United States General Accounting Office

GAO Report to the Chairman, Committee on

Ways and Means, House of

Representatives

March 1997 TAX POLICY

Effects of the Alcohol

Fuels Tax Incentives

GAO/GGD-97-41

GAO United States

General Accounting Office

Washington, D.C. 20548

General Government Division

B-271977 

March 6, 1997

The Honorable Bill Archer

Chairman, Committee on Ways and Means

House of Representatives

Dear Mr. Chairman:

In the late 1970s and early 1980s, Congress enacted tax incentives for

biomass-derived alcohol fuels.1

 Proponents maintained that the incentives

would reduce U.S. dependence on petroleum imports and provide an

additional market for U.S. agricultural products. Subsequent

environmental legislation has increased the demand for alcohol fuels.

These alcohol fuels currently are blended with gasoline to increase its

oxygen content in certain areas of the country that have mandatory

minimum oxygen requirements for transportation fuel.2

In recent months, Congress has debated the need for continuing to provide

tax incentives for alcohol fuels. In this context, you asked the following

questions relating to tax incentives for alcohol fuels, which we address in

this report:

• Whom do the incentives benefit and disadvantage economically?

• What environmental benefits, if any, have the incentives produced?

• Have the incentives increased the nation’s energy independence?

• To what extent has the partial exemption from the excise tax for alcohol

fuels reduced the flow of revenue into the Highway Trust Fund?

Background In the 1970s and 1980s, the federal government adopted numerous policies

to encourage the use of alternatives to imported fossil fuels.3

 Among these

policies were tax incentives that were specifically targeted at the use of

alcohol fuels derived from biomass materials. Supporters claimed that the

tax incentives would not only reduce U.S. reliance on imported petroleum

but would also help support farm incomes by finding another market for

the agricultural products from which alcohol can be produced, such as

corn. In the late 1980s, Congress’ attention turned to the possible benefits

of using alcohol fuels as additives to fossil-based fuels to reduce urban air

1

Biomass-derived alcohol fuels are chemical compounds made from nonfossil material of biological

origin and constitute a renewable energy source.

2

Ethanol, which is an alcohol fuel, has been used traditionally as a gasoline extender and octane

enhancer mainly in those areas of the Midwest where it is produced.

3

See appendix I for a chronology of events and federal legislation relating to alcohol fuel use.

Page 1 GAO/GGD-97-41 Tax Policy
B-271977 

pollution. The Clean Air Act Amendments of 1990 required that

transportation fuel used in some urban areas have a minimum oxygen

content to reduce these areas’ levels of carbon monoxide and ground-level

ozone. In the early 1990s, congressional attention turned to the possible

benefits of using renewable energy sources, including alcohol fuels, to

reduce emissions of greenhouse gases that may contribute to global

warming.4

Tax Incentives for Alcohol

Fuels5

 The federal tax incentives that are specifically targeted for motor fuels

containing biomass alcohol are (1) a partial exemption from the federal

motor fuel excise taxes that are earmarked for the Highway Trust Fund6

and (2) a set of three credits against the income tax. The partial excise tax

exemption has been much more important than the income tax credits in

terms of the amount of tax benefits claimed.

The size of the partial exemption depends on how much and what type of

alcohol is contained in each gallon of fuel. Virtually all of the excise tax

exemptions for alcohol fuels claimed in 1995 were for fuel mixtures of

gasoline and ethanol. The partial exemption lowers the after-tax cost of

the gasoline that fuel blenders mix with ethanol. Each of the three income

tax credits is directed at a distinct line of business. The “alcohol mixtures

credit” allows blenders to reduce their income taxes by 54 cents for each

gallon of biomass ethanol that they use in their blended fuel. The “alcohol

credit” allows businesses to reduce their income taxes by 54 cents for each

gallon of “qualified” biomass ethanol fuel (which must contain at least

85-percent alcohol) that they sell at the retail level or use themselves.7

Finally, the “small ethanol producers credit” allows businesses that

produce less than 15 million gallons of ethanol for fuel each year to reduce

their income taxes by 10 cents for each gallon produced. Taxpayers who

4

The preponderant greenhouse gas is water vapor. Other greenhouse gases are carbon dioxide,

methane, and nitrous oxide. Greenhouse gases are emitted when a fossil fuel, such as gasoline, natural

gas, or coal, or a renewable fuel is combusted. There are also substantial natural sources of

greenhouse gases in addition to human-made sources. Greenhouse gases collect in the earth’s

atmosphere, trapping heat and, some believe, raising the earth’s surface temperature. (See Energy

Information Administration, Emissions of Greenhouse Gases in the United States 1995,

DOE/EIA-0573(95), October 1996, for more information.)

5

This section provides only a summary description of the tax incentives. Details and estimates are

provided in appendix II.

6

The Highway Trust Fund was established in 1956 as an accounting mechanism to finance the

federal-aid highway program.

7

“Qualified” biomass ethanol fuel is often referred to as “neat” alcohol fuel. Blenders or producers of

neat alcohol fuel that use biomass alcohols other than ethanol can earn income tax credits or excise

tax exemptions equal to 60 cents for each gallon of alcohol used.

Page 2 GAO/GGD-97-41 Tax Policy
B-271977 

claim the alcohol mixtures credit or the alcohol credit must reduce their

credits by the amount of the partial excise tax exemption that is

associated with the same fuel.

Current Alcohol Fuel Use According to U.S. Department of Energy (DOE) data, almost all of the

alcohol that was used as transportation fuel in the United States in 1995

was either ethanol or alcohol that was used to make methyl tertiary butyl

ether (MTBE), which is a fuel additive derived from methanol. In 1995, MTBE

accounted for about 3 percent of the total transportation fuels consumed

and ethanol accounted for less than 1 percent.8

 Alcohol fuels usually are

blended with gasoline, where they serve as oxygenates, octane enhancers,

and/or fuel extenders.9

Currently, 95 percent of the U.S. production of ethanol fuel is derived from

corn. In contrast, the methanol used to produce MTBE is currently derived

from natural gas because that is how it can be produced most

cost-effectively. Despite the fact that nonbiomass MTBE does not qualify for

the tax incentives, according to DOE, it is more widely used than ethanol.

This is, in part, because MTBE’s lower volatility, compared with ethanol,

makes it a more acceptable ingredient to blenders of reformulated

gasoline (RFG)10 in summer months. MTBE’s lower volatility permits the

gasoline fraction of RFG to have a higher volatility than otherwise would be

permitted in achieving the RFG standard. In addition, ethanol has

transportation problems that MTBE does not have (see app. IV), and MTBE

may be a cheaper oxygenate than ethanol.

Results in Brief The value of the ethanol tax incentives is shared among different groups in

the economy, including alcohol fuel blenders, ethanol producers, and corn

farmers. The tax incentives effectively lower the blenders’ after-tax cost of

using ethanol when they mix ethanol with gasoline. However, the

blenders’ increased demand for ethanol raises the market price of ethanol

above what it would have been without the incentives. For this reason, the

after-tax cost to the blenders is not lowered by the full value of the

8

Table III.1 in appendix III shows the composition of U.S. transportation fuel consumption from 1992

to 1996. Table III.2 shows the percentage share of each fuel, by air quality area.

9

In addition, a negligible amount of alcohol fuel is used as a fuel in alternative-fuel vehicles.

10RFG, which is a subset of oxygenated fuel, is gasoline whose composition has been changed (from

that of conventional gasoline sold in 1990) to (1) include combustion-enhancing oxygenates and

(2) reduce emissions of the ozone precursors, volatile organic compounds and nitrogen oxides, and

toxic components. (Toxic components of fuel include benzene, butadiene, and other harmful

substances.)

Page 3 GAO/GGD-97-41 Tax Policy
B-271977 

incentives. Other groups in the economy, such as ethanol producers and

corn farmers, share in the value of the incentives because the blenders’

increased demand for ethanol increases the prices and sales of the

products of these groups.

According to the analysts we contacted or whose work we read, the tax

incentives allow ethanol to be priced to compete with substitute fuels,

such as gasoline and MTBE; thus, without the incentives, ethanol fuel

production would largely discontinue. This information implies that

ethanol producers benefit from the tax incentives because the blenders’

demand for ethanol raises its price at least high enough to cover

production costs. However, we did not estimate how much of the value of

the incentives is shifted to ethanol producers. According to economic

theory, the extent to which the benefits of the tax incentives are shifted

depends on (1) the responsiveness of ethanol supply and demand to price

changes and (2) whether producers control prices and, if so, how much

control they have over prices that they charge. We could not obtain

sufficient information on these factors to quantify the shift in value.

The tax incentives benefit farmers who grow corn and may benefit farmers

who grow crops such as soybeans by increasing the prices that they

receive for these products. According to analysts at the U.S. Department of

Agriculture (USDA) and Congressional Budget Office (CBO), corn farmers

benefit because the tax incentives create a demand for ethanol by the

blenders, which in turn creates a demand for corn by the ethanol

producers. Corn prices and incomes are higher as a result, providing

incentives to farmers to plant corn on idle land and switch other crop

acreage (mainly soybean acreage) into corn production. Soybean farmers

may also benefit because lower soybean production is likely to raise the

price of soybeans. However, by raising the prices of corn and soybeans,

the tax incentives may cause farmers who raise livestock to pay higher

prices for feed. We have not estimated the size of these effects on prices

and income or the net effect on aggregate farm income because recent

changes in government farm policy, which allow more flexibility in

farmers’ planting decisions, have not been in place long enough to provide

information on how farmers respond to price changes under the new

policy. The recent changes in government farm policy may cause farmers’

responses to price changes to differ from historical experience because

farmers’ planting decisions will now be based more on market forces than

on government programs.

Page 4 GAO/GGD-97-41 Tax Policy
B-271977 

The tax incentives may affect producers and consumers of fuels that

substitute for ethanol and the consumers of some food products. The

producers of some fuels, such as gasoline and MTBE, may be adversely

affected because increased competition from ethanol may cause the

producers of these fuels to lower their prices. However, the available

evidence indicates that the decrease in the price of a gallon of fuel is likely

to be small. Furthermore, the price decrease that adversely affects

producers will benefit the consumers of these fuels. Although the

producers receive slightly less revenue from each gallon they sell because

of the price decrease, consumers pay slightly less for each gallon that they

purchase. Similarly, the price increases that benefit farmers may adversely

affect the consumers of some food products. As previously noted, the tax

incentives may benefit farmers by causing the prices of some crops to be

higher, which could mean that consumers would have to pay slightly

higher prices for some food products. Thus, if the prices of some food

products are slightly higher due to the incentives, the benefit to consumers

from slightly lower gasoline prices might be partly offset.

Available evidence, including the views of analysts we interviewed,

indicates that the ethanol tax incentives have had little effect on the

environment. The substitution of other fuels for ethanol, if the tax

incentives were removed, would likely have little effect on air quality given

current technologies for ethanol production. In areas where gasoline

containing oxygenates is mandated to help meet existing air quality

standards, the likely substitute for ethanol would be MTBE. Both ethanol

and MTBE meet existing standards for gasoline containing oxygenates, and

gasoline oxygenated with MTBE already has more than a 50-percent share

of the market for gasoline containing oxygenates in areas where its use is

required.11

In areas that already meet existing air quality standards, ethanol has been

used mainly as a gasoline extender and octane enhancer. According to the

analysts we interviewed, the elimination of ethanol use in these areas

would be expected to result in little reduction in overall air quality.

Because ethanol is difficult to transport, it traditionally has been used

mainly where it is produced, in midwestern corn-farming states. In these

areas, which generally meet existing air quality standards, the likely

substitute for ethanol-blended gasoline would be conventional

11Ethanol also is used as an octane enhancer in gasoline. Refiners have other alternatives than using an

oxygenate to increase the octane level of gasoline. However, in the absence of ethanol, at the current

time, the oxygenate MTBE would likely supply almost the entire market for octane enhancers with no

likely effect on air quality, according to officials at DOE and the Environmental Protection Agency

with whom we spoke.

Page 5 GAO/GGD-97-41 Tax Policy
B-271977 

(unblended) gasoline. According to the best available data, if gasoline

entirely replaced ethanol, gasoline use would likely increase by no more

than 4 percent in the most ethanol-intensive state. According to the

Environmental Protection Agency (EPA), even if ethanol use were

eliminated, these areas would most likely continue to meet national

ambient air quality standards.12 However, according to analysts we

interviewed, if ethanol use were eliminated there would likely be small

changes in emissions in these areas that would have both positive and

negative effects on air quality. A negative effect would likely be slightly

increased carbon monoxide emissions. A positive effect would likely be

slightly decreased emissions of ozone precursors.13

The effect on global environmental quality (i.e., global warming) through

changes in greenhouse gas emissions that would occur if ethanol fuel were

not subsidized is likely to be minimal. The net effect on the quantity and

quality of greenhouse gas emissions from the ethanol fuel cycle versus

from the conventional gasoline fuel cycle is not precisely known.

However, according to the EPA analyst we interviewed, the global-warming

effects of using ethanol are likely to be no better than, and could be worse

than, those of using conventional gasoline. Furthermore, even if current

ethanol use were to contribute to lowered greenhouse gas emissions,

ethanol is such a small part of total U.S. fuel use that global environmental

quality should not be significantly affected if ethanol use were

discontinued.

Although available evidence suggests that the tax incentives for alcohol

fuels increase ethanol fuel use, it also indicates that these incentives do

not significantly reduce petroleum imports. Therefore, the tax incentives

do not significantly contribute to U.S. energy independence. Today’s

petroleum imports account for about 20 percent of the total U.S. energy

consumption and about 50 percent of the U.S. petroleum consumption.

This consumption is about the same as the petroleum imports accounted

for in 1978, before ethanol incentives were offered (see table III.3 in app.

III). By comparison, ethanol currently accounts for less than 1 percent of

U.S. motor vehicle fuel consumption.

In addition, ethanol tax incentives have not significantly enhanced U.S.

energy security. This lack of increased energy security is because the tax

12EPA has developed the national ambient air quality standards based on all of the known health

effects from air pollutants.

13The most commonly used ethanol-gasoline blends release more ozone precursor compounds than

does conventional gasoline. These precursors combine to produce ozone in the presence of sunlight.

Ozone concentrations most often exceed the ozone standard during summer months.

Page 6 GAO/GGD-97-41 Tax Policy
B-271977 

incentives have not created enough usage to reduce the likelihood of oil

price shocks and their consequences, which are increased U.S. fuel prices

and reduced economic output and employment. As we recently reported,

oil consumption, not oil imports, creates vulnerability to oil price shocks.14

 If technological breakthroughs were to occur and the resulting increased

ethanol production lowered oil’s share of total U.S. fuel consumption

significantly, then energy security could be improved. The impact of an

increase in the worldwide price of oil on U.S. fuel prices depends chiefly

(1) on the share of oil in total U.S. fuel consumption and (2) on whether

fuel production from alternative sources could be expanded rapidly in the

event of an oil price shock. However, ethanol currently constitutes less

than 1 percent of the total U.S. fuel consumption and, according to DOE,

cannot be rapidly expanded with existing technologies.

We estimate that the partial exemption for alcohol fuels reduced motor

fuels excise tax revenues by about $7.1 billion from fiscal years 1979 to

1995.15 We estimate that about 108 billion gallons of alcohol fuel mixtures

were sold over that period and that about $7.5 billion of motor fuels excise

tax revenues were collected on the sales of this fuel. Without the partial

exemption, the amount of tax paid on an equivalent gallonage of gasoline

would have been about $14.6 billion. Virtually all of the revenue forgone

due to the exemption is money that otherwise would have been earmarked

for the Highway Trust Fund. In fiscal year 1995, the gross federal highway

user tax receipts for the Highway Trust Fund were $23.1 billion. We

estimate that without the partial exemption for alcohol fuels, an additional

$617 million of revenue would have been allocated to the Highway Trust

Fund for fiscal year 1995.

Objectives, Scope,

and Methodology

To meet our first objective of determining whom the ethanol tax

incentives benefit and disadvantage economically, we relied on economic

theory and the empirical literature to describe the factors that determine

how the reduced demand for ethanol would likely affect (1) the prices of

various goods and (2) the incomes and profits derived from the production

14Energy Security: Evaluating U.S. Vulnerability to Oil Supply Disruptions and Options for Mitigating

Their Effects (GAO/RCED-97-6, Dec. 12, 1996).

