January marked the first month that the ethanol industry had to stand on its own feet was only supported by a massive taxpayer mandate for their product, rather than tax preferences, tariff protections, and a mandate.

Do not fret, as sales for E10 (10% ethanol 90% gasoline, commonly purchased at the pump) will hold remarkably steady, because this is the primary venue the rent-seekers use to dilute our nations gasoline supply with ethanol. I only slightly kid, as it makes sense to blend small percentages of ethanol into our fuel supply, though not in amounts exceeding 10 percent.

However, in the United States there are also niche markets for E-85, which is made up of 85% ethanol and 15% gasoline. E85 sales more accurately reflect what an actual competitor to gasoline would look like, as E10 blends only supplement regular fuel production. While there are a number of flex-fuel vehicles on the road (FFVs) capable of running on any blend of ethanol and gasoline, E85 sales have never taken off in the United States. This is because, after adjusting for the lower energy content in ethanol, it costs more money per mile traveled to fuel your vehicle with E85 than E10. It has always been this way and its unclear if it will ever change.

The lapse of the volumetric ethanol tax credit (VEETC) in January made this much worse, as E85 was receiving a tax credit worth just short of 40 cents per gallon, allowing the fuel to be sold more cheaply than it would absent the tax credit. Sales of E85 in Minnesota are about to discover this new reality:

The post-subsidy era also brings tough choices for owners of flexible-fuel vehicles, including the state of Minnesota, which has more than 3,000 vehicles capable of burning E85, and in 2010 used 963,000 gallons of it.

They must decide whether to support a fuel that is 85 percent home-grown ethanol even it it’s no longer competitively priced. Minnesota is the nation’s fourth-largest ethanol producer, and leads the nation with 364 retailers selling E85.

“We have our eyes open, and we are watching this,” said Tim Morse, director of Minnesota’s fleet. “We think it is too early to make any kind of decision right now.”

Morse said he wants to see if the full 38 cents of lost E85 subsidy gets added to the state’s fuel price. That could boost the state’s annual E85 bill by $366,000.

Last week in the Twin Cities, E85 was 16 cents to 40 cents lower than regular gasoline, which also rose in price. That’s as little as a 5 percent price difference. E85′s price advantage has sometimes been more than four times better and averaged 17 percent last year, according to the state Commerce Department.

The state of Minnesota has been purchasing E85 for state-owned flex fuel vehicles in the past. It isn’t clear if this saved them money, which is incredibly unlikely, or if they were doing it out of “statriotism.” Regardless, even now they feel the need to balance budget savings versus the very minute and possibly non-existent environmental benefits of corn ethanol.

More broadly, this demonstrates why the ethanol mandate is non-sensical and needs to be abandoned. Cellulosic ethanol has hit its 4th or 5th straight year of still being “right around the corner” and even environmentalists are becoming skeptical of its touted environmental benefits, after seeing the realities of corn ethanol. Allowing increasing blends of ethanol beyond E10 into our fuel supply is a pointless handout to an industry friendly with the Obama Administration. It’s hurting our refining industries which already operate on very low margins, and consumers have demonstrated that they prefer the price savings to vague and questionable environmental benefits.

Something will have to give soon. Our fuels market is not ready to go beyond E10 (and absolutely not beyond E15 in its present form), and consumers are not going to purchase E85 or flex fueled vehicles unless it saves them money. If not abandoning the ethanol mandate completely, the EPA could start by capping it (or suggesting that Congress cap it) at its current level.

Just a few days after our previous post outlining the ethanol industry’s brave, unprecedented, legendary, and 100% voluntary decision to give up the ethanol tax credit, we see that there are still other subsidies that they are interested in keeping:

But the head of the Renewable Fuels Association—Bob Dinneen—says the industry will work to ensure that tax credits for cellulosic ethanol will continue past the end of 2012.

“We think that the production tax credit and the depreciation that is now allowed for cellulose needs to continue,” Dinneen says.

Extension of the cellulosic tax credits will send an important signal to the marketplace and encourage investment in the next generation of ethanol technology, Dinneen says.

And to those who consider it just another federal subsidy for ethanol…

“They need only look at the tax incentive for grain-based ethanol that has just expired–that demonstrates you don’t need a tax incentive forever,” Dinneen says.

