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The Economics of U.S. Ethanol Import Tariffs with a Consumption Mandate and Tax Credit

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Abstract

This paper analyzes the impact of an ethanol import tariff in conjunction with a consumption mandate and tax credit. A tax credit alone acts as a subsidy to ethanol producers, equally benefiting exporters like Brazil. If an import tariff is imposed to offset the tax credit, world prices of ethanol decline by less than the tariff (unless oil prices are unaffected). Eliminating the tariff with a tax credit in place results in a significant gain to exporters like Brazil but eliminating the tax credit too reduces the initial benefits to Brazil of the tariff reduction substantially. The results change however if there is “water” in the tax credit. Then exporters benefit much more with the elimination of both the tariff and tax credit compared to a situation of both policies in place. If only a mandate was in place, exporters like Brazil again benefit as much as domestic ethanol producers do. Eliminating the tariff with a mandate results in an increase in domestic ethanol prices (even if oil prices do not change) because more domestic supply is required to maintain the mandate. The tariff therefore has a smaller negative impact on world ethanol prices with a mandate compared to a tax credit. A tax credit with a binding mandate is a subsidy to fuel consumers and only indirectly benefits ethanol producers if ethanol prices increase due to increased demand for ethanol with the increase in fuel consumption). Therefore, eliminating the tax credit with a binding mandate has little effect on market prices of ethanol – domestic and foreign producers alike benefit very little with a tax credit in this situation. Brazil would much prefer the elimination of the tax credit and the so-called offsetting import tariff when a mandate is binding. Hence, the protective effects of an import tariff are not additive with either a tax credit or the price premium due to a mandate.

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WP 2007-21 October 2007

JEL Classification Codes: F13; Q17; Q18; Q42

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2007-10-01

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Charles H. Dyson School of Applied Economics and Management, Cornell University

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