15These estimates are based on excise tax data compiled by the Internal Revenue Service and

published data on ethanol fuel production. Unless otherwise noted, all revenue figures presented in

this report are stated in constant 1996 dollars. Appendix II contains a discussion of our estimating

methodology in which we note some reasons why this estimate may slightly overstate the revenue

loss.

Page 7 GAO/GGD-97-41 Tax Policy
B-271977 

of those goods. We used our prior work,16 studies of the ethanol industry,

and estimates of consumer demand for ethanol to provide, where possible,

an indication of the direction and broad magnitude of changes in prices,

incomes, and profits that would likely occur if the incentives were

removed. We did not try to determine who may have paid for the tax

incentives in the form of higher taxes, less federal spending on other

programs, or increased government borrowing. Nor did we look at any

economywide efficiency losses resulting from the resource reallocations

that have been made in response to the tax incentives.

To meet our second objective of determining what, if any, environmental

benefits the incentives have produced, we relied on the empirical

literature on fuel characteristics and emissions and air quality and also on

interviews with energy and air quality analysts. Our major sources of

information were DOE and EPA. We relied on fuel usage data and on expert

opinion from DOE, EPA, and the U.S. Department of Transportation to

determine what percentage of total fuel consumption ethanol represents

and what fuels would likely have been used in place of ethanol if tax

incentives had not existed. We used these sources to describe the

differences in vehicle emissions with and without ethanol fuels and the

likely effects of these differences on environmental quality.

To meet our third objective of determining whether the incentives have

increased the nation’s energy independence, we examined DOE data on

U.S. energy consumption and petroleum imports to determine if the

incentives had reduced U.S. reliance on imported petroleum. Concern over

this reliance had been one of the reasons Congress originally adopted the

incentives. We also relied on the energy economics literature, including

work by DOE and Resources for the Future, and on data on fuel supply and

fuel prices, mainly by DOE, to determine if U.S. vulnerability to oil price

shocks were likely to be different if tax incentives for ethanol use had not

existed.

To meet our fourth objective of determining to what extent the partial

exemption from the excise tax for alcohol fuel reduced the flow of

revenue into the Highway Trust Fund, we used Internal Revenue Service

(IRS) excise tax data and published data on alcohol fuel production to

estimate the amounts of excise tax exemptions that have been claimed for

alcohol fuels for fiscal years 1979 to 1995. We also compiled estimates

made by the Department of the Treasury and the Joint Committee on

16GAO/RCED-97-6; Motor Fuels: Issues Related to Reformulated Gasoline, Oxygenated Fuels, and

Biofuels (GAO/RCED-96-121, June 27, 1996); and Ethanol Tax Exemption (GAO/RCED-95-273R, Sept.

14, 1995).

Page 8 GAO/GGD-97-41 Tax Policy
B-271977 

Taxation of the projected future revenue costs of both the partial excise

tax exemptions for alcohol fuels and the alcohol fuels tax credits. We

restated all of these estimates in terms of constant 1996 dollars. We spoke

with analysts from Treasury and CBO to ensure that we correctly

characterized the estimates presented in this report.

We conducted our review from March 1996 through November 1996 in

accordance with generally accepted government auditing standards. We

obtained written comments on a draft of this report from IRS and EPA, oral

comments from Treasury and DOE, and both written and oral comments

from USDA. Treasury’s oral comments were provided by the Director of the

Office of Tax Analysis and by economists from that office and from a tax

legislative counsel at a meeting on November 22, 1996. USDA’s oral

comments were provided by the Deputy Director, Office of Energy and

New Uses, Economic Research Service, and by policy analysts from that

office and the Office of the Chief Economist at a meeting on November 21,

1996. DOE’s oral comments were provided by policy analysts from the

Offices of Energy Efficiency, Alternative Fuels, and Oil Policy; Fuels

Development; and Technology Utilization on November 20, 1996. The

written and oral comments are summarized and discussed at the end of

this report.

The Ethanol Tax

Incentives May

Benefit or

Disadvantage Certain

Groups in the

Economy

The groups that are legally required to pay a tax do not always enjoy the

entire benefit of a tax incentive. The alcohol fuels tax incentives affect

prices and incomes of other groups in the economy because they lower

the after-tax cost of using ethanol, thereby increasing the demand for

ethanol and causing changes in the price and production level of ethanol,

as well as changes in the price and production level of other products.

Some groups that do not claim the tax incentives would benefit if they

paid lower prices or received higher incomes because of the tax

incentives, while other groups would be adversely affected if they paid

higher prices and received lower incomes. The positive and negative

impacts of the tax incentives are shifted among groups in the economy

through these price and income changes.

Although the tax incentives lower the after-tax cost of gasoline to ethanol

blenders, the blenders do not enjoy the full benefit of the tax incentives.

The analysts that we contacted, or whose work we read, agreed that the

blenders’ demand for ethanol raises the price of ethanol above what it

would have been without the incentives, and that this price increase

offsets part of the benefit that the blenders receive from the tax reduction.

Page 9 GAO/GGD-97-41 Tax Policy
B-271977 

As explained in the following sections of this report, the available data

indicate that the incentives are shifted, in part, back to the ethanol

producers as higher ethanol prices and back to farmers as higher corn

prices. The incentives may also be shifted forward to consumers because

an increase in the supply of ethanol-blended gasoline is likely to cause a

small decrease in the price that consumers paid for motor fuels.

Ethanol Tax Incentives

Benefit Ethanol Producers

Without the tax incentives, ethanol-blended gasoline currently cannot be

priced to compete with the substitute fuels, and ethanol fuel production

would largely discontinue. The ethanol producers benefit because the

incentives create a demand for ethanol by the blenders that raises the

price of ethanol at least high enough to cover production costs. This

conclusion is based on recent estimates of ethanol production costs by

USDA and on the opinions of analysts on the ethanol industry. This

conclusion is also based on the results from simulation models of DOE’s

Energy Information Administration (EIA) that estimate the effect of

removing the ethanol tax incentives.17

The incentives permit ethanol blends to be priced competitively with

substitute fuels, such as gasoline and MTBE, even though the cost of

producing ethanol with the current technology and corn prices exceeds

the prices of these fuels. Because the incentives generally are equivalent to

54 cents per gallon of ethanol, the effective, or after-tax, price to the

ethanol blenders is 54 cents per gallon less than the price charged by the

ethanol producers. The ethanol producers can charge a price high enough

to cover their costs, while blenders buy ethanol at an effective price that is

competitive with substitute fuels.

If the ethanol tax incentives were eliminated, the effective cost of ethanol

to the blenders would increase because they would not get a tax benefit

from using the fuel. In this case, the blenders would be expected to

purchase less expensive substitute products. As the blenders demand less

ethanol, the price that ethanol producers can charge would decrease. If

the price declined below production costs, some ethanol producers would

likely stop producing ethanol. The large-scale ethanol producers with the

lowest production costs might continue to produce ethanol over the short

term, but, over the long term, the ethanol-fuel industry would largely

discontinue. Some ethanol production for export might continue for a

while without the federal tax incentives.

17See appendix IV for further discussion of the effect of the incentives on the ethanol industry.

Page 10 GAO/GGD-97-41 Tax Policy
B-271977 

We were unable to estimate the size of the benefit that ethanol producers

receive. We could not make this estimate because we did not have

information (1) on the responsiveness of ethanol supply and demand to

price changes or (2) on whether ethanol producers control their prices,

and, if so, how much control they have over their prices. The ethanol

industry is dominated by a few large firms. Sixty-five percent of capacity is

owned by the three largest firms, and the largest firm, Archer Daniels

Midland, owns 50 percent of capacity. We did not have information on

how prices are determined in an industry with this level of concentration.

Consequently, we could not estimate how much of the value of the

incentives is shifted from the blenders to the producers. We also did not

have information on economies of scale or technological, managerial, or

marketing advantages that individual ethanol producers may possess.

Without any of this information, we did not know the extent, if any, to

which the prices these producers were able to charge exceeded their

production costs.

Ethanol Tax Incentives Are

Likely to Benefit Farmers

Who Grow Corn and

Soybeans

The tax incentives benefit farmers who grow corn and likely benefit

farmers who produce other crops, such as soybeans, by increasing the

prices that they receive for these products. Conversely, the tax benefits

may cause farmers who raise livestock to pay higher feed prices. The new

farm policy, established in the Federal Agricultural Improvement and

Reform (FAIR) Act of 1996, has not been in effect long enough to provide

the information needed to make reliable quantitative estimates of the size

of the tax incentives’ effect on farm prices and income.

Corn farmers benefit from the tax incentives, according to analysts at USDA

and CBO, because the tax incentives create a demand for corn by ethanol

producers that raises the price of corn and the income derived from corn

sales. In 1995, the industry used approximately 500 million bushels of corn

to produce 1.3 billion gallons of ethanol. This usage represented about

6 percent of the total corn crop. Soybean farmers also likely benefit

because the higher corn prices due to the incentives make growing corn

more attractive than it would have been without the incentives, thereby

reducing the acreage planted with soybeans, which is likely to raise

soybean prices. However, livestock farmers may be adversely affected by

the incentives because the higher corn and soybean prices may increase

the cost of feeding their livestock.

In 1995, before the significant changes in farm policy introduced by the

FAIR Act, we estimated, using various assumptions about ethanol use and

Page 11 GAO/GGD-97-41 Tax Policy
B-271977 

how the old farm policy would be implemented, that corn prices would

decline by 6 to 9 percent and soybean prices by 3 to 5 percent if the

incentives were removed.18 We also estimated that net farm income, which

combines the effect on crop and livestock farmers, would decline by 1 to

2 percent under the old policy.19 The size of these price declines and the

effect on net income is likely to be different under the FAIR Act. We have

not estimated the effect of the tax incentives on farm income and prices

because the FAIR Act has not been in place long enough to provide the

information on how farmers respond to prices under the new policy. This

information would be needed to make reliable estimates.

The FAIR Act affects (1) farm incomes by removing the link between

income support payments and farm prices and (2) farm prices by giving

farmers greater flexibility in making planting decisions. Before the FAIR

Act, farmers received payments that depended on farm prices. That is, as

prices dropped below a legislated level, farm payments increased. In

addition, farmers were required to plant corn if they wanted to participate

fully in the federal corn program. Under the FAIR Act, farmers receive

annual, fixed but declining, payments regardless of farm prices. The FAIR

Act gives farmers greater flexibility to make planting decisions because

the act eliminates the requirement that farmers must plant corn to qualify

for full payments under the federal corn program. The remaining farm

program linked to prices under the FAIR Act is a program of government

loans that may moderate the decline in farm incomes if market price

declines are severe.

If the tax incentives were removed under the FAIR Act, corn prices would

fall. However, the effect of removing the tax incentives on the size of the

price decline may differ from the effect under the old farm policy. The

increased planting flexibility under the FAIR Act makes it difficult to

predict the size of the price decline. In addition, under the FAIR Act, farm

support payments cannot increase in response to price declines to mitigate

the effect on farm incomes. If the price falls far enough, farmers may

offset some of the effect of the price decline through government loans.

However, USDA believes that the price of corn is unlikely to fall far enough

for the loans to be used to mitigate the effect of the price decline on farm

incomes. USDA projects no outlays under the loan program in its current

long-term budget projections.

18GAO/RCED-95-273R. We noted in this report that our assumptions about how farm policy would be

implemented did not include the full range of policy alternatives that were available at that time. Under

some of these alternatives, the decline in corn and soybean prices may have been smaller.

19See appendix IV for a description of how prices and incomes were estimated under the old farm

policy.

Page 12 GAO/GGD-97-41 Tax Policy
B-271977 

Ethanol Tax Incentives

May Benefit Consumers

and Disadvantage

Producers of Substitute

Fuels

The tax incentives may benefit consumers of substitute fuels, such as

gasoline and MTBE, and disadvantage producers of these fuels because the

incentives increase the production of ethanol, which may cause a small

decrease in the price of a gallon of the substitute fuels. This benefit to

consumers from lower fuel costs may be partially offset by small increases

in the prices of some food products due to the incentives.

If there were no tax incentives for ethanol, the fuel would no longer be

used and other fuels would be used as substitutes. According to analysts at

DOE, the oxygenate MTBE is likely to serve as a substitute for ethanol that is

used as an oxygenate—i.e., mixed with gasoline to help meet air quality

standards. According to these analysts, MTBE also may substitute for

ethanol used as an octane enhancer in gasoline.20 For ethanol that is used

as a gasoline extender, the analysts said that more gasoline and less

ethanol are likely to be used21

The effect of the tax incentives on the price of a gallon of MTBE is likely to

be small. We have not estimated this effect, but the available evidence

suggests that, if the incentives were removed, the increased demand for

MTBE would cause only a slight increase in price. EIA estimates that, over

the long term, removing the tax incentives would increase the difference

in price between RFG, which would be made only with MTBE, and

conventional gasoline by about 1 cent per gallon.

The effect of the tax incentives on the price of a gallon of gasoline also is

likely to be small. Because most consumers consider ethanol blends close

substitutes for gasoline, removing tax incentives would increase demand

for gasoline by causing consumers to switch from ethanol blends to

gasoline. Since ethanol currently makes up less than 1 percent of the total

U.S. motor fuel consumption, removing the ethanol tax incentives is

unlikely to have a large impact on prices. In 1988, the American Petroleum

Institute estimated that the tax incentives for ethanol reduced the price of

conventional gasoline by 0.27 percent.

The benefit to consumers from lower gasoline prices could be offset by

any higher food prices due to the incentives. As previously discussed, the

tax incentives may cause the prices of certain crops to be higher, which

20However, refiners have alternatives other than the addition of an oxygenate to increase the octane

level of gasoline. The route chosen by each refiner will depend on the most cost-effective option that

fits with their refinery’s specific configuration, product slate, environmental requirements, and

numerous other variables.

21Table III.3 in appendix III shows the amounts of gasoline, MTBE, and ethanol that are consumed

within and outside of air quality nonattainment areas.

Page 13 GAO/GGD-97-41 Tax Policy
B-271977 

could lead to slightly higher prices to consumers for some food products.

However, the effect on food prices is likely to be small. For example, the

increased price that farmers receive for their corn may represent a much

smaller price increase for consumers because, in many cases, the corn is

only a part of the product purchased by the consumer and the farmer’s

price is only a part of the product’s retail cost to the consumer.

Furthermore, the effect of the increased corn price on the consumer’s total

food costs is likely to be small because spending on corn and products

derived from corn represents only a part of the consumer’s food budget.

Tax Incentives for

Ethanol Fuel Are

Likely to Have Had

Little Effect on

Environmental

Quality

The tax incentives for biomass alcohol fuels are likely to have had little

effect on the environment. If there were no tax incentives for these fuels,

the price of ethanol would be higher compared with substitute fuels.

Analysts we contacted or whose work we read believe little, if any, ethanol

fuel would likely be used in the United States without these incentives. As

previously mentioned, the fuels that would likely replace ethanol differ

according to which ethanol use one is considering. Replacing ethanol with

other fuels would result in differences in the emissions from fuel

production, combustion, and evaporation. However, on the basis of our

analysis of the data as well as on discussions with analysts at DOE and EPA,

it seems that, with current technologies, there would likely be only slight

changes in emissions. Consequently, little change in air quality or global

environmental quality would be expected.

The net emissions changes from replacing ethanol with other fuels are

likely to be small for several reasons provided us by environmental and

energy analysts. These reasons are that (1) ethanol represents only a small

portion of the total fuel used; (2) the production of ethanol creates

emissions that are not much less polluting than those created by the

production of other oxygenates; (3) likely ethanol substitutes such as MTBE

are as clean-burning as ethanol; and (4) in certain areas of the United

States at certain times of the year, ethanol has greater emissions than

conventional gasoline because of its higher volatility.

No Effect Likely Where

Gasoline Containing

Oxygenates Is Required

Because tax incentives are only likely to cause substitution among equally

clean fuels in areas where the use of gasoline containing oxygenates is

mandated, it is unlikely that eliminating the tax incentives would affect air

quality in these locations. In areas that do not meet existing air quality

standards for the pollutants associated with transportation fuels, the use

of gasoline containing oxygenates is required during part or all of the year.

Page 14 GAO/GGD-97-41 Tax Policy
B-271977 

Because the use of clean-burning fuel is mandated in these areas, without

the ethanol incentives, the next cheapest clean-burning fuel, most likely

MTBE, would have been used instead of ethanol. In 1995, in areas where the

use of gasoline containing oxygenates was required, gasoline oxygenated

with MTBE, which does not receive tax incentives, had more than a

50-percent share of the market for gasoline containing oxygenates.