“You need to encourage investment—convince the marketplace that there is going to be consistent government support that will allow the industry to get on its feet.”

Cellulosic ethanol has not yet been produced commercially, but according to the U.S. Department of Energy web site, several commercial cellulosic plants are under construction.

Not including the federal mandate for their product or various state-level incentives, the ethanol industry has been federally subsidized in some form for over 3 decades. Just think, at this pace, after another 2-3 decades of timely, critical subsidies for the cellulosic ethanol industry they might be able to make a tiny dent in our oil consumption. What a bargain!

With the current partisan fighting over oil subsidies (and energy policy more generally), its worthwhile to look at energy legislation that has found bipartisan support: the New Alternative Transportation to Give Americans Solutions Act of 2011 (the NAT GAS Act, often called the Boone Pickens bill). It currently has 180 cosponsors, split roughly even between Republicans and Democrats. Joe Nocera likes it.

True fiscal/small government conservatives understand the danger of using the tax code to steer the economy. It has brought us ethanol, subsidized home ownership for the wealthy, etc. Populist conservatives-in-name-only don’t actually care about applying consistent principles, or often let their concern be overshadowed by campaign donations.

Which is why I was surprised to see Representative Ron Paul, principled libertarian/free-market extraordinaire, as a cosponsor. I spoke to someone in Ron Paul’s office, and they explained (roughly) that support for tax credits (i.e., industries paying less in income tax relative to the status quo) is consistent with Ron Paul’s support for lower taxes.

This YouTube clip seems to explain Paul’s position (he was asked about a bill to end tax credits for the oil industry):

PAUL: Well, how do you define a subsidy? I don’t consider any tax break as a subsidy. That was not a spending bill, that was not a grant.

…

I never vote to increase any taxes. I vote to always give tax credits, and I always cut spending. I’ve never voted for a real spending bill, so, I don’t think that is in the category of something I’d consider a spending bill.

Essentially, Paul’s position appears to be that any move to lower taxes is a good move. This position isn’t unique to Ron Paul. This post examines a similar fight over whether or not repealing the ethanol tax credit amounts to a tax increase that would violate a pledge to oppose tax increases endorsed by many conservatives. However, I think that supporting selective tax credits for industry is bad policy, and has the effect of steering the economy, something Paul doesn’t support:

Government cannot invest, it can only redistribute resources. Just look at the mess government created with ethanol. Congress decided that we needed more biofuels, and the best choice was ethanol from corn. So we subsidized corn farmers at the expense of others, and investment in other types of renewables was crowded out.

Now it turns out that corn ethanol is inefficient, and it actually takes more energy to produce the fuel than you get when you burn it. The most efficient ethanol may come from hemp, but hemp production is illegal and there has been little progress on hemp ethanol. And on top of that, corn is now going into our gas tanks instead of onto our tables or feeding our livestock or dairy cows; so food prices have been driven up. This is what happens when we allow government to make choices instead of the market; I hope we avoid those mistakes moving forward.

Flex-fuel vehicles, capable of running on 85% ethanol blends, mostly exist because of government policy (note, not technically due to a tax credit), and are largely considered to be a government-science-experiment gone wrong. Electric vehicles largely only exist because of enormous tax credits. This natural gas legislation will result in increased production of natural gas vehicles.

Paul wants to get rid of the income tax. Great. But is it a good idea to lower taxes (often at the behest of industry who come begging to Washington) in a piecemeal fashion? Given the constraints of a corporate tax rate already in place, lowering taxes for specific industries would seem to do more harm than good.

(Curiously, Paul has voted against tax credits for renewable power before. Note that these bill summaries don’t always explain the entirety of the bill, and Paul often will vote against bills for small provisions on principle, so this might not be inconsistent.)

Imagine two pizza companies competing against one another. Now allow one company to pay zero dollars in corporate taxes. They now have an unfair advantage and can potentially force the other company out of business via lower prices. Now phase that up into enormous industries like the natural gas, coal, or oil industry. Allowing these industries to pay lower taxes relative to one another distorts the most efficient use of our energy resources.

