direction
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