Because they have similar effects on air quality—they both meet existing

standards for clean fuels—little change in the composition of emissions

and no change in overall air quality in these locations would be expected

from a substitution between ethanol and MTBE.

Little Effect Likely Where

Gasoline Containing

Oxygenates Is Not

Required

If eliminating the tax incentives for ethanol fuel caused its replacement by

gasoline in the areas where the use of gasoline containing oxygenates is

not required, there likely would be little effect on air quality. According to

the best available estimate, if ethanol were entirely replaced with gasoline,

the average increase in gasoline use would be about 0.5 percent in these

areas. In the state with the greatest percentage increase, gasoline use

would increase by less than 4 percent.

As previously noted, ethanol traditionally has been used in midwestern

corn-producing states, where it is produced for use as a gasoline extender

and octane enhancer. These areas generally meet existing air quality

standards for the pollutants associated with transportation fuels, and the

use of gasoline containing oxygenates is not required. Because there

generally is no mandate to use a clean-burning fuel in these areas, analysts

believe that if there were no tax incentives, ethanol’s use as a gasoline

extender would disappear. Consumers would then use the next cheapest

fuel, which would most likely be conventional gasoline. Ethanol’s use as

an octane enhancer also would likely disappear if there were no tax

incentives and substitute octane enhancers would be used, mainly MTBE.

22

According to DOE, conventional gasoline generally has more carbon

monoxide and toxic components emissions than ethanol-blended gasoline.

Therefore, switching from using an ethanol blend to using conventional

22Ethanol’s disappearance as a gasoline octane enhancer may lead to the increased use of

methylcyclopentadienyl manganese tricarbonyl (MMT) as a substitute. EPA has found the use of MMT

to be a cause for concern because of possible adverse effects on human health. However, even if MMT

were to entirely replace ethanol as an octane enhancer, the growth in MMT use would likely not be

large for these reasons. First, MMT cannot be used in reformulated gasoline. Second, even in states

where reformulated gasoline use is not required, MMT use would be limited to its role as an octane

enhancer. If MMT were to entirely replace ethanol in these states, its share in total fuel use would not

be large. As previously noted, in the most ethanol-intensive state, ethanol currently represents only

4 percent of all gasoline plus gasoline blended with ethanol fuel used.

Page 15 GAO/GGD-97-41 Tax Policy
B-271977 

gasoline would likely increase these emissions. However, environmental

analysts believe air quality would be unlikely to decline to the point that

these areas would not meet existing air quality standards for these

pollutants. The areas in which ethanol traditionally has been sold as a

gasoline extender generally are not areas where gasoline containing

oxygenates is required. In these areas, motor vehicle emissions are not

concentrated enough to create air quality problems. Furthermore, under

certain conditions,23 ethanol-blended fuel has a higher volatility than

conventional gasoline and its use releases more ozone-precursor

compounds than the use of conventional gasoline.24 In these

circumstances, switching from an ethanol blend to conventional gasoline

would be expected to decrease emissions of volatile organic compounds.25

No Significant Effect

Likely Through the Use of

Alternative-Fuel Vehicles

Eliminating the use of ethanol in alternative-fuel vehicles would likely not

significantly affect air quality because, to date, ethanol has been little-used

as an alternative fuel. In 1995, the share of total alternative fuel

(gasoline-equivalent gallons of fuel used in alternative-fuel vehicles)

represented by ethanol was less than 0.08 percent. EIA has projected that

ethanol used in alternative-fuel vehicles will account for only 0.28 percent

of the total transportation fuel market by 2015.

The number of alternative-fuel motor vehicles, particularly those fueled by

ethanol, is small and expected to remain so, even if tax incentives for

ethanol remain in place. In 1995, fewer than 1,000 alternative-fuel vehicles

were fueled by neat ethanol. Fuel used in these special vehicles

represented only 0.0002 percent of the total transportation fuel

consumption and only 0.02 percent of the total ethanol fuel consumption.

Energy analysts expect ethanol’s use as an alternative motor fuel to

increase. However, even with anticipated improvements in technology

during the next two decades and retention of the tax incentives, EIA

projects that ethanol use in alternative-fuel vehicles will represent a

negligible amount of the total fuel used.

23When ethanol is simply blended with gasoline in a 10-percent, 90-percent ratio rather than used as an

ingredient in specially reformulated gasohol or used as a gasoline alternative in 85- to 100-percent

ethanol-gasoline blends, the resulting blend can have higher volatility than conventional gasoline under

conditions of high ambient air temperature, such as in the summer.

24For example, ethanol-blended fuel does not meet the stringent summertime fuel volatility restrictions

in ozone nonattainment areas without adjustments to the gasoline fraction.

25However, some ethanol-producing states have suggested that ethanol’s higher volatility is offset by its

lower reactivity with sunlight in producing ozone, compared with conventional gasoline. Currently, the

National Academy of Sciences is studying this issue at EPA’s request.

Page 16 GAO/GGD-97-41 Tax Policy
B-271977 

No Significant Effect Is

Likely on Global

Environmental Quality

The production, evaporation, and combustion of different fuels produce

different levels and types of greenhouse gas emissions, depending on

whether the fuels are derived from biomass or from fossil fuel materials.26

On the basis of a review of the scientific literature and discussions with

EPA and other energy and environmental analysts, we conclude that

ethanol fuel use likely has had no significant net effect on greenhouse gas

emissions or on global environmental quality. According to the EPA analyst

we interviewed, the net effect on greenhouse gas emissions from the

corn-based ethanol fuel cycle is such that the possible global-warming

effects of using ethanol are likely no better than those of conventional

gasoline.27 Moreover, even if ethanol did reduce greenhouse gas emissions,

relative to gasoline, ethanol is such a small part of worldwide fuel use that

global environmental quality is not likely to be significantly affected.

The EPA analyst’s assessment is based on inferences from studies

comparing the net energy use and, in some cases, the greenhouse gas

emissions of different fuels. The exact net effect on the quantity of

greenhouse gases from using ethanol made with current corn-based

technologies instead of conventional gasoline is difficult to determine, and

we are not aware of any direct estimate of this net effect. In addition, the

results of the studies that provide indirect evidence are sensitive to

assumptions made by the researchers. The EPA analyst also noted that the

greenhouse gases emitted during the ethanol fuel cycle have so much

greater global-warming potential than those emitted during the

conventional gasoline fuel cycle that the global-warming picture may be

worsened by using ethanol. The greenhouse gases released during the

ethanol fuel cycle contain relatively more nitrous oxide and other potent

greenhouse gases. In contrast, the greenhouse gases released during the

conventional gasoline fuel cycle contain relatively more of the less potent

type, namely, carbon dioxide.

26For example, when a fossil fuel such as gasoline is burned, the greenhouse gases that would have lain

buried in oil fields are released into the atmosphere, possibly contributing to global warming. In

contrast, when a fuel derived from biomass is burned, only the greenhouse gases that were taken up by

the plant material as it grew are released—the emissions from combustion, net of the carbon dioxide

absorbed during growing, are zero. Of course, some greenhouse gases are released during the

production of both the fossil fuel and the biomass-derived fuel. However, in contrast to the fossil fuel,

if the biomass fuel had no production emissions, the effect of its use on greenhouse gases would be

zero.

27To completely evaluate the emission effects of alternative transportation technologies, one must

consider emissions and energy use from upstream fuel production processes as well as from vehicle

operations. This “full fuel cycle” approach is especially important when comparing technologies that

employ fuels with distinctly different primary energy sources and fuel production processes—such as

corn-based ethanol and conventional gasoline—for which upstream emissions and energy use are

significantly different. In the case of corn-based ethanol, one must also assume the share of emissions

from ethanol plants and upstream corn production that will be allocated to ethanol’s byproducts.

Page 17 GAO/GGD-97-41 Tax Policy
B-271977 

EPA has not yet evaluated the most recent DOE study of ethanol’s

greenhouse gas emissions.28 USDA infers from this new study that replacing

corn-based ethanol fuel with gasoline would increase the quantity of

greenhouse gases emitted over the entire fuel cycle. However, the study

focused on the net greenhouse gas effect of using neat and near-neat

ethanol (in alternative-fuel vehicles) in place of gasoline oxygenated with

MTBE. The study did not estimate the net greenhouse gas effect of

eliminating the ethanol in use today, which is almost always ethanol and

gasoline mixtures that are mainly gasoline and are used in conventional

vehicles. Furthermore, because of the different assumptions made by

modelers regarding upstream energy conversion efficiencies, technology

pathways, emission control intensities, and vehicular emissions, different

studies of the same technology may generate significantly different

emissions results.

If sufficient breakthroughs in the technologies used to make ethanol from

biomass other than corn were to occur, then the use of ethanol instead of

fossil fuels possibly could cause a net reduction in greenhouse gas

emissions.29 DOE believes that, if the technological breakthroughs in

ethanol production over the next 20 years were significant enough, ethanol

produced from cellulosic biomass feedstocks could conceivably achieve a

market share of 10 to 15 percent of all U.S. transportation fuel.30 In that

event, the environmental benefits could far exceed those of the current

corn ethanol industry. However, neither EIA, nor anyone else to our

knowledge, has forecasted future levels of production of ethanol from

cellulosic biomass.

28M. Q. Wang, GREET 1.0 — Transportation Fuel Cycles Model: Methodology and Use, Argonne

National Laboratory, U.S. Department of Energy, ANL/ESD-33, June 1996.

29Ethanol can be derived from plant materials other than corn, such as wood, wood and other crop

waste, weeds, and municipal solid waste. Because crop and municipal waste have very low-valued

alternative uses compared with the alternative uses for corn, ethanol from these materials is expected

to be considerably cheaper to produce than corn-based ethanol, when (and if) manufacturing

breakthroughs occur.

30The constraints of engine- and fueling-system design limit the use of ethanol in conventional motor

vehicles to no more than about 15 percent of the total fuel used.

Page 18 GAO/GGD-97-41 Tax Policy
B-271977 

Tax Incentives for

Ethanol Fuel Are

Unlikely to Have

Significantly Affected

U.S. Energy

Independence or

Energy Security

Tax incentives for alcohol fuels are unlikely to have significantly increased

U.S. energy independence because, despite the tax incentives, ethanol use

has not significantly reduced the United States’ reliance on imported

energy. Nor is it likely that ethanol tax incentives have significantly

lessened U.S. susceptibility to oil price shocks. Vulnerability to oil price

shocks depends on the nation’s level of oil consumption as a proportion of

total fuel consumed, on the oil dependence of the transportation sector,

and on the difficulty of substituting other fuels for oil in case of a crisis.

Many energy analysts believe that the percentage of the nation’s oil that is

imported is not a major cause of vulnerability to oil price shocks. The

alcohol-fuel tax incentives could only have been successful at enhancing

energy security if they had decreased oil’s proportion of total fuel

consumed or if the tax incentives had caused the supply of ethanol fuel to

be capable of rapid expansion in case of a crisis. According to DOE, it is

possible that with continuing tax subsidies for ethanol, future

technological breakthroughs may permit ethanol production at costs so

low that ethanol use would become more widespread.

Despite the tax incentives available since the late 1970s for ethanol, which

is produced almost entirely from domestically grown corn, U.S. fuel

imports as a percent of total energy consumption have not declined.

Imports today account for about 20 percent of the total U.S. energy

consumption, and about 48 percent of the oil consumption. In contrast,

ethanol31 currently accounts for less than 1 percent of U.S. motor vehicle

fuel consumption. Oil imports account for the same share of domestic

energy consumption that the imports did in 1978, before the ethanol fuel

tax incentives were implemented.32 EIA projections indicate that oil

imports, as a percentage of U.S. consumption, will continue to rise through

2015,33 even if the ethanol tax incentives remain in place.

In addition, tax incentives for alcohol fuel use have not been a factor in

deterring or moderating potential price shocks in the energy sector. For

this reason, the tax incentives do not increase the United States’ energy

31This includes the ethanol used in gasoline blends as well as the ethanol used to make the gasoline

oxygenate, ethyl tertiary butyl ether (ETBE). ETBE is an ether produced from ethanol and used in

making oxygenated gasoline.

32Appendix I contains more details about the events and legislation that have encouraged ethanol fuel

use.

33Oil imports are projected to grow through 2015 in EIA’s reference case, as well as under most of the

alternative scenarios that they model. (EIA’s reference case represents the midlevel of EIA’s

alternative assumptions about the growth of the domestic economy and world oil market conditions.)

However, under the special case assumption of more rapid technology improvement, projected oil

imports begin to decline after 2005.

Page 19 GAO/GGD-97-41 Tax Policy
B-271977 

security. As we recently reported,34 vulnerability to oil price shocks

depends on the nation’s level of oil consumption, including the oil

dependence of the transportation sector. The economic effects of oil price

disruptions are largely the same, regardless of the level of oil imports. The

rapid oil price increases of 1973 and 1979 disturbed U.S. economic stability

because there were (and are) few good substitutes for oil. Following these

crises, legislation encouraging alcohol fuel use was enacted in part to

diversify the sources of fuel beyond the consumption of petroleum to

guard against the potential impact of future shocks.

The greater the share of nonpetroleum-based fuels in total U.S. fuel

consumption, the smaller would be the impact of any oil price increase. To

the extent that ethanol is substituted for petroleum-based fuels, it can

mitigate the effects of any oil supply disruption or rapid increase in oil

prices, which could threaten U.S. economic stability. However, ethanol

currently comprises less than 1 percent of total U.S. fuel consumption and,

according to EIA projections, even if tax incentives for ethanol remain in

place, will still comprise less than 1 percent in 2015. Therefore, ethanol

use would not significantly mitigate the effects of oil price increases.

Alternatively, if ethanol’s supply were capable of rapid expansion, it could

mitigate the effects of any oil supply disruption or rapid increase in oil

prices. However, given existing technologies of production, the U.S.

ethanol-fuel supply cannot be greatly and cheaply expanded whenever

necessary. If a sufficient future breakthrough were to occur in the

technology used to make ethanol from biomass other than corn, then

ethanol/gasoline blends could become more widely used.

The Partial

Exemption Reduced

Highway Trust Fund

Revenues From Fiscal

Years 1979 to 1995

We estimated that the partial exemption for alcohol fuels reduced motor

fuels excise tax revenues by about $7.1 billion from fiscal years 1979 to

1995 (see table II.2 in app. II).35 We also estimated that about 108 billion

gallons of alcohol-fuel mixtures were sold over that same period and that

about $7.5 billion of motor fuels excise tax revenues were collected on the

sales of this fuel. The amount of tax that would have been paid on an

equivalent gallonage of gasoline is about $14.6 billion. In 1995, Treasury

projected that the partial exemption for alcohol fuels would reduce excise

tax receipts by $3.3 billion from fiscal years 1996 to 2000 (see table II.3 in

app. II).

34GAO/RCED-97-6.

35Unless otherwise noted, all revenue figures presented in this report are stated in constant 1996

dollars.

Page 20 GAO/GGD-97-41 Tax Policy
B-271977 

Virtually all of the motor fuels excise tax revenue that has been forgone

due to the partial exemption would otherwise have been earmarked for

the Highway Trust Fund. Only a negligible amount of that forgone revenue

would have been earmarked for the Leaking Underground Storage Tanks

Trust Fund. In 1995, the gross federal highway user tax receipts for the

Highway Trust Fund were $23.1 billion.36 We estimated that, without the

partial exemption for alcohol fuels, an additional $617 million of revenue

would have been allocated to the fund for fiscal year 1995.

The income tax credits for alcohol, alcohol mixtures, and small ethanol

producers are offset against the Treasury’s General Fund and, therefore,

do not affect the amount of revenue allocated to the Highway Trust Fund.

Past estimates by Treasury indicate that these tax credits have reduced

general fund revenues by less than $0.2 billion from fiscal year 1981, when

the credits were first introduced, to fiscal year 1995. Although both the

partial exemption and the income tax credit for alcohol mixtures provide a

subsidy of 54 cents per gallon of alcohol blended as a fuel, there are

several reasons why the exemption may be preferable to taxpayers. First,

the benefit of the exemption can be realized immediately, while the benefit

of the credit is realized no earlier than when the taxpayer files a quarterly

estimated income tax return.37 Second, a blender must have a positive

precredit income tax liability to use the credit. Third, the benefit of the

income tax credits can be constrained by the general business tax credit

limitation and by the alternative minimum tax.38 Treasury projects that

about $50 million of alcohol fuels tax credits will be claimed against the

income tax from fiscal years 1996 to 2000.

