Ethanol Production Follows the Subsidies

Federal Policy Drives Production Goals, but Huge State Credits Determine Location

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While Congress debates the economic and environmental value of extending substantial federal tax credits for ethanol production, it’s important to remember that Washington provides only one slice of the financial pie served up to U.S. ethanol producers.

State ethanol policies add significantly to that payoff, raising the subsidy of a gallon of ethanol from the federal level of 45 cents per pure gallon of ethanol blended to, in some cases, more than 80 cents.

A new economic analysis in the Southern Economic Journal finds that, while federal policy might be the driving force behind the amounts of ethanol we produce, where exactly we produce it is more a function of those state-level handouts.

“If you’re an ethanol producer and you can get 40 cents a gallon instead of 10 cents a gallon, it’s kind of a no brainer,” said Mark Skidmore, a professor of agricultural economics at Michigan State University and one of the paper’s authors. “If you can find a good location, you’re going to do it.”

Driving Forces

Skidmore and his co-author, Chad Cotti of the University of Wisconsin-Oshkosh, tracked state ethanol policies since the early 1980s, about the time that ethanol production began on a large scale in the United States.

They found that although states that produce large quantities of ethanol generally began doing so without the aid of subsidies, it was only when those subsidies kicked in that production really took off.

Notably, the states that dominate ethanol production also are strong corn producing states. Iowa was far and away the biggest producer of ethanol, at close to 2 billion gallons in 2007, the last year included in the paper’s analysis (Iowa now produces close to 3.5 billion gallons). That same year, Iowa edged out [XLS document] Illinois as the top producer of corn in the country, with about 2.4 billion bushels; Nebraska was third on the list.

Nebraska was second, though, in terms of ethanol production, at more than 1.3 billion gallons, with Illinois a good deal behind at 813 million gallons. This flipping of spots could at least partially be attributed to the 20.7 cent per gallon credit that was offered in Nebraska at the time; Illinois granted up to $5.5 million for construction of a new ethanol plant, but it lacked a per-gallon subsidy.

As Skidmore put it, ethanol producers will follow the money.

It is not enough, though, to simply provide a state subsidy and wait for the ethanol to flow. Several states have tried to spur the industry’s growth with subsidies but found the unfriendly corn-growing conditions of, say, Montana, held it back. That state had a policy giving out close to 40 cents on every gallon produced in 2007, yet it produced zero gallons of the fuel that year. Oklahoma was in a similar situation, with a 44-cents-per-gallon subsidy and only 2 million gallons of production.

Jobs Don’t Come Cheap

Skidmore also pointed out that these programs are considered job creators, or general spurs to economic growth. However, a simple analysis of how many jobs are created when an ethanol plant starts up suggests that taxpayer dollars may not be best spent in this way.

“If you can get a lot of jobs with a small subsidy, that’s really a good thing because you don’t give up a lot of tax dollars,” Skidmore said.

“If you look at how many workers work in an ethanol plant, it works out to between $70,000 and $75,000 per worker. That’s kind of an expensive jobs program.”

Beyond jobs growth, the discourse pushing subsidization of corn ethanol is a tenuous-at-best claim of environmental benefit with ethanol. Federal mandates will push production of ethanol up to 36 billion gallons by 2022, and environmentalists hope that the move toward advanced fuels rather than corn-based ethanol comes sooner rather than later.

The total amounts may be federally set, but how and where those amounts are used seems to be driven by surprisingly heterogeneous state rules.

“I think that the combination of state and federal policies is what is really driving ethanol production,” said Alice McKeown, a research associate at environmental group Worldwatch Institute. “And at the state level, you have a patchwork of different types of policies.”

With the federal tax credits set to expire at the end of 2010 unless Congress extends them, the question arises as to how important those patchy state rules will soon become. McKeown, though, doesn’t think it will become an issue.

“I would say that I find it very unlikely that congress will let that expire,” she said. “Historically speaking, they always extend it.”

Skidmore said that regardless of whether the money is coming from states or the federal government, the enormous amounts involved call the entire enterprise of ethanol subsidization into question. In 2007, the federal tax credit doled out $3 billion to ethanol blenders.

“One thing as an economist that I really wrestle with is that, in some states, if it’s 40 cents a gallon, and then you get another 51 cents a gallon, we’re paying producers in some states 90 cents per gallon to produce ethanol, and that’s really expensive,” Skidmore said.

According to some estimates, ethanol costs about $1.10 per gallon to produce. In states like Minnesota and North Dakota, where state credits are high, government handouts cover close to 80 percent of the production cost.

“I really struggle with whether this is the right path for us to be heading down and investing those type of resources,” Skidmore said. “It does cost money. It’s not free.”


See also:

Will Extending the Ethanol Tax Credit Slow Progress Toward Advanced Biofuels

Developing World Sees Wealth in Biofuel Production

Turning Food Into Fuel While Families Go Hungry

(Photo: Ethanol plant in Iowa, via Wikimedia Commons/USDA)