News reports suggest that the Administration and Congress are now considering action that would open up the ethanol market to competition, thereby reducing retail gasoline prices.
As previous posts have made clear, if the current crisis in the gasoline market is suddenly high prices and localized supply shortages, recent legislative proposals would not help.
Supply-side proposals such as permitting more development in Alaska and the outer continental shelf would increase long- but not short-run supply. Increasing long-run supply reduces long-run prices. Expropriating the assets of oil company stockholders (whether explicitly through “windfall-profits” taxes or implicitly by prohibiting LIFO accounting) will not increase short- or lung-run supply. Also, they reduce funds available for investment in future supply expansions. Demand-side proposals such as subsidies for the use of alternative fuels and tighter fuel economy standards can’t reduce short-run demand, and their long-run effectiveness is uncertain.
Finally, sending households $100 checks, ostensibly to compensate them for higher gasoline prices, isn’t targeted at all on the stated problem and easily could make matters worse. Unless gasoline is what economists call an “inferior good,” giving households more money will result in higher, not lower, gasoline consumption and higher, not lower, retail gasoline prices. (Gasoline is not an “inferior good,” so this proposal may be the worst one of all from an economic perspective. Learn about income elasticity of demand here. Also, the money to pay for these checks must come from somewhere.
Now comes word that the Administration and some in Congress are considering reducing or eliminating the 54 cent per gallon tariff on imported ethanol. Tariffs are protectionist subsidies that benefit U.S. producers at the expense of U.S. consumers. Laura Meckler of the Wall Street Journal (subscription required) reports that Department of Energy Secretary Samuel Bodman has “urged Congress to consider lifting the tariff on imported ethanol, as lawmakers scrambled for a response to the surge in gasoline prices.” Ethanol is needed to replace MTBE as the oxygenate in summer blend gasoline.
Support for lifting the tariff has bipartisan support, but it would have powerful opponents among farm-state lawmakers.
No kidding. The proposal is controversial precisely because it would be effective.
Sens. Charles Grassley (R-IA) and John Thune (R-SD) assert that its elimination would not reduce retail gasoline prices. But their argument lacks any economic basis:
Everyone’s looking for a way to lower gas prices, but lifting the ethanol tariff won’t mean lower prices for consumers. What’s more, it would undermine efforts to make our country more energy independent and reward the oil companies that are already raking in record profits.
“Energy independence” might be a good thing, perhaps for national security reasons, but it’s important to recognize that energy independence requires higher energy prices. Imports lower prices, and restricting imports always increases them. Thus, the very argument Grassley and Thune use to defend the subsidy contradicts their assertion that its elimination would not reduce gasoline prices. Of course it would, and quite rapidly at that.
Grassley and Thune then suggest that Brazil, the likely source of imported ethanol, can’t actually supply U.S. needs:
The world’s only other major ethanol producer is Brazil, and Brazil simply doesn’t have enough ethanol to export at significant levels right now.
In other words, the tariff is needed to exclude Brazilian ethanol that Brazil can’t actually provide.
Economic logic having failed them, Grassley and Thune resort to demonizing the oil companies, an increasingly popular pastime. Eliminating the subsidy, they claim
would reward the oil companies because the oil companies would be the major buyers of imported ethanol. And lifting the tariff would save these companies big money with no guarantee that they would pass the savings on to the consumer.
So lifting the tariff would be a victory for the oil companies, a kick in the face to rural America where the ethanol comes from, and leave consumers with the same high gas prices we have today.
These statements are bereft of economic logic. If the retail gasoline market is competitive–and no legislator has provided evidence otherwise–cost savings will be passed on to consumers very quickly. Ethanol is added to refined gasoline blendstock, so whatever profits there might be in oil refining are irrelevant. Finally, recent oil industry profits are the result of the high worldwide price of crude oil, not profitability in refining or the retail gasoline market. If refining were profitable, oil companies would be building new capacity right and left. If the retail gasoline market was profitable, there would be a filling station outside every Starbucks.
Support for the ethanol subsidy is bipartisan and concentrated among legislators from corn-producing states. Opposition to the subsidy also is bipartisan, and concentrated among legislators from states that do not make ethanol. These are entirely rational positions to take from the perspective of the constituents each group represents.
Perhaps unwittingly, Grassley and Thune do provide helpful information, however. As they acknowledge, eliminating the ethanol subsidy would save “big money.” A lot of Brazilian ethanol would be imported–ethanol that Grassley and Thune say Brazil can’t supply to the market.