The net effect that the partial excise tax exemption has had on total

federal revenues may be less than the $7.1 billion previously cited because

the excise tax exemption may increase the amount of real income that is

subject to the federal income tax. By convention, when the Joint

Committee estimates the amount of revenue that is attributable to an

excise tax, it reduces the estimated gross revenue gain from the tax by 25

percent to account for offsetting declines in income tax revenue.39

36This amount includes receipts from excise taxes on highway motor fuels, vehicles, and tires.

37Credits for overpayments of excise taxes are distinct from the income tax credit. See appendix II for

details.

38The general business tax credit is the combination of the alcohol fuels credits and 11 other tax

credits. The amount of general business credit that a taxpayer may claim cannot exceed the taxpayer’s

net regular income tax liability minus the greater of (1) the taxpayer’s tentative alternative minimum

tax liability or (2) 25 percent of the net regular tax liability above $25,000.

39See appendix II for the rationale behind this 25-percent offset.

Page 21 GAO/GGD-97-41 Tax Policy
B-271977 

Conversely, when the Joint Committee estimates the amount of revenue

forgone due to an excise tax exemption, it reduces the gross revenue

forgone by 25 percent to account for offsetting increases in income tax

revenue. The Joint Committee projected that the net revenue cost of the

partial exemption will be $2.6 billion from fiscal years 1996 to 2000.

Agency Comments

and Our Evaluation

At our request, officials representing the heads of the Department of

Energy, the Department of Agriculture, the Environmental Protection

Agency, the Department of the Treasury, and the Internal Revenue Service

provided comments on a draft of this report. Generally, their concerns

centered on (1) the benefits and costs of the tax incentives, (2) the

potential future benefits from an expanded ethanol industry, (3) the

short-term economic effects of eliminating the incentives, (4) the effects of

unstable government subsidy policies, (5) oxygenate security, (6) the

energy balance40 of ethanol compared with other fuels, and (7) the effect

of the incentives on federal outlays. The following is a summary of the

agencies’ principal comments, accompanied by our responses.

Benefits and Costs of the

Tax Incentives

Both USDA and DOE officials expressed concern that the draft report would

be viewed by some readers as an assessment of the costs and benefits of

the ethanol tax incentives. In their view, the draft report did not provide a

balanced cost-benefit analysis because it quantified the excise tax revenue

loss due to the incentives but did not quantify the benefits received by

farmers, consumers, and others. The USDA and DOE officials were

concerned that readers would think that the benefits of the tax incentives

are small relative to their cost because the draft report described the

benefits that various groups receive in terms of small percentage changes

in prices or incomes. For example, the draft report suggested that the

effect of the tax incentives on gasoline consumers is likely to be small

because the incentives lower the price of a gallon of gasoline by an

estimated 0.27 percent. Both USDA and DOE officials pointed out that this

price decline, when multiplied by total gallons of gasoline consumed,

represents a yearly saving of over $200 million in consumer spending on

gasoline. USDA officials also commented that a balanced presentation of

the costs and benefits of the tax incentives for ethanol would include a

discussion of the tax benefits provided to petroleum and other energy

industries.

40The energy balance of ethanol compares its energy contribution as a motor fuel component with the

net energy consumed in the production of ethanol, including the energy consumed in the production of

feedstocks.

Page 22 GAO/GGD-97-41 Tax Policy
B-271977 

Our response to the agencies’ comments involves several parts. First, we

agree that our report should not be viewed as an overall cost-benefit

analysis of the incentives. It was not intended to provide such an analysis,

and we have added statements to this report clarifying this point.

Second, we did not make dollar estimates of the benefits and costs to

particular groups because, in most cases, we did not have sufficient

information to make reliable estimates.41 Moreover, if we had quantified

the benefits to various groups, as USDA and DOE officials suggested, it

would not be appropriate to include either those estimates or our revenue

cost estimate in a cost-benefit analysis of the tax incentives. Inclusion

would not have been appropriate because benefits to specific groups in

society do not represent a net benefit to society. A benefit to one

group—higher incomes for farmers—is typically a cost to another

group—higher prices for consumers of certain foods. Similarly, the tax

revenue forgone due to the incentives does not represent a net cost to

society; it is a transfer from one group to another.

Third, in preparing an overall cost and benefit analysis, the real benefits of

a government program should be measured in terms of the extent to which

the program expands the total production potential of society.42 Similarly,

the cost of a program should be measured in terms of the lost opportunity

to increase production under an alternative allocation of resources. A

program would have a net benefit if it leads to a resource allocation that

increases production and consumption above what they would have been

under the best alternative resource allocation.

Fourth, sufficient information for completing a reliable, overall

cost-benefit analysis of the tax incentives is not available at this time. For

example, given the uncertainties regarding how farmers would respond to

a decline in the demand for corn under the new farm policy, we would be

unable to determine how the allocation of resources without the

incentives would differ from the current allocation of resources.

Finally, regarding the USDA and DOE officials’ point about the benefits

provided to petroleum and other energy industries, we agree that a proper

cost-benefit analysis of the alcohol fuels tax incentives should take

41We presented a dollar estimate of the excise tax revenues forgone because the requester is interested

in the effect that the incentives have had on the amount of revenue available to the Highway Trust

Fund. We did not present the estimate as part of a cost-benefit comparison.

42Total production includes the production of intangibles, such as energy security, and improvements

in environmental quality.

Page 23 GAO/GGD-97-41 Tax Policy
B-271977 

account of pre-existing distortions in resource allocation, such as those

caused by other tax provisions.

Potential Future Benefits

From Cellulosic Biomass

Ethanol

USDA and DOE officials also said that a balanced assessment of the tax

incentives requires consideration of (1) the potential economic and

environmental benefits of the much larger and cost-effective ethanol

industry, based on cellulosic biomass, that may emerge in the future and

(2) the role the existing ethanol industry would play as a launching

platform for this new technology. They said that our draft report did not

discuss these potential benefits. Representatives of both departments said

that government incentives would play an important role in the future

development of the ethanol industry. The officials expressed the opinion

that, if ethanol use can be increased significantly over time by using new

technologies and biomass feedstocks other than corn, then fossil energy

use and emissions of greenhouse gases, ozone, and particulates could be

reduced substantially. USDA officials pointed out that U.S. energy security

would be enhanced if the nation could reduce its heavy reliance on a

single transportation fuel, fossil-based gasoline.

In response to the agencies’ assertion that the existing ethanol industry

could play a significant role as a launching platform for the new

technology, we note that cellulose-based ethanol remains an experimental

rather than an economically viable technology. We clarified our report to

acknowledge that, if sufficient breakthroughs in the technologies used to

make ethanol from biomass other than corn were to occur, then the use of

ethanol in place of fossil fuels could possibly cause a net reduction in

greenhouse gas emissions. However, we also added that neither EIA, nor

anyone else to our knowledge, has forecasted future levels of production

of ethanol from cellulosic biomass.

Short-Term Economic

Effects of Eliminating the

Tax Incentives

The USDA and DOE officials noted that the draft report did not discuss the

economic effects that would occur under various scenarios for eliminating

the incentives. For example, the draft report did not include the effect on

prices of near-term market disruptions that would occur if the incentives

were eliminated quickly. The officials said that the short-term increase in

the price of MTBE would likely be significantly larger than the estimate of

the long-term increase that we report.

We agree; however, we chose not to discuss the short-term effects of

eliminating the incentives because such effects would depend on the

Page 24 GAO/GGD-97-41 Tax Policy
B-271977 

specific scenario. Such short-term effects would be important for

computing the costs of different proposals for eliminating the incentives.

Effects of Unstable

Government Subsidy

Policies

DOE officials said that unstable government subsidy policies could be

devastating to the ethanol industry. They noted that investors need to plan

several years ahead when investing in plants that are based on new

technologies or when bringing production on-line for plants that take a

long time to build. If investors cannot count on a stable government

policy, they are unlikely to invest in new technologies. DOE officials noted

that one of our previous reports found this to be true in the alternative

fuels industries in several other countries.43

We agree that frequently changing levels of government support can cause

uncertainty that can negatively affect any industry. Our previously

mentioned report stated that “wavering government subsidies and

support” can discourage private investors from investing in an unproved

technology. However, the alcohol fuels tax incentives were enacted in the

late 1970s and early 1980s. Furthermore, we would not characterize the

history of the incentives to date as being one of “wavering government

subsidies and support.”

Oxygenate Security DOE officials commented that the draft report did not note that if MTBE

were to replace ethanol as an oxygenate, the additional MTBE would likely

come almost entirely from foreign sources. They said that this could

reduce U.S. energy security by increasing the percentage of oxygenates

that is imported. DOE officials noted that the use of replacement fuels was

encouraged in the 1992 Energy Policy Act and that another of our recent

reports stressed that oxygenates are an important part of the whole

replacement fuel picture.44

We agree that we are on record in saying that oxygenates displace some

petroleum. However, as we explained above, ethanol’s potential for

substituting for petroleum is so small that it is unlikely to significantly

affect overall energy security. Furthermore, the United States’

vulnerability to disruptions in MTBE supply is not comparable to its

vulnerability to disruptions in oil supply. A disruption of MTBE supply is

probably less likely than an oil supply disruption because MTBE has more

43Alternative Fuels: Experiences of Brazil, Canada, and New Zealand in Using Alternative Motor Fuels

(GAO/RCED-92-119, May 7, 1992).

44GAO/RCED-96-121.

Page 25 GAO/GGD-97-41 Tax Policy
B-271977 

widely varied sources of supply. Moreover, in the event of a disruption of

MTBE imports, oxygenate regulations could be relaxed or suspended until

the disruption ended or until domestic production increased to fill the

shortage.

Energy Balance of Ethanol

Compared With Other

Fuels

USDA officials said that the draft report understated the energy balance

from ethanol made with current technology and did not mention the even

better energy balance that might be achieved if a cellulosic biomass

ethanol industry emerges in the future. The officials also noted that the

report failed to mention the large amounts of fossil fuel used in making

fossil-fuel products, such as gasoline and diesel fuel.

We agree that there is some evidence that ethanol use may have some

energy balance advantages relative to gasoline, in that the former may

involve lower levels of fossil energy and petroleum consumption.45 We

also acknowledge that, if sufficient breakthroughs in the technologies

used to make ethanol from biomass other than corn were to occur in the

future, then even better fossil energy and petroleum consumption

balances might be achieved through using ethanol in place of gasoline.

However, because so little ethanol fuel is used, our evaluation of energy

security benefits would not change even if no petroleum or other fossil

fuels were consumed in the production of ethanol. For this reason, we did

not compare the energy balance of ethanol with the energy balance of

gasoline. Our evaluation of the effects of ethanol use on greenhouse gas

emissions takes into account the latest research on full fuel-cycle

emissions.

Effect of the Tax

Incentives on Federal

Outlays

USDA officials noted that in a 1990 report, we estimated the savings in

federal outlays for deficiency payments to corn farmers that result from

the partial exemption for ethanol.46 They said that we should include these

effects when discussing federal outlays before passage of the FAIR Act.

We disagree for several reasons. First, our 1990 report did not estimate the

impact of the partial exemption for ethanol on federal farm payments; it

simulated what would happen if ethanol production increased by a range

of assumed growth rates.

45For example, see Wang, GREET 1.0 — Transportation Fuel Cycles Model: Methodology and Use,

pages 40 to 43 and 46.

46Alcohol Fuels: Impact From Increased Use of Ethanol Blended Fuels (GAO/RCED-90-156, July 1990).

Page 26 GAO/GGD-97-41 Tax Policy
B-271977 

Second, as we noted in the “objectives, scope, and methodology” section

of this report, our objective relating to fiscal impact was limited to

estimating the effect that the tax incentives have had on the flow of

revenue into the Highway Trust Fund.

Third, while federal farm payments before the passage of the FAIR Act may

have been lower than they would have been in the absence of the tax

incentives, it is not possible to determine with certainty the size of any

federal outlay savings that may have occurred. Such savings would depend

on the unknown extent to which the Secretary of Agriculture would have

used the acreage reduction program to restrict corn supply in the absence

of the incentives. A sufficient restriction of corn acreage could have

mitigated or eliminated the effect of the reduced demand for corn on corn

prices. Therefore, such a restriction, if brought to bear, could also have

mitigated or eliminated any effect on federal outlays.

Finally, since the FAIR Act has now removed the link between income

support payments and farm prices, the tax incentives are not likely to have

any future effect on federal farm outlays.

Other Comments USDA, DOE, EPA, Treasury, and IRS officials provided a number of

suggestions for rewording our discussion of technical details in the draft.

We made corrections and clarifications where appropriate. As a result of

our discussions with Treasury officials, we determined that the excise tax

data we used to make our revenue loss estimates did not reflect claims for

refunds or credits for excise tax overpayments on gasoline used to make

alcohol fuel mixtures. We obtained additional data from Treasury and IRS

and made the proper adjustments to our estimates.

Unless you publicly announce its contents earlier, we plan no further

distribution of this report until 30 days from the date of this letter. At that

time, we will send copies of this report to the Ranking Minority Member of

your committee, the Chairman and Ranking Minority Member of the

Senate Finance Committee, other appropriate congressional committees,

and other interested parties. Copies will also be made available to others

upon request.

This work was performed under the direction of James Wozny, Assistant

Director, Tax Policy and Administration Issues. Major contributors to this

Page 27 GAO/GGD-97-41 Tax Policy
B-271977 

report are listed in appendix V. If you have any questions, please contact

me on (202) 512-9110.

Sincerely yours,

James R. White

Associate Director, Tax Policy

 and Administration Issues

Page 28 GAO/GGD-97-41 Tax Policy
Page 29 GAO/GGD-97-41 Tax Policy
Contents

Letter 1

Appendix I 

Chronology of the

Legislation and

Events Affecting

Ethanol Fuel Use

32

Appendix II 

Details and Estimates

Relating to the Tax

Incentives for Alcohol

Fuels

35

Federal Tax Incentives for Alcohol Fuels 35

Allocation of Excise Tax Revenues to the Highway Trust Fund 39

Revenue Estimates for the Tax Incentives 40

Appendix III 

Data on U.S. Fuel

Consumption and

Imports

45

Appendix IV 

Description of Groups

in the Economy That

the Ethanol Tax

Incentives Affect

49

The Factors Determining the Incidence of the Tax Incentives 49

Description of the Markets and Consumers of Ethanol and

Related Products

51

Appendix V 

Major Contributors to

This Report

60

Tables Table II.1: Rates of Excise Taxes, Excise Tax Exemptions, and

Income Tax Credits for Selected Highway Motor Fuels

36

Page 30 GAO/GGD-97-41 Tax Policy
Contents

Table II.2: Estimates of the Amounts of Excise Tax Revenues

Forgone Due to the Partial Exemptions for Alcohol Fuels,

1979-95

41

Table II.3: Department of the Treasury and Joint Committee on

Taxation Projections of Revenue Losses Attributable to the

Excise Tax Exemptions for Alcohol Fuels, Fiscal Years 1996-2000

44

 Table III.1: U.S. Transportation Fuel Consumed, 1992-96 45

Table III.2: Gasoline, MTBE, TAME, Ethanol, and ETBE Used in

the United States in 1995, by Air Quality Area

46

 Table III.3: U.S. Energy and Petroleum, Consumed and Imported

(Actual and Projected), 1973-2015

47

Abbreviations

API American Petroleum Institute

CBO Congressional Budget Office

DOE U.S. Department of Energy

EIA Energy Information Administration

EPA Environmental Protection Agency

ERS Economic Research Service

ETBE ethyl tertiary butyl ether

FAIR Federal Agricultural Improvement and Reform Act of 1996

FAPRI Food and Agriculture Policy Research Institute

GDP gross domestic product

IRS Internal Revenue Service

MMT methylcyclopentadienyl manganese tricarbonyl

MTBE methyl tertiary butyl ether

OPEC Organization of Petroleum Exporting Countries

RFG reformulated gasoline

USDA U. S. Department of Agriculture

Page 31 GAO/GGD-97-41 Tax Policy
Appendix I 

Chronology of the Legislation and Events

Affecting Ethanol Fuel Use

Year Legislation/Event Ethanol summary

1967 Air Quality Act of 1967

(P.L. 90-148)

Regulated ambient air quality. Established emissions standards and a

basic fuel and fuel additive registration program.

1970 U.S. production of crude oil peaked Increased U.S. dependence on foreign sources of crude oil, primarily from

OPEC.