Cheers to Ron Paul for opposing subsidies. And I understand the difference between a “subsidy” where the government gives you money, and a “tax credit”, where you get to keep more of your own hard earned money. However, in the macroeconomic sense, the destructive outcome of either a tax credit/subsidy is often the same. Aim for overall corporate tax reform, not more individual deductions or credits that further distort economic activity.

And shame on all of the cosponsors on those bills who pretend to ideologically oppose picking winners, or who consistently vote against the same type of energy tax credits for industries that are less popular with their constituents.

Via Steven Mufson at The Washington Post.

Black liquor is a by-product of paper production and much of it is burned in house at the paper mills to produce energy. Note that these companies need no incentive to do this as they already have been doing it on their own for quite a long time as its an efficient way for them to produce their own energy. This was an issue in the past, which Congress had theoretically fixed, but as the article notes:

Eager to limit the cost to the Treasury — more than $4 billion by the end of fiscal year 2009 — Congress said that black liquor would not qualify for the alternative fuel tax credits after Dec. 31, 2009. And to help cover the cost of the January 2010 health-care law, Congress also barred black liquor from qualifying for the cellulosic biofuel tax credit.

I can understand how this might happen initially. Laws are written vaguely and companies take advantage of a law not intended to benefit them. This is frustrating in and of itself, but given the complexity of our tax code its bound to happen sometimes. However, the fact that our laws are so complicated that Congress tried, and failed, to fix this loophole is beyond belief.

One can’t really blame the companies here. As one representative from a trade group said, the companies have the responsibility to take advantage of these legal tax loopholes as they owe it to their stockholders to maximize profits.

The number of dollars involved is staggering, with credits ranging from a relatively low $29 million to a staggering $2.1 billion by International Paper. The article mentioned that this represented up to almost a quarter of profits for companies in some instances. Score another for scrapping the entire ethanol experiment. And remember this when they tell you there’s little real waste in Washington, and they need more revenue.

There is an ongoing ethanol spat between Senator Coburn (R-OK) and Grover Norquist, President of Americans for Tax Reform. The dispute is over conservative support for a bill that would repeal the ethanol tax credit, which has the effect of raising an industry specific tax. Americans for Tax Reform comes down hard on any effort to increase taxes. The Wall Street Journal added their two cents in favor of Senator Coburn:

Our readers know Mr. Norquist as the plucky author of the no-new-taxes pledge, which has helped to make tax increases a red line in Republican politics. In a letter to Mr. Coburn, a deputy of Mr. Norquist writes: “Repealing the ethanol credit is the right thing to do, but other taxes must be reduced in the same legislation by at least this much to prevent a net tax increase.”

We understand the larger principle that Americans for Tax Reform is trying to defend. Axing every credit, exemption and deduction in the tax code, while leaving tax rates high, would result in a higher general tax burden and more money for Washington to spend. A true tax reform would trade such tax loopholes and subsidies for lower rates.

Coburn’s amendment (which would have been attached to a larger bill) is dead, so the fight is in recess and will reappear before the end of the year. It seems that it would be much harder to pass legislation that would kill the VEETC and also lower taxes, rather than solely ending the VEETC. It also raises the question of which other taxes should be lowered. The VEETC goes back to oil refiners, though some of the savings are passed onto consumers.

This issue came up in 2010. Americans for Tax Reform clearly articulated their position here:

In recent days, Americans for Tax Reform’s opinion on extending the Volumetric Ethanol Excise Tax Credit (“VEETC”)has come into question.  Below is our position on the issue:

1. VEETC is poor energy policy. Encouraging inefficient fuels which accomplishes neither reductions in carbon—its purported impetus— nor monetary gains for American families is bad energy policy.
2. The VEETC is a tax credit which expires at the end of 2010.  There is no obligation on the part of pro-taxpayer elected officials to vote to extend an expiring tax credit which they believe is bad policy.  In the past, the question has been the elimination of the VEETC while it was still in force.  This affirmative tax hike would have been a violation of the Taxpayer Protection Pledge, but that issue is not applicable to this debate.
3. Therefore, Americans for Tax Reform neither supports nor opposes extending the Volumetric Ethanol Excise Tax Credit.