Clean Air Amendments of 1970

(P.L. 91-604)

Established the National Ambient Air Quality Standards and began

regulating fuel additives for air pollution reduction. Section 211 gave EPA

the authority to regulate fuel and fuel additives, which included the

authority to control or prohibit the sale of any fuel or fuel additive that it

determined would endanger the public health or welfare.

1973 1973 Arab Oil Embargo Disrupted petroleum supply and escalated price. Was the beginning of

consumer efforts to conserve energy and reduce petroleum consumption.

Emergency Petroleum Allocation

Act of 1973

(P.L. 93-159)

Established government controls on domestic petroleum price and

supply, replacing market forces.

1974 Supplier-Purchaser Rule, Buy-Sell

Program, and Crude Oil Entitlement

Program

Below-market petroleum prices and allocated supplies caused lowered

incentives for oil exploration and production, increased incentives to

import oil, and greater domestic oil demand.

Unleaded motor gasoline was introduced

at gasoline stations

Began the transition to unleaded gasoline. Transition was enhanced by

the compatibility of unleaded gasoline with the catalytic converter, which

was developed to reduce tailpipe emissions.

1975 Energy Policy and Conservation

Act of 1975

(P.L. 94-163)

Established the Strategic Petroleum Reserve to deter and mitigate effects

of future oil supply disruptions.

1978 U.S. demand for petroleum peaked Subsequent decline in demand contributed to lower oil imports.

Powerplant and Industrial Fuel

Use Act of 1978

(P.L. 95-620)

Restricted construction of electric powerplants with petroleum or natural

gas as their primary fuel.

Energy Tax Act of 1978

(P.L. 95-618)

Established a 4 cents per gallon (then the entire amount of the federal

gasoline excise tax) exemption from excise taxes for motor fuels blended

with biomass-derived alcohols (minimum of 10-percent alcohol).a

1978 Iranian Revolution Declines in Iran’s crude oil production began a series of OPEC price

escalations between 1979 and 1981. A worldwide recession occurred and

oil consumption was depressed.

1980 Energy Security Act of 1980

(P.L. 96-294)

Authorized funds for building alcohol fuel production plants.

Crude Oil Windfall Profit Tax Act of 1980

(P.L. 96-223)

Extended the 4-cent exemption for gasohol to December 1, 1992, and

established a blender’s tax credit of 40 cents per gallon of alcohol used in

the production of gasoline/alcohol mixtures.

Omnibus Reconciliation Tax Act of 1980

(P.L. 96-499)

Placed a tariff on imported ethyl alcohol to be used in the production of

gasoline/alcohol mixtures.

1981 Petroleum Price and Allocation Decontrol

(E.O. 12287)

Reinstated market forces for petroleum prices. Domestic crude oil

production was revitalized. Deregulation of oil prices and the development

of futures markets reduced the economic cost of an oil price shock.

During an oil market shock, producers had the incentive to bring forth

additional energy supplies and consumers had an incentive to reduce

energy consumption because prices could adjust quickly and completely

to changing information about potential future oil supplies.

(continued)

Page 32 GAO/GGD-97-41 Tax Policy
Appendix I 

Chronology of the Legislation and Events

Affecting Ethanol Fuel Use

Year Legislation/Event Ethanol summary

1982 Surface Transportation Assistance

Act of 1982

(P.L. 97-424)

Raised the gasoline tax rate from 4 to 9 cents per gallon and increased

the exemption for gasohol from 4 to 5 cents per gallon. Set a 9 cents per

gallon exemption for fuels containing 85 percent or more alcohol.

1984 Tax Reform Act of 1984

(P.L. 98-369)

Raised the exemption for gasohol from 5 to 6 cents per gallon. Increased

the blender’s tax credit from 40 to 60 cents per gallon of blend for

190-proof alcohol.

1986 Price of crude oil collapsed Domestic crude oil production declined, dependence on OPEC crude oil

increased, and lower petroleum prices stimulated economic growth.

Tax Reform Act of 1986

(P.L. 99-514)

Reduced the exemption for 85-percent alcohol fuels from 9 to 6 cents per

gallon.

Superfund Revenue Act of 1986

(P.L. 99-499)

Raised the gasoline excise tax rate from 9.0 to 9.1 cents per gallon.

1988 Alternative Motor Fuels Act of 1988

(P.L. 100-494)

Addressed national energy policy concerns and created a program of

financial support for research, development, and demonstration of

alternative motor vehicles and alternative fuels.

Technical and Miscellaneous

Revenue Act of 1988

(P.L. 100-647)

Permitted gasohol blenders to purchase gasoline and alcohol at different

locations and still get the 6 cent per gallon exemption without having to file

a claim for an excise tax refund.

1989 Reid Vapor Pressure Regulations Reduced evaporative emissions of smog-producing compounds in

gasoline.

1990 Persian Gulf Crisis of 1990-91 Unlike with previous oil supply disruptions, the impact from the sudden oil

price increase and supply cutoff was reduced. Reduction was attributable

to the deregulation of oil prices, to the development of futures markets, to

the achievement of greater efficiency and fuel-switching capabilities by oil

users, and to greater worldwide cooperation. Cooperation included the

use of worldwide strategic reserves, an OPEC increase in production, and

non-OPEC producer supply shifts.

Omnibus Budget Reconciliation

Act of 1990

(P.L. 101-508)

Raised the gasoline excise tax rate from 9.1 to 14.1 cents per gallon,

reduced the gasohol exemption from 6.0 to 5.4 cents per gallon, and

reduced the blender’s tax credit from 60 to 54 cents per gallon. Retained

the exemption for 85-percent alcohol fuels at 6 cents per gallon. Extended

these incentives to the year 2000. Provided an income tax credit of 10

cents per gallon for the first 15 million gallons of ethanol manufactured by

qualified small producers with annual outputs of less than 30 million

gallons.

Clean Air Act Amendments of 1990

(P.L. 101-549)

Initiated a mandated phaseout in the use of lead as a gasoline octane

enhancer. Established the requirement that areas with the worst

ground-level air pollution should use the following cleaner-burning motor

fuels: oxygenated gasoline in carbon monoxide nonattainment areas

during winter months and reformulated gasoline in ozone nonattainment

areas. Reduced the sulfur content of diesel fuel.

1992 Energy Policy Act of 1992 

(P.L. 102-486)

Extended gasohol excise tax exemption to blends containing less than

10-percent (7.7 and 5.7 percent) alcohol. To encourage the use of

alternatives to petroleum-based transportation fuels, set guidelines and

established incentives for (1) purchasing clean-fuel vehicles for federal,

state, and private fleets and (2) arranging refueling facilities for these

fleets.

Oxygenated fuels program began Required oxygenated gasoline use in wintertime in air quality

nonattainment areas for carbon monoxide.

(continued)

Page 33 GAO/GGD-97-41 Tax Policy
Appendix I 

Chronology of the Legislation and Events

Affecting Ethanol Fuel Use

Year Legislation/Event Ethanol summary

1993 Omnibus Budget Reconciliation

Act of 1993

(P.L. 103-66)

Raised gasoline excise tax rate from 14.1 to 18.4 cents per gallon.

1994 EPA mandated 30-percent minimum

renewable oxygenate content for

reformulated gasoline

Issued a ruling that at least 30 percent of each refinery’s annual

production of reformulated gasoline in 1996 and for each year thereafter

should be derived from renewable oxygenates.

1995 Courts struck down 30-percent renewable

oxygenate mandate

Struck down EPA’s ruling of June 1994 mandating the use of at least

30-percent renewable alcohol in reformulated gasoline, which would have

significantly expanded demand for ethanol.

Reformulated gasoline program began Required reformulated gasoline use in the worst air quality nonattainment

areas for ozone.

aAlthough under the Internal Revenue Code, blends of gasoline with any biomass-derived alcohol

receive the exemption, the only economically feasible biomass-derived alcohol has been ethanol.

Sources: U.S. Department of Energy, Energy Information Administration, The Energy Information

Administration’s Assessment of Reformulated Gasoline, Volume 1, SR/OOG/94-02/1, October

1994, pages 5 and 6; Volume 2, SR/OOG/94-02/2, October 1994, pages 132-134; U.S.

Department of Energy, Energy Information Administration, The U.S. Petroleum Industry: Past as

Prologue, 1970-1992, DOE/EIA-0572, September 1993, pages 2 and 3; U.S. Department of

Energy, Energy Information Administration, Renewable Energy Annual 1995, DOE/EIA-0603(95),

December 1995, pages 68-70; U.S. Department of Energy, Energy Information Administration,

Estimates of U.S. Biomass Energy Consumption 1992, DOE/EIA-0548(92), May 1994, page 29;

U.S. Department of Energy, Energy Information Administration, Alternatives to Traditional

Transportation Fuels: An Overview, DOE/EIA-0585/O, June 1994, pages 33-38; U.S. Department

of Energy, Energy Information Administration, Alternatives to Traditional Transportation Fuels

1994, Volume 1, DOE/EIA-0585(94)/1, February 1996, pages 5-7; U.S. Senate, Committee on the

Budget, Tax Expenditures: Compendium of Background Material on Individual Provisions, S.Prt.

103-101, December 1994, pages 80-82; Congressional Research Service, Alcohol Fuels Tax

Incentives and EPA’s Renewable Oxygenate Requirement, 94-785 E, October 7, 1994, pages 6

and 7; Congressional Research Service, Federal Excise Taxes on Gasoline and the Highway

Trust Fund: A Short History, 96-394 E, May 3, 1996, pages 5-8; Congressional Research Service,

Alternative Transportation Fuels: Oil Import, Highway Tax, and Implementation Issues, IB93009,

March 28, 1996, pages 3 and 4; Congressional Research Service, Alcohol Fuels Tax Incentives:

Current Law and Proposed Options to Expand Current Law, 89-343 E, June 2, 1989, pages 4-7

and 11-12.

Page 34 GAO/GGD-97-41 Tax Policy
Appendix II 

Details and Estimates Relating to the Tax

Incentives for Alcohol Fuels

Federal Tax

Incentives for Alcohol

Fuels

The partial exemptions from motor fuels excise taxes were adopted in the

Energy Tax Act of 1978 and first became effective in 1979. Currently,

motor fuels consisting of at least 10-percent biomass-derived ethanol are

exempt from 5.4 cents of the per-gallon federal excise taxes on gasoline,

diesel fuel, and other motor fuels that are earmarked for the Highway

Trust Fund. Table II.1 shows that the exemption is also available, at lower

rates per gallon of fuel, for blends that are at least 7.7- or 5.7-percent

ethanol.1

 For all of these fuel blends, the exemptions provide a subsidy of

54 cents per gallon of ethanol used (i.e., if the lowest alcohol content

within a given range is used). Exemptions for alcohol fuel blends that

contain biomass methanol or other biomass alcohols, instead of ethanol,

provide a subsidy worth 60 cents per gallon of alcohol used.2

 The alcohol

contained in any of these blends must be at least 190 proof. The Internal

Revenue Code refers to these blends collectively as “gasohol.”

1

The 5.7- and 7.7-percent blends correspond to oxygen content standards for gasoline sold in ozone

nonattainment areas and carbon-monoxide nonattainment areas under the Clean Air Act. The tax

incentives were extended to these additional blends by the Energy Policy Act of 1992.

2

In the Internal Revenue Code sections relating to motor fuels, the term “methanol” refers to any

alcohol other than ethanol.

Page 35 GAO/GGD-97-41 Tax Policy
Appendix II 

Details and Estimates Relating to the Tax

Incentives for Alcohol Fuels

Table II.1: Rates of Excise Taxes, Excise Tax Exemptions, and Income Tax Credits for Selected Highway Motor Fuels

Motor fuel

Combined motor

fuels excise tax

rates (cents per

gallon of fuel)a

Rates of exemption

(cents per gallon of

fuel)

Rates of exemption

(cents per gallon of

alcohol)b

Rates of alcohol

fuels tax credits

(cents per gallon of

alcohol)b,c

Gasoline 18.3 0.0 N/A N/A

Diesel fueld 24.3 0.0 N/A N/A

Gasohol from ethanol:

At least 10-percent ethanol 12.9 5.4 54.0 54.0

At least 7.7-percent but less than

10-percent ethanol 14.14 4.16 54.0 54.0

At least 5.7-percent but less than

7.7-percent ethanol 15.22 3.08 54.0 54.0

Gasohol from methanol:

At least 10-percent methanol 12.3 6.0 60.0 60.0

At least 7.7-percent but less than

10-percent methanol 13.68 4.62 60.0 60.0

At least 5.7-percent but less than

7.7-percent methanol 14.88 3.42 60.0 60.0

10-percent dieselhol

from ethanol 18.9 5.4 54.0 54.0

10-percent dieselhol

from methanol 18.3 6.0 60.0 60.0

Qualified ethanol fuels from other than

petroleum or natural gas 12.9 5.4 6.35 54.0

Qualified methanol fuels (other than

ethanol) from other than petroleum or

natural gas 12.3 6.0 7.06 60.0

Special motor fuels 18.3 0.0 0.0 e

Partially exempt methanol and ethanol

fuels from natural gas 11.3 7.0 8.24 N/A

(Table notes on next page)

Page 36 GAO/GGD-97-41 Tax Policy
Appendix II 

Details and Estimates Relating to the Tax

Incentives for Alcohol Fuels

Legend: N/A = not applicable.

aThe combined tax rates encompass the Highway Trust Fund taxes and the General Fund tax.

bThe rates of exemptions and credits per gallon of alcohol as shown in the table are for blends

that meet the minimum alcohol content percentage. Blends that have higher contents than the

minimum for a given range receive a lower subsidy per gallon. For example, gasohol that is

6-percent ethanol receives a subsidy of 51.3 cents per gallon of alcohol.

cThe credit rates shown are for alcohol fuels in which the alcohol is at least 190 proof; credit rates

for proofs between 150 and 190 are lower. No credit is given for alcohol that is less than 150

proof. The credit rates shown do not include the credit for small ethanol producers.

dThere is a lower rate of tax for diesel fuel used for intercity buses.

eAlcohol fuels that qualify as special fuels are eligible for the separate “alternative fuels

production tax credit.”

Sources: Internal Revenue Code and GAO computations.

Neat alcohol fuels—those that contain at least 85-percent alcohol—also

qualify for partial excise tax exemptions, but the subsidies per gallon of

alcohol are less than 10 cents. These fuels are referred to in the tax code

and in table II.1 as “qualified” ethanol and methanol fuels. A lower-rate

exemption is also available for “partially exempt methanol or ethanol

fuel,” which, in the tax code, means any liquid fuel that is at least

85-percent alcohol produced from natural gas.

In fiscal year 1995, over 99.9 percent of the alcohol fuel reported in

Internal Revenue Service (IRS) excise tax summaries was gasohol that

contained ethanol. All of the other alcohol fuels were aggregated into a

single line in the IRS summaries and, together, these fuels accounted for

less than 0.1 percent of the alcohol fuel reported.

The partial excise tax exemption may be claimed by the blenders of

gasohol or by the distributors that sell them the gasoline used to make

gasohol. The partial exemption may be claimed when the blenders or

distributors file their quarterly federal excise tax returns,3

 when blenders

file their annual income tax returns, or, if certain conditions are met, when

3

According to IRS regulations, the “position holder,” with respect to the taxable fuel at a distribution

terminal, is the one liable for paying the excise tax. In some cases, this may be the blender; in other

cases, it may be the terminal operator.

Page 37 GAO/GGD-97-41 Tax Policy
Appendix II 

Details and Estimates Relating to the Tax

Incentives for Alcohol Fuels

blenders file quarterly claims for refunds of excise taxes.4 Most of the

exemptions are scheduled to expire after September 30, 2000, which is 1

year after the scheduled expiration of the Highway Trust Fund motor fuel

excise taxes. The exemption for partially exempt methanol and ethanol

fuels expires after September 30, 1999.

In addition to the excise tax exemptions, the tax code provides income tax

credits for alcohol used or sold as a fuel, whether the alcohol is blended

with another motor fuel or used neat. These income tax credits were

enacted as part of the Crude Oil Windfall Profit Tax Act of 1980, and they

are scheduled to expire after December 31, 2000. The “alcohol mixture

credit” is available to “blenders”—businesses that mix alcohol with other

motor fuels and use the mixtures in a trade or business or sell it for use as

a fuel. The credit provides a subsidy of 54 cents per gallon of ethanol used,

if it is at least 190 proof, or 40 cents, if the ethanol is between 150 and 190

proof. The subsidy per gallon of alcohol other than ethanol is 60 cents, if it

is at least 190 proof, or 45 cents, if the alcohol is between 150 and 190

proof. No credit is available for alcohols that are less than 150 proof. The

“alcohol credit” is available to businesses that either use neat alcohol fuels

or sell them at the retail level. This credit provides the same subsidy per

gallon of alcohol as the alcohol mixtures credit.

The tax code also provides for an income tax credit for small ethanol

producers—those that produce no more than 15 million gallons of

qualified ethanol fuel per year. Qualified ethanol fuel is ethanol that is

produced by a small producer and used or sold for use as a motor fuel.

The credit is equal to 10 cents per gallon of qualified ethanol.

For the most part, to qualify for an excise tax exemption or an income tax

credit, alcohol used in a motor fuel cannot be produced from petroleum,

natural gas, coal, or peat. One exception is the partially exempt methanol

or ethanol fuel previously mentioned. The other exception is that certain

alcohol fuels that are derived from coal or lignite (falling under the

heading “special motor fuels” in table II.1) could qualify for the alternative

fuels production tax credit. Little, if any, alcohol fuel is produced from

coal or lignite.

4

The credit that a gasohol blender may claim for excise taxes previously paid on gasoline is distinct

from the income tax credits described in the following paragraph. Even though this claim for

previously paid tax is filed with the annual income tax return, it is an offset against excise tax receipts,

not income tax receipts, and Treasury subtracts the claims from the Highway Trust Fund rather than

from the General Fund. Blenders may claim credits for, or refunds of, excess excise taxes paid on the

gasoline they blend with ethanol, even if they are not the ones who originally made the tax payments,

as long as the original taxpayer did not claim the partial exemption.

Page 38 GAO/GGD-97-41 Tax Policy
Appendix II 

Details and Estimates Relating to the Tax

Incentives for Alcohol Fuels

Taxpayers who claim the alcohol mixtures credit or the alcohol credit

must reduce their credits by the amount of the partial excise tax

exemption associated with the same fuel. The taxpayers must choose

between the exemptions and the credits. One of the reasons why Congress

supplemented the exemption with the alcohol fuels credits was to provide

incentives for the production and use of alcohol fuels in mixtures that

contained less than 10-percent alcohol. At the time the credits were

introduced, the excise tax exemption applied only to mixtures that were at

least 10-percent alcohol. Congress also wanted to give users who were

exempt from all fuel excise taxes, such as farmers, an incentive to use

alcohol-fuel blends instead of gasoline and diesel.

Final regulations promulgated by IRS in 1990 interpreted section 40 of the

tax code to say that blends of gasoline and ethyl tertiary butyl ether (ETBE)

could qualify for the alcohol mixtures credit.5

 This interpretation was

made retroactive to sales or uses of the fuel blends after September 30,

1980. In 1994, IRS published proposed regulations saying that blends of

gasoline and ETBE could qualify for the partial exemption from excise tax,

effective January 1, 1993.6

 This ruling was confirmed by final regulations

that became effective October 1, 1995.7

 The final regulations also

contained a ruling that enables gasoline refiners to claim the partial

exemption for mixtures of gasoline and ETBE that are blended at a refinery

and then distributed through pipelines, even if the ETBE content of this fuel

becomes diluted as it passes through the pipelines.

Allocation of Excise

Tax Revenues to the

Highway Trust Fund

The second column of table II.1 shows the current combined rates (per

gallon of fuel) of federal excise taxes on highway motor fuels. Most of the

tax on these fuels is allocated to the Highway Trust Fund. In the case of

10-percent gasohol and dieselhol, 7.5 cents of the tax per gallon of fuel

remains in the Treasury’s General Fund. In the case of the other gasohol

blends, 6.9 cents of the tax per gallon remains in the General Fund and 4.3

cents of the tax per gallon of the remaining fuels shown in the table is left

in the General Fund. The remainder of the taxes collected on these fuels is

transferred to the Highway Trust Fund. The partial exemptions for alcohol

fuels reduce the excise tax revenues that are allocated to the trust fund;

5

T.D. 8291, RIN 1545-AN72, Alcohol Fuels Credit; Definition of Mixture, March 9, 1990, 55 Fed. Reg.

8946. ETBE is an ether produced from ethanol.

6

PS-66-93, RIN 1545-AS10, Gasoline and Diesel Fuel Excise Tax; Rules Relating to Gasohol, 59 Fed.

Reg. 52735; Tax on Compressed Natural Gas, October 19, 1994.

7

T.D. 8609, RIN 1545-AS10, Gasohol; Compressed Natural Gas, July 25, 1995, 60 Fed. Reg. 40079, Aug. 7,

1995.

Page 39 GAO/GGD-97-41 Tax Policy
Appendix II 

Details and Estimates Relating to the Tax

Incentives for Alcohol Fuels

they do not affect the portion of the tax that is allocated to the general

fund.

The federal Highway Trust Fund was established by the Highway Revenue

Act of 1956 as an accounting mechanism to finance anticipated

expenditures under the federal-aid highway program for the 16-year period

from fiscal years 1957 to 1972. Congress has subsequently passed laws

extending the fund and the excise taxes that are earmarked to it.8

 The trust

fund excise taxes are currently scheduled to expire after September 30,

1999. The 4.3-percent general fund tax rate is permanent.9

During fiscal year 1995, the Highway Trust Fund excise taxes generated

about $23.1 billion for the fund, with 60 percent of these revenues coming

from the gasoline tax. However, the total tax collections were subject to

certain tax refunds, credits, and transfers, such as a tax rebate for

diesel-powered vehicles, totaling about $.7 billion. Therefore, the net taxes

generated amounted to about $22.4 billion in fiscal year 1995.

Revenue Estimates

for the Tax Incentives

Table II.2 shows our estimates of the amounts of excise tax revenue

forgone from fiscal years 1979 to 1995 due to the exemptions for alcohol

fuels. We estimated that approximately $7.1 billion of excise tax revenue,

in constant 1996 dollars, was forgone over that period due to the

exemptions.

8

In addition to excise taxes on motor fuels, excise taxes on certain tires, a use tax on heavy vehicles,

and a retail tax on heavy trucks are also earmarked for the fund.

9

Before expiring on January 1, 1996, there was also a small excise tax on motor fuels that was

allocated to the Leaking Underground Storage Tanks Trust Fund. This fund was established to help

finance the cost of cleaning up leaking, underground storage tanks for petroleum products. The rates

of the tax were 0.1 cent per gallon of fuel for all of the fuels shown in table II.1, except for the qualified

ethanol and methanol fuels. The rate for qualified ethanol and methanol fuels was 0.05 cent per gallon

of fuel.

Page 40 GAO/GGD-97-41 Tax Policy
Appendix II 

Details and Estimates Relating to the Tax

Incentives for Alcohol Fuels

Table II.2: Estimates of the Amounts of

Excise Tax Revenues Forgone Due to

the Partial Exemptions for Alcohol

Fuels, 1979-95 Fiscal year

Excise tax revenues

forgone (in millions of

current dollars)

Excise tax revenues

forgone (in millions of

constant 1996 dollars)

1979-86 $1,436 $2,049

1987 489 642

1988 483 612

1989 465 564

1990 467 543

1991 510 569

1992 420 455

1993 518 549

1994 504 524

1995 605 617

Total N/A $7,124

Legend: N/A = not applicable.

Sources: GAO estimates on the basis of excise tax collection data from IRS (for fiscal years

1987-95) and gasohol production data from a publication entitled The Economics of Gasoline

Ethanol Blends (for calendar years 1979-86).

The data sources and methodologies used to estimate the revenues

forgone for the period 1979 through 1986 in table II.2 differed from those

used for the period 1987 through 1995 because of differences in the data

available for each period. For fiscal years 1987 through 1995, IRS’ quarterly

reports on excise tax receipts contained sufficient detail for us to

determine the amount of tax receipts collected from sales of gasohol and

from sales of gasoline that would later be used to produce gasohol. This

information on tax receipts for each quarter, combined with information

on tax rates in effect for each quarter, enabled us to estimate the number

of gallons of gasohol that were sold in each fiscal year.10 Once we had

estimated the number of gallons of gasohol sold, we multiplied the tax rate

for gasoline by the number of gallons of gasohol to compute the amount of

revenue that would have been collected if the gasohol had been taxed at

the full rate. To obtain our estimate of the amount of excise tax revenue

forgone, we subtracted the amount of revenue actually collected on

gasohol from the amount that would have been collected if it had been

subject to the full rate.

10In the case of gasohol that was taxed directly, the gallonage of gasohol could be computed as: gallons

= tax receipts / rate of tax per gallon of gasohol. In the case of gasoline sold for later use in gasohol,

the gallonage of gasohol could be computed as: gallons = (tax receipts / rate of tax per gallon of

gasoline used for gasohol) / gasoline content as a fraction of each gasohol gallon.

Page 41 GAO/GGD-97-41 Tax Policy
Appendix II 

Details and Estimates Relating to the Tax

Incentives for Alcohol Fuels

IRS’ excise tax reports before 1987 do not contain sufficient detail to allow

us to estimate the gallons of gasohol sold each year. Instead, we relied on

published estimates of the amounts of gasohol produced in calendar years

1979 through 1986.11 We used the published estimates of gasohol

production and the applicable tax rates to estimate the amount of tax that

was collected on the sale of gasohol from 1979 to 1986 and the amount

that would have been collected if the gasohol had been taxed at the full

excise tax rate. By subtracting the former from the latter, we obtained our

estimate of the revenue excise tax revenue forgone each year.12

We also obtained data from the Department of the Treasury and IRS

relating to the amount of revenue subtracted from the Highway Trust Fund

when taxpayers claim refunds or credits for overpayments of excise tax on

gasohol. We included these revenue losses in our totals for each year.

In the absence of the exemption, the amount of excise tax forgone would

not necessarily have been exactly equal to the $7.1 billion shown in table

II.2. Without the exemption, the 108 billion gallons of gasohol that we

estimated were consumed from 1979 to 1995 might have been replaced by

a slightly smaller gallonage of other motor fuels that had been subject to

the full motor fuel excise tax rates. Since ethanol has less energy content

than gasoline or methyl tertiary butyl ether (MTBE), if these other fuels had

been used instead of ethanol, then less total gallonage of fuel would have

been needed to support a given mileage total. Another reason why less

motor fuel might have been consumed is that, without the exemption, the

price of motor fuels might have been slightly higher than it was with the

exemption, which might have caused the demand for motor fuels to be

slightly lower than it was.

The estimates that we present in table II.2 are “static” estimates in that

they do not take into account the potential changes in motor fuel

consumption in response to the elimination of the exemptions. In this

respect, our estimates are similar in concept to the projections that

Treasury and the Joint Committee on Taxation make each year for the

amounts by which excise tax receipts are reduced due to the existence of

11These estimates were published in Anderson, Robert C., Thomas J. Lareau and Roger D. Wollstadt,

The Economics of Gasoline Ethanol Blends, Research Study #045, (American Petroleum Institute,

Washington, D.C., 1988).

12We were not able to present our results for individual fiscal years in this period because the data

were available for complete calendar years only. However, we did make an adjustment to our 1986

data which, when combined with the fact that the exemption became effective at the beginning of

1979, makes our estimate for the 1979 through 1995 period equivalent to the sum for the fiscal years

during that period.

Page 42 GAO/GGD-97-41 Tax Policy
Appendix II 

Details and Estimates Relating to the Tax

Incentives for Alcohol Fuels

the exemption.13 These projections do not represent the amount of

revenue that would be saved if the exemption were eliminated because

they do not account for the potential behavioral responses that might alter

the total gallonage of motor fuels consumed in the future.

When Treasury or the Joint Committee make revenue-savings projections

or revenue-cost projections for policy changes, they do take potential

behavioral responses into account. The Joint Committee has made

projections of the amount of revenue that would be saved if the exemption

were eliminated. These projections are virtually identical (after the

assumed effective date for the tax law change) to the Joint Committee’s

static projections of the amount of revenue that will be forgone, due to the

exemption, if it is not eliminated. This equality indicates that the

estimators believe behavioral responses to the elimination of the

exemption would be negligible. Treasury has not made public any

revenue-savings estimate for the elimination of the alcohol fuels

exemptions in recent years.

The estimates that we have made and the projections that Treasury has

made are of the reduction in excise tax revenues due to the exemptions. In

contrast, the projections that the Joint Committee has made are of the

reduction in total federal revenues due to the exemptions, net of income

tax effects. By convention, when the Joint Committee estimates the

amount of revenue that is attributable to an excise tax, it reduces the

estimated gross revenue gain from the tax by 25 percent to account for

offsetting declines in income tax revenue.14 Conversely, when the Joint

Committee estimates the amount of revenue forgone due to an excise tax

exemption, it reduces the gross revenue forgone by 25 percent to account

for offsetting increases in income tax revenue.

13Treasury’s projections are published each year in the “Tax Expenditure” section of the President’s

Budget. The Joint Committee’s projections are published each year in its “Estimates of Federal Tax

Expenditures.”

14When the Joint Committee produces revenue estimates for an existing or proposed tax law provision,

it assumes that the adoption or elimination of the provision will not affect aggregate economic

variables, such as the gross domestic product (GDP), total employment, and the overall price index.

The Joint Committee expects that the imposition of an excise tax would raise the prices of the taxed

goods and, thereby, increase nominal GDP by the amount of tax collected. However, to maintain its

assumption that GDP remains fixed, the Joint Committee assumes that aggregate income would fall by

an amount equal to the excise tax collected so as to offset the tax-induced increase in GDP. This

decline in income would reduce income tax receipts by an amount equal to the excise tax collected

multiplied by the average marginal income and payroll tax rate on all income. The average marginal

income tax rate is assumed to be about 25 percent. Therefore, the Joint Committee estimates that the

excise tax’s net effect on federal revenues would be equal to only 75 percent of the amount of excise

tax collected. (See Congressional Budget Office, Budget Estimates: Current Practices and Alternative

Approaches, Jan. 1995 and Bruce F. Davie, “Tax Expenditure in the Federal Excise Tax System,”

National Tax Journal, Vol. XLVII, No. 1, Mar. 1994, pp. 39-62), and Joint Committee on Taxation,

Discussion of Revenue Estimation Methodology and Process (JCS-14-92), August 13, 1992.

Page 43 GAO/GGD-97-41 Tax Policy
Appendix II 

Details and Estimates Relating to the Tax

Incentives for Alcohol Fuels

The projections made by Treasury and the Joint Committee are presented

in table III.3. The Joint Committee’s projection of total federal revenues

that will be forgone due to the partial tax exemption in fiscal years 1996

through 2000—about $2.6 billion—is significantly lower than Treasury’s

projections of excise tax revenues forgone—about $3.3 billion.

Treasury projects that the alcohol fuels income tax credits will cost a total

of about $50 million in forgone income tax revenue from fiscal years 1996

to 2000. The Joint Committee has not made precise projections of the

revenue costs of the credits; they simply project that the cost will be less

than $50 million in each of the fiscal years from 1996 to 2000.

Table II.3: Department of the Treasury and Joint Committee on Taxation Projections of Revenue Losses Attributable to the

Excise Tax Exemptions for Alcohol Fuels, Fiscal Years 1996-2000

Fiscal year

Treasury projections

of excise tax

revenue losses (in

millions of current

dollars)

Treasury projections

of excise tax

revenue losses (in

millions of constant

1996 dollars)

Joint Committee

projections of total

net tax revenue

losses (in millions

of current dollars)

Joint Committee

projections of total

net tax revenue

losses (in millions of

constant 1996

dollars)

1996 $645 $645 $600 $600

1997 665 651 600 587

1998 685 656 500 479

1999 705 660 500 468

2000 730 668 500 458

Total $3,430 $3,280 $2,700 $2,592

Sources: Treasury projections are published in Analytical Perspectives: Budget of the United

States Government for Fiscal Year 1997, Table 5-1, “Total Revenue Loss Estimates for Tax

Expenditures in the Income Tax,” pages 62-64. The Joint Committee’s projections are from the

Committee’s print Joint Committee on Taxation Staff Estimates of Federal Tax Expenditures for

Fiscal Years 1996-2000, issued September 5, 1995, Table 1, “Tax Expenditure Estimates By

Budget Function, Fiscal Years 1996-2000,” pages 12-19. We put the projections into constant

dollars using the GDP deflator published in the fiscal year 1997 budget.

Page 44 GAO/GGD-97-41 Tax Policy
Appendix III 

Data on U.S. Fuel Consumption and Imports

Table III.1: U.S. Transportation Fuel

Consumed, 1992-96 Fuel consumption (millions of gasoline-equivalent gallons)

Fuel type 1992 1993 1994 1995 1996

Traditional:

Gasoline 108,259 108,494 110,279 111,716 113,673

Diesel 23,866 24,297 26,422 26,740 27,316

Total 132,125 132,791 136,701 138,456 140,989

Oxygenates:

Ethanolb 701 760 846 919 914

MTBEc 1,175 2,069 2,019 2,973 3,330

TAMEd + ETBEe N/A N/A N/A 201 N/A

Total 1,876 2,829 2,865 4,093 4,244

Alternative fuels:

E-85f 0.021 0.048 0.080 0.105 1

E-95g 0.085 0.080 0.140 0.140 0.140

M-85h 1 2 2 2 4

M-100i 3 3 3 3 3

Liquified Petroleum

Gases (propane) 208 265 249 260 263

Compressed

Natural Gas (CNG) 17 22 24 44 48

Liquified Natural

Gas (LNG) 1 2 2 3 3

Electricity 0.374 0.309 0.430 1 1

Total 230 294 281 313 323

Legend: N/A = not available.

aProjected.

bRepresents the ethanol used in all fuel blends that are 10-percent or less ethanol and 90-percent

or more gasoline.

cMTBE is methyl tertiary butyl ether, derived from fossil materials.

dTAME is tertiary amyl methyl ether, derived from fossil materials.

eETBE is ethyl tertiary butyl ether, derived from biomass.

f

E-85 is a fuel mixture of 85-percent ethanol and 15-percent gasoline.

gE-95 is a fuel mixture of 95-percent ethanol and 5-percent gasoline.

hM-85 is a fuel mixture of 85-percent methanol and 15-percent gasoline.

i

M-100 is a fuel consisting of 100-percent methanol.

Source: U.S. Department of Energy, Alternatives to Traditional Transportation Fuels, Vol. 1,

DOE/EIA-0585(94)/1, February 1996, page 37.

Page 45 GAO/GGD-97-41 Tax Policy
Appendix III 

Data on U.S. Fuel Consumption and Imports

Table III.2: Gasoline, MTBE, TAME, Ethanol, and ETBE Used in the United States in 1995, by Air Quality Area

Fuel/Source material

Percent of that fuel

type used in area

(percent)

Quantity of fuel

used (millions of

gallons)

Gasoline energy

equivalent

(percent)

Quantity of

gasoline-equivalent

fuel (millions of

gasoline-equivalent

gallons)

Percent of total

gasolineequivalent fuel

used (percent)

All areas meeting air quality standards:

Gasolinea 58% 63,802 100% 63,802 55.0%

MTBE 0 0 82 0 0

TAME 0 0 88 0 0

Ethanol 38 495 67 332 0.3

All air quality nonattainment areas:

Gasolinea 42 47,057 100 47,057 40.7

MTBE 100 4,745 82 3,891 3.4

TAME 100 123 88 108 0.1

Ethanol 62b 742 67 497 0.4

ETBE N/A 63 85 54 0.05

All areas:

Gasolinea/Fossil 100 110,859 100 110,859 95.8

MTBE/Fossil 100 4,745 82 3,891 3.4

TAME/Fossil 100 123 88 108 0.1

Ethanol/Biomass 100 1,237 67 829 0.7

ETBE/Biomass 100 63 85 54 0.05

Legend: N/A = not applicable.

aGasoline category does not include MTBE, TAME, ethanol, or ETBE.

bIncludes the ethanol used to make ETBE.

Sources: Urbanchuk, John M., Ethanol: Fueling An Economic Engine: Macroeconomic and Fiscal

Impacts of Ethanol Production Under the 1996 Farm Bill, April 19, 1996, AUS Consultants, page

10; U.S. Department of Energy; and GAO.

Page 46 GAO/GGD-97-41 Tax Policy
Appendix III 

Data on U.S. Fuel Consumption and Imports

Table III.3: U.S. Energy and Petroleum, Consumed and Imported (Actual and Projected), 1973-2015

(quadrillion Btu) (percent) (quadrillion Btu) (percent)

Energyb consumed Petroleumc consumed

Yeara Total Imported Imported Total Imported Imported

1973 74.28 12.68 17 34.84 12.98 37

1974 72.54 12.19 17 33.46 12.66 38

1975 70.55 11.75 17 32.73 12.51 38

1976 74.36 14.65 20 35.18 15.20 43

1977 76.29 18.02 24 37.12 18.24 49

1978 78.10 17.32 22 37.97 17.06 45

1979 78.90 16.75 21 37.12 16.93 46

1980 75.96 12.25 16 34.20 13.50 39

1981 73.99 9.65 13 31.93 11.38 36

1982 70.85 7.46 11 30.23 9.05 30

1983 70.52 8.31 12 30.05 9.08 30

1984 74.14 8.96 12 31.05 9.89 32

1985 73.98 7.87 11 30.92 8.95 29

1986 74.30 10.38 14 32.20 11.53 36

1987 76.89 11.91 15 32.87 12.53 38

1988 80.22 13.15 16 34.22 14.01 41

1989 81.33 14.18 17 34.21 15.33 45

1990 81.27 14.08 17 33.55 15.29 46

1991 81.12 13.36 16 32.85 14.22 43

1992 82.14 14.63 18 33.53 14.96 45

1993 83.86 17.18 20 33.84 16.40 48

1994 88.74 18.59 21 34.77 17.28 50

1995 90.93 17.93 20 34.92 16.87 48

2000 97.85 24.18 25 37.92 22.41 59

2005 103.36 27.43 27 40.46 25.59 63

2010 107.89 29.33 27 42.24 27.48 65

2015 110.67 30.53 28 43.26 28.60 66

(Table notes on next page)

Page 47 GAO/GGD-97-41 Tax Policy
Appendix III 

Data on U.S. Fuel Consumption and Imports

Note: Imports are net of exports.

aFigures for 2000 and later years are Energy Information Administration (EIA) projections. Ethanol

preferences expire after 2000; however, EIA projections assume the preferences will be renewed

and continue at current levels through 2015.

bEnergy includes natural gas, coal, nuclear, and renewable, in addition to petroleum.

cPetroleum includes crude oil, lease condensate, petroleum products, unfinished oils, pentanes

plus, and gasoline-blending components.

Sources: 1973-1993: U.S. Department of Energy, Monthly Energy Review, DOE/EIA-0035(96/06),

June 1996, pages 7 and 9. 1994-2015: U.S. Department of Energy, Annual Energy Outlook 1997:

With Projections to 2015, DOE/EIA-0383(97), December 1996, page 96.

Page 48 GAO/GGD-97-41 Tax Policy
Appendix IV 

Description of Groups in the Economy That

the Ethanol Tax Incentives Affect

The ethanol tax incentives benefit or disadvantage different groups in the

economy by changing the prices these groups pay and the income they

receive. By lowering the after-tax price of ethanol, the tax incentives

change the price of ethanol relative to the prices of other goods and,

thereby, change the supply and demand for these goods. The incentives

may cause the groups that buy and sell these goods to pay different prices

and receive different incomes than they would receive in the absence of

the incentives.

Determining the groups that the tax incentives benefit or

disadvantage—what economists call the “incidence” of the incentives—

requires analyzing how prices and incomes would be different in the

absence of the incentives. The groups that benefit from the incentives are

those that would pay higher prices or receive lower incomes in the

absence of the incentives. This appendix explains the factors that

determine the incidence of the incentives and describes the economic

groups that may be affected by the incentives.

The Factors

Determining the

Incidence of the Tax

Incentives

The groups that bear the burden of a tax or receive the benefit of a tax

incentive are not necessarily those who legally must pay the tax. Levying a

tax may change the price of one good relative to another and, thereby, may

change prices and the allocation of resources. In this way, the tax may be

shifted to other households and firms in the economy through price

changes.

The groups that legally must pay the excise tax on gasoline do not receive

the full benefit of the ethanol tax incentives. In some cases, those who

legally must pay the tax may be the blenders; in other cases, they may be

the gasoline distributors. In either case, the tax incentives reduce the

blenders’ after-tax cost of using ethanol because they are the ones who

undertake the activity of blending ethanol and gasoline that gives rise to

the tax reduction. If the blenders pay the tax, they can also claim the tax

reduction. If gasoline distributors pay the tax and claim the tax reduction,

they will reduce the price that they charge the blenders by virtually the full

amount of the tax benefit. The reasons for this are: (1) the gasoline

distributors are just as well off selling gasoline to be blended with ethanol

at the lower price and receiving the tax reduction as they are selling

gasoline for other uses at the higher price and receiving no tax reduction

and (2) the blenders have the option of not telling the distributors that the

gasoline will be blended with ethanol, in which case the distributors would

Page 49 GAO/GGD-97-41 Tax Policy
Appendix IV 

Description of Groups in the Economy That

the Ethanol Tax Incentives Affect

not claim the tax reduction, and the blenders could later claim refunds of

the overpayment of tax.

However, the blender does not receive the full benefit of the incentives

because the reduction in the after-tax cost of ethanol increases the

blenders demand for ethanol, and thereby raises its price. Therefore, a

part of the benefit that the blenders could receive is offset due to the

increase in the pre-tax cost of ethanol. A part of the benefit is shifted back

to ethanol producers and may be shifted to other groups in the economy

through price and income changes.

How prices and incomes are altered by the shifting of the incentives

among groups depends on how responsive market supply and demand are

to price changes and on market conditions that affect a firm’s ability to

control prices. The responsiveness of supply and demand to price changes

is called the “price elasticity.” Determining the incidence of the incentives

requires (1) information on price elasticities for all of the markets

potentially affected by the incentives and (2) information on the

conditions in the markets that determine whether firms control prices and,

if so, how much control firms have over the prices they can charge to

consumers.

In competitive markets where firms do not control the prices they charge,

the incidence of the incentives depends on the elasticity of supply and

demand. In general, the less elastic is supply and the more elastic is

demand, the more suppliers benefit from the incentives. For example, if

the supply of corn by farmers is less responsive to price changes than the

demand for corn by ethanol producers, more of the value of the incentives

would be shifted back to farmers as higher corn prices. These elasticities

also make it likely that the short-term effect on prices of removing tax

incentives will be greater than the long-term effect because the supply of

products and resources is less elastic over shorter periods of time. For

example, fuel producers may need time to adjust their production levels

when a tax is removed, and, therefore, the short-term effect on their prices

is likely to be greater than the long-term effect.

Except in the case of a monopoly, the factors governing the incidence of

the tax incentives in noncompetitive markets are more difficult to

determine. The incidence of the tax incentives in a market with a few firms

that can influence market price depends on the behavior of these firms.

Whether a firm shifts the tax incentives forward to consumers will depend

on whether it believes other firms in the industry will also lower prices.

Page 50 GAO/GGD-97-41 Tax Policy
Appendix IV 

Description of Groups in the Economy That

the Ethanol Tax Incentives Affect

The incidence of the tax incentives may also depend on whether firms are

maximizing profits, total revenues, or market share.

Description of the

Markets and

Consumers of Ethanol

and Related Products

The tax incentives, by altering supply and demand conditions in the

ethanol market, can affect prices in markets throughout the economy. For

example, the increased demand for ethanol increases demand and price in

the corn market, while it lowers demand and price in markets for

substitute fuels. In this section, we describe the groups for whom the

incentives have a nonnegligible effect on prices. We do not describe the

groups such as workers for whom the effect is likely to be negligible.

Although the tax incentives increase the demand for workers in the

ethanol industry, this increased demand merely shifts labor from other

sectors in the economy and does not produce a net increase in

employment. Furthermore, the ethanol industry is relatively small and

increased demand in this industry is unlikely to have any net effect on

wage rates in the economy.

Ethanol Blenders and

Distributors

The blending and distribution of the ethanol blends usually are not

integrated with ethanol production. Ethanol and gasoline usually have

been blended by businesses that purchase gasoline at wholesale from

refiners and purchase ethanol at wholesale from ethanol producers. Most

fuel ethanol is sold in the open market rather than through integrated

distribution channels. The ethanol is sold primarily to wholesalers beyond

the refinery gate so that ethanol competes directly with wholesale gasoline

and other blending agents. Most petroleum pipelines will not carry ethanol

because the ethanol can suffer water contamination or cross

contamination with other petroleum products, and because of ethanol’s

corrosive properties. Therefore, ethanol is usually transported by truck or

rail and blended with gasoline, which arrives by pipeline at the distribution

points.

However, in the future, gasoline refiners may begin to account for a larger

share of alcohol fuel-blending than they have in the past. New IRS

regulations (effective Oct. 1, 1995) allow ETBE, which is an ether derived

from ethanol, to qualify for both the partial excise tax exemption and the

income tax credits. ETBE (like the ether MTBE) can be blended with gasoline

and transported via pipelines without serious problem.

Page 51 GAO/GGD-97-41 Tax Policy
Appendix IV 

Description of Groups in the Economy That

the Ethanol Tax Incentives Affect

Ethanol Producers The ethanol industry is dominated by a few firms. Sixty-five percent of

capacity is owned by the three largest firms, and the largest firm, Archer

Daniels Midland, owns 50 percent. In 1994, total capacity of the industry

was about 1.6 billion gallons per year, and total output was about 1.3

billion gallons. A few large plants account for the bulk of capacity, with 50

percent of industry capacity accounted for by four large plants owned by

Archer Daniels Midland. The average capacity of these plants was about

215 million gallons per year.

Economies of scale are difficult to quantify because of diverse plant

configurations in the industry. However, some estimates are that plants

need an annual capacity of 50 to 100 million gallons per year to take

advantage of economies of scale. In 1995, the four large plants owned by

Archer Daniels Midland accounted for about 70 percent of the capacity of

plants in the industry that can produce more than 50 million gallons per

year.

The ethanol is produced using dry-milling and wet-milling technologies.

Both processes convert a bushel of corn into approximately 2.5 gallons of

ethanol. The technologies differ in the byproducts produced and capital

costs. Generally, wet milling has higher capital costs but produces more

valuable byproducts than dry milling. The byproducts of the wet-milling

process include corn gluten meal, corn gluten feed, corn oil, and carbon

dioxide. The principal byproduct of dry milling is direct distillers grains,

which is a high protein livestock feed. Wet milling accounts for about

60 percent of the total ethanol production.

The net cost of producing ethanol depends on the price of corn; the value

of the byproducts generated in the production process; the costs of

energy, chemicals, and labor; the size of the plant; and the technology used

to produce the ethanol. The estimates of total costs can vary significantly

depending on variations in these components of costs. A 1988 report15 by

the American Petroleum Institute (API) estimated the total cost of ethanol

production in a wet-milling plant with a capacity of about 50 million

gallons per year at $1.14 per gallon with corn prices at $1.80 per bushel

and at $1.38 per gallon with corn prices at $2.75 per bushel. API estimated

dry-milling costs in a plant with the same capacity at $1.25 and $1.48 using

the same variation in corn prices. A 1992 analysis by the U.S. Department

15Anderson, Lareau, and Wollstadt, The Economics of Gasoline Ethanol Blends.

Page 52 GAO/GGD-97-41 Tax Policy
Appendix IV 

Description of Groups in the Economy That

the Ethanol Tax Incentives Affect

of Agriculture’s (USDA) Economic Research Service (ERS)16 estimated the

total cost, in 1992, for a wet-milling plant with 100-million gallon capacity

at $1.24 per gallon of ethanol produced. This estimate was based on

average corn prices and byproduct prices from 1981 to 1991. ERS reported

estimates by other researchers that range from $1.08 to $1.95 per gallon.

The Effect on the Ethanol

Industry of Removing the Tax

Incentives

Without the tax incentive, fuel ethanol production would largely

discontinue. This conclusion is based on estimates of ethanol production

costs, the opinions of industry analysts, and the results of simulation

models estimating the effect of removing the exemptions.

The cost of producing ethanol exceeds the price of the alternatives, given

the current technology and recent prices of substitute fuels. The wholesale

price of gulf coast regular gasoline at the rack averaged about $0.55 per

gallon in the second half of 1995, and the price of the methanol-based

additive, MTBE, averaged about $0.81 per gallon. The estimates of ethanol

production costs reported above all exceed the prices of these alternative

products. On the basis of these cost estimates, ethanol could not be priced

to match the prices of the alternative products and cover the cost of

producing ethanol and the additional costs of distributing ethanol to

blenders.

The economic viability of the ethanol industry depends on the size of state

subsidies as well as the federal incentives. States provide incentives for

ethanol in the form of tax exemptions and production subsidies. As of

December 1995, according to one industry survey, eight states had

production subsidies that ranged from 20 to 40 cents per gallon of ethanol,

and nine states had a sales tax or motor fuels tax exemption for ethanol.

These exemptions range from 10 cents per gallon of ethanol in

Connecticut and Iowa to 80 cents per gallon in Alaska. These state tax

incentives, combined with the federal exemption of 54 cents per gallon,

allow ethanol to compete profitably with substitute fuels.

However, ethanol producers may be able to price ethanol competitively

without the incentives if the price of corn were lower and the price of the

substitute fuels were higher, or if significant cost savings were made

through technological improvements. In 1988, API estimated that corn

would need to cost as little as $1.80 per bushel and wholesale gasoline

would have to sell for as much as $1.25 per gallon for producers to price

ethanol competitively with gasoline and cover their production cost.

16Hohman, Neil and C. Matthew Rendleman, “Emerging Technology in Ethanol Production,”

Agriculture Information Bulletin, No. 663, (Economic Research Service, U.S. Department of

Agriculture, January 1993), pages 1 to 17.

Page 53 GAO/GGD-97-41 Tax Policy
Appendix IV 

Description of Groups in the Economy That

the Ethanol Tax Incentives Affect

Estimates made in 1993 of cost savings from improvements in technology

show short-term gains (in the next 2 to 5 years) of 5 to 7 cents per gallon

and long-term gains (in the next 5 to 10 years) of an additional 4 to 8 cents

per gallon.

In addition to the cost analysis, the views of analysts of the ethanol

industry also lead us to conclude that the ethanol production would

largely discontinue if the incentives were removed. For our 1995 report,

we interviewed ethanol and gasoline industry trade groups, ethanol

producers, and government officials.17 We concluded from the interviews

that, without the incentives, large-scale ethanol producers having the

lowest production costs may continue to produce ethanol, at least in the

short term, but that the amount of ethanol used would decline

dramatically. Some ethanol production for export may continue for a

while, although the amount of U.S. exports of ethanol varies a great deal

from year to year.18 In our 1995 report, we used declines of 50 and

90 percent with no expected future growth in ethanol use in the

simulations used to assess the effect of eliminating the exemption on farm

prices and incomes.

Simulations by the Energy Information Agency (EIA) also led to the

conclusion that the ethanol fuel production would largely discontinue if

the incentives were removed. According to EIA, ethanol would represent

about 21 to 33 percent of the oxygenate content of gasoline through 2015 if

the exemption were continued at current levels, while the rest of the

oxygenate content would be MTBE and other ethers. The EIA model projects

that ethanol-blending would discontinue if the exemptions actually were

to expire after 2000, but it would recover slightly by 2015 to cover about

2 percent of the oxygenate market. The recovery would occur because the

prices of other blending components would rise more rapidly than the

price of ethanol throughout the forecast period.

Producers of Alternative

Gasoline Additives

Substitutes for ethanol as an octane enhancer are hydrocarbon aromatics,

such as benzene, toluene, and xylene. The chief substitute for ethanol as

an oxygenate is MTBE, which is produced using methanol. MTBE also

enhances octane but to a smaller extent than ethanol. MTBE is a less costly

source of oxygen in blended fuels than ethanol. MTBE is currently derived

17GAO/RCED-95-273R.

18The export market for ethanol is volatile because the foreign demand for U.S. ethanol depends on the

price of sugar. Because ethanol production involves the fermentation of sugar, when sugar prices are

low, more ethanol is produced abroad and demand for U.S. ethanol is less.

Page 54 GAO/GGD-97-41 Tax Policy
Appendix IV 

Description of Groups in the Economy That

the Ethanol Tax Incentives Affect

from natural gas and, therefore, it does not benefit from the federal tax

preferences. These preferences are sufficient to make ethanol competitive

with MTBE as an oxygenate. Ethanol and ethanol-based additives had

35 percent of the oxygenate market in 1994, while MTBE had about

65 percent.

If the tax incentives were removed, MTBE is likely to supply nearly all of the

oxygenate and octane enhancer markets. According to EIA simulations,

MTBE would almost entirely replace ethanol if the incentives were

removed. EIA also measured the impact of eliminating the incentives on the

price of reformulated gasoline. The differential between the price of

reformulated gas and conventional gasoline would increase from about 4

cents per gallon to 5 cents per gallon after 2000 if the exemption is

eliminated.

Farmers Corn is the principal feedstock used for ethanol production. About 95

percent of the ethanol sold for gasoline in the United States is made from

corn; the rest is made from wheat, barley, and potato waste. In 1995,

approximately 500 million bushels of corn were used to produce about

1.3 billion gallons of ethanol. Corn used in ethanol production represented

about 6 percent of the total corn output in 1995. Most ethanol production

is in corn-growing states.

Ethanol production increases the supply of high-protein animal feed and

corn oil byproducts from the conversion of corn into ethanol. The

dry-milling process generates distilled dried grains, while the wet-milling

process produces gluten meal, gluten feed, corn oil and carbon dioxide.

The increased supply of these byproducts may reduce the demand for and

price of oil seeds, such as soybeans, cottonseed, and sunflower seeds. The

increased supply of byproducts may reduce demand for soybeans because

the byproducts compete with soybean meal in the high protein meal

markets and with soybean oil in the vegetable oil markets. However, the

effect of reduced demand on soybean prices may be offset by a reduction

in supply as farmers switch to more profitable corn production following

an increase in the price of corn. Corn is a primary competitor for soybean

acreage, and as farmers substitute corn for soybean acreage, soybean

supply may fall and its price increase, offsetting the effect on soybean

prices of the drop in soybean demand due to increased production of

ethanol byproducts.

Page 55 GAO/GGD-97-41 Tax Policy
Appendix IV 

Description of Groups in the Economy That

the Ethanol Tax Incentives Affect

Farmers use corn and other feed grains for their livestock. The higher corn

prices due to the ethanol tax incentives may increase the feed costs of

some livestock producers, such as those who raise cattle. However, to the

extent that the increased supply of ethanol byproducts lowers the price of

high protein animal feed, other producers, such as those who raise

poultry, may face lower costs. Although, as a group, grain producers may

increase their income, the total effect on farmers’ incomes depends on the

net effect of the price changes on grain, oilseed, and livestock producers.19

The Effect of the Ethanol Tax

Incentives on Farm Prices and

Incomes

In our 1995 report, we estimated the effect of removing the tax incentives

on farm prices and income assuming that all agricultural policies set forth

in the 1990 farm bill would be maintained. We used an econometric model

developed by the Food and Agriculture Policy Research Institute (FAPRI) to

estimate the effect of the removing the incentives, assuming that the

demand for ethanol would decline by 50 percent and 90 percent.20 Each of

these scenarios was estimated for the period 1995 through 2000, assuming

alternatively no corn acreage reduction and that corn acreage would be

reduced as modeled in the 1995 FAPRI baseline.21 Under both sets of

assumptions, we concluded that corn prices, soybean prices, and net farm

income would decline if the tax incentives were removed. We found that

the average decline in the price of corn over the period 1995 through 2000

would range from 5.9 to 9.3 percent for a 50- and 90-percent decline in

ethanol use. We also found that, for a 50-and 90-percent decline in ethanol

use, the average decline in the price of soybeans would range from 3.0 to

4.8 percent, and the average decline in net income for all farmers would

range from 1.4 to 2.4 percent.

We did not estimate the effect on prices and incomes of removing the

incentives under the new policies introduced by the Federal Agricultural

Improvement and Reform (FAIR) Act of 1996. According to analysts at USDA

19In cases where farmers do not own the land they work, in theory, the benefit of higher farm prices

could be shifted back to the owners in terms of higher land prices or rents. In these cases, the effect of

the incentives on farm incomes would include the effect on the income of land owners as well as the

farmers who work the land.

20FAPRI uses a set of integrated models to determine the consequences of policies and programs that

affect U.S. and world agriculture. The FAPRI modelling system consists of U.S. domestic crop models;

U.S. livestock models; world trade models for feed grains, wheat and soybeans; a model that estimates

the cost of domestic government agricultural programs; and a model that estimates net farm income.

21The FAPRI baseline assumes that the acreage that farmers can plant with corn and still be eligible for

federal farm payments would be reduced by 7.5 percent in the first year and 5 percent thereafter. CBO

suggested that a reasonable alternative is to assume that the Secretary of Agriculture would have

reduced the acreage that farmers were allowed to plant with corn to remain eligible for federal

payments sufficiently to offset the effect of the reduced demand for corn on corn prices.

Page 56 GAO/GGD-97-41 Tax Policy
Appendix IV 

Description of Groups in the Economy That

the Ethanol Tax Incentives Affect

and the Congressional Budget Office (CBO), corn and net farm income

would decline under the FAIR Act if the incentives are removed. The FAIR

Act, by eliminating the barriers to shifting acreage among crops, also

increased the likelihood that the drop in ethanol production would result

in a decrease in soybean prices if the incentives were removed. However,

our estimates of the size of these price and income declines would be

different because the estimates would reflect these new policies and

changed market conditions since our report. For example, the decline in

farm incomes may be different under the FAIR Act because the act removed

the link between farm payments and farm prices so that lower market

incomes from corn would not be offset by increasing deficiency payments.

Our 1995 analysis assumed that government deficiency, or income

support, payments would be made as corn prices declined, somewhat

compensating corn farmers for lower market receipts from corn. The FAIR

Act retained a program of government loans, which may moderate the

decline in farm incomes if market price declines are severe.22 However,

USDA believes that the price of corn is unlikely to fall far enough for the

loans to be used to mitigate the effect of the price declines on farm

income.

Consumers Consumer demand for ethanol is based on its characteristics as a motor

fuel and on environmental regulations. Ethanol is used in gasohol in

unregulated markets as a gasoline extender and octane enhancer. Over

76 percent of all gasohol is sold in midwestern states where it is

competitive in price with gasoline because of the states’ proximity to

ethanol producers and because of state tax incentives for gasohol. Ethanol

is also used as an oxygenate to meet environmental regulations. According

to estimates that are based on ethanol industry data, in 1995, ethanol

represented 28 percent of the oxygenates used in the oxygenated fuels

market and 7 percent of the oxygenates used in the reformulated gasoline

market. By 2002, these ethanol shares are estimated to increase to

38 percent and 13 percent of the respective markets, if the tax incentives

are continued at the current levels.

22Farmers may receive a loan from the government at a designated rate per unit of production (loan

rate) by pledging and storing a crop as collateral. The farmers have the option either to repay their

loans with interest at any time or, at the end of the loan period, to forfeit their crop to the government

and have their interest payments forgiven. Farmers who raise certain crops, such as oilseeds, wheat,

and feedgrains, may repay the loans at alternative repayment rates that are based on price data from

USDA when these rates are lower than the loan rates. Because the farmers keep the difference

between the loan rate and the alternative payment rate, they can sell their crops at market prices

without reducing their returns. Farmers who do not take out loans may also receive amounts called

loan deficiency payments that are equal to this difference between the loan rate and the alternative

payment rate.

Page 57 GAO/GGD-97-41 Tax Policy
Appendix IV 

Description of Groups in the Economy That

the Ethanol Tax Incentives Affect

Consumers benefit if the tax incentives are passed on in the form of lower

motor fuel prices. Price-shifting depends on the price elasticity of demand

for ethanol-blended fuels. The more inelastic is demand, the more the

consumer would benefit from the incentives. The price elasticity for

ethanol blends is affected by the availability of substitute fuels with similar

characteristics and by environmental regulations requiring the use of

additives, such as ethanol. Demand would be less responsive to price

changes to the extent that the use of ethanol is required to meet

environmental standards and to the extent the ethanol blend is perceived

to have characteristics different from other motor fuels.

Consumers are not likely to benefit much from the tax incentives in the

regulated markets because the regulations do not require the use of

ethanol. The environmental regulations have increased demand for

ethanol for use as an oxygenate. Since the Clean Air Act Amendments of

1990, demand for ethanol and MTBE has more than doubled. However,

these regulations do not specify that ethanol be used as the oxygenate.

MTBE, which is less costly to produce than ethanol, already has about

65 percent of these regulated markets. The demand for ethanol blends in

these markets is likely to be highly elastic because consumers will respond

to any price differences by purchasing the lower-priced fuel.

Consumers also are not likely to benefit much from the tax incentives in

unregulated markets because the fuel characteristics of ethanol blends

make them a close substitute for gasoline. Ethanol blends have higher

octane levels than gasoline, which improves driveability by reducing

engine knock. However, the blends also have higher volatility than

gasoline, which reduces driveability by causing vapor lock in hot weather,

and the blends get fewer miles per gallon because ethanol has about

two-thirds the energy content of gasoline. API concluded from its review of

driveability studies that the octane, volatility, and mileage tradeoffs turn

out to be about equal, and that most consumers view ethanol blends as

close substitutes for gasoline.

Because the ethanol blends are viewed as close substitutes for gasoline by

most consumers, the effect of the incentives on gasoline prices would be

limited by the size of ethanol production relative to the total market for

motor fuels. Since ethanol makes up only 1 percent of the motor fuel

supply, removing the incentives is unlikely to have a large impact on price.

In 1988, API estimated that the tax incentives lowered the price of motor

fuels by 0.27 percent.

Page 58 GAO/GGD-97-41 Tax Policy
Appendix IV 

Description of Groups in the Economy That

the Ethanol Tax Incentives Affect

MTBE blends are also close substitutes for ethanol blends for use as an

octane enhancer and gasoline extender in the unregulated markets.

Ethanol blends have a higher octane level but have lower mileage and

higher volatility. Removing the ethanol tax incentives would increase

demand for MTBE both as an oxygenate and as an octane enhancer. The

consumers are likely to respond to any difference in price by purchasing

the lower-priced fuel. As previously described, EIA has estimated that

removing the tax incentives would produce a small increase in the price of

reformulated gasoline produced with MTBE.

The ethanol tax incentives may also affect consumers as buyers of food.

As previously discussed, the incentives may cause the prices of some

crops to be higher, which could then lead to slightly higher prices to

consumers for some food products. The benefit to consumers from lower

gasoline prices could be reduced by the higher food prices due to the

incentives. However, like the effect on gasoline prices, the effect on food

prices is likely to be very small. For example, the increased price that

farmers receive for their corn may represent a much smaller price increase

for consumers because, in many cases, the corn is only a part of the

product purchased by the consumer, and the farmer’s price is only part of

the product’s retail cost to the consumer. Furthermore, the effect of the

increased corn price on the consumer’s total food costs is small because

spending on corn and products derived from corn represents only a part of

the consumer’s food budget.

Page 59 GAO/GGD-97-41 Tax Policy
Appendix V 

Major Contributors to This Report

General Government

Division, Washington,

D.C.

James A. Wozny, Assistant Director, Tax Policy and Administration Issues

Anne O. Stevens, Economist-in-Charge

Kevin E. Daly, Senior Economist

Charles C. Tuck, Senior Economist

Resources,

Community and

Economic

Development

Division, Washington,

D.C.

Mary C. Kenney, Senior Economist

(268734) Page 60 GAO/GGD-97-41 Tax Policy
Ordering Information

The first copy of each GAO report and testimony is free.

Additional copies are $2 each. Orders should be sent to the

following address, accompanied by a check or money order

made out to the Superintendent of Documents, when

necessary. VISA and MasterCard credit cards are accepted, also.

Orders for 100 or more copies to be mailed to a single address

are discounted 25 percent.

Orders by mail:

U.S. General Accounting Office

P.O. Box 6015

Gaithersburg, MD 20884-6015

or visit:

Room 1100

700 4th St. NW (corner of 4th and G Sts. NW)

U.S. General Accounting Office

Washington, DC

Orders may also be placed by calling (202) 512-6000 

or by using fax number (301) 258-4066, or TDD (301) 413-0006.

Each day, GAO issues a list of newly available reports and

testimony. To receive facsimile copies of the daily list or any

list from the past 30 days, please call (202) 512-6000 using a

touchtone phone. A recorded menu will provide information on

how to obtain these lists.

For information on how to access GAO reports on the INTERNET,

send an e-mail message with "info" in the body to:

info@www.gao.gov

or visit GAO’s World Wide Web Home Page at:

http://www.gao.gov

PRINTED ON RECYCLED PAPER
United States

General Accounting Office

Washington, D.C. 20548-0001

Official Business

Penalty for Private Use $300

Address Correction Requested

Bulk Rate

Postage & Fees Paid

GAO

Permit No. G100