Corn ethanol tax credit: most expensive way to create jobs ever?

Today, in yet another example of ethanol industry spin, the Renewable Fuels Association released a state-by-state version of its highly inflated jobs study. This is just another part of big ethanol’s effort to make the case for extending the Volumetric Ethanol Excise Tax Credit (VEETC)—a massive, taxpayer-funded subsidy for corn ethanol—on top of both blending mandates under the Renewable Fuels Standard (RFS) and stiff border tariffs to protect domestic ethanol producers from foreign competition. I wrote yesterday about some of the reasons why the industry’s jobs numbers are way off, but given RFA’s release, it seems worth getting into more of the details.

There are three basic points here:

  1. Inflated jobs multipliers: As I discussed yesterday, big ethanol is using wildly inflated job multipliers. For every direct job created at an ethanol plant, the industry group Growth Energy is claiming 31.5 additional new jobs are created throughout the economy. For studies that try to be realistic and specific about jobs in the ethanol industry, a multiplier of about 6 is aggressive. A job multiplier of 3-4 is much more realistic, especially since big ethanol claims to have little to no impact on food and feed production or prices and therefore cannot take credit for somehow magically creating thousands of corn growing jobs that would have existed anyway.
  2. Inflated economic impact: To get to their inflated jobs numbers, big ethanol is also claiming that it will take a big economic hit from the loss of the VEETC and the associated import tariff. Unfortunately, they play fast and loose with the economics. (To get close to their numbers you have to assume that the industry is wildly uneconomic.) More on this below, but adjusting their numbers for a bit of reality and the hit is half to one quarter of what they claim. Estimates from the Food and Agricultural Policy Research Institute (FAPRI) come in at about a quarter. That means the direct jobs impact is 1/4 of industry estimates even before we get to a more realistic jobs multiplier.
  3. Just about any other use of $31 billion would create more jobs: If we start with a more realistic economic impact and the resulting, much smaller direct jobs impact and then use a more realistic jobs multiplier, we end up with a job impact of about two thousand. A five year extension of the VEETC will cost over $31 billion in taxpayer dollars. That means using the VEETC to keep about two thousand people employed for the next 5 years will cost of about $2.5million per job per year. I’ve written about NRDC’s proposal for a Greener Biofuels Tax Credit and obviously believe that would create more jobs, more security and more environmental benefits, but the reality is just about anything would be more cost effective than simply extending the VEETC in its current form.

So now to some of the wonky numbers behind points 2 and 3 above. The analysis in RFA’s study starts with the claim that if the VEETC and tariff expire, the price of ethanol will drop by the full $0.45 per gallon value of the VEETC. The premise here is that industry has fully internalized this incentive and so their marginal costs fully reflect it. For this to be true we have to accept the notion that corn ethanol is wildly uneconomic and needs this $0.45 simply to survive—meaning that neither the industry nor the oil companies are profiting at all at the taxpayers’ expense. While big ethanol likes to claim that its margins are razor thin, this implies that we’ll have to subsidize them forever. A more realistic assumption is that the oil companies are pocketing most if not all of the VEETC value. After all, the demand and supply have been a bit above the RFS mandated levels every year, which means the oil companies are setting the demand level and thus the price levels. Big oil gets to keep big ethanol’s prices low and keep the VEETC as profit.

This is a key assumption because the initial price hit of removing the VEETC triggers shifts in demand, which trigger further shifts in price and thus supply based on elasticities of supply and demand. The net result is a smaller change in the price and supply of ethanol.

[Since I had to remind myself, here’s a quick refresher on elasticity of demand and supply: the former refers to how demand in the market for a good changes in response to changes in price, whereas the latter refers to changes in the supply of the good as a result of price changes. When demand is perfectly inelastic, even large changes in price will not cause a decrease in demand. Perfectly inelastic supply—i.e. supply that is fixed no matter what the price—means that regardless how high a price people are willing to pay, no more supply of a specific good will be produced].

RFA notes that the elasticity of demand for ethanol, as with gasoline, is relatively inelastic, with fairly consistent published estimates (between -0.37 and -0.43, meaning a 10% decline in the price of ethanol would result in a 3.7 to 4.3% increase in demand). In the case of the elasticity of supply, however, the range of published estimates is much wider: from 0.37 on the low end to 4.0 on the high end. This large a discrepancy in estimates should prompt further discussion or perhaps the use of ranges and/or scenarios in an analysis such as RFA’s. Instead, RFA chooses the dubious route of simply averaging available supply elasticities to arrive at a magic estimate of 1.375 (meaning that a 10% decline in ethanol prices would result in a much higher 13.8% decline in production).

The results of their full calculation can be seen in this table from RFA’s study:

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Combining this averaged elasticity of ethanol supply with their earlier assumption that removing the VEETC would cause a $0.45 per gal drop in the price paid to ethanol producers, RFA estimates that producers will see a net drop in ethanol prices of 37 per gal or 22.5%, forcing them to cut supply by nearly 38%.

If we repeat RFA’s calculation with more modest assumptions—a $0.225 per gal drop in the price of ethanol with the removal of the VEETC (half the VEETC value assuming that the other half goes into the pockets of the oil companies) and lower-end estimates of the elasticity of supply to changes in ethanol prices (0.37 to 0.75)—the result is ethanol prices that are only 7 to 12% lower without the VEETC and a reduction in supply of only 5 to 10%.

Base Ethanol Price (cts/gal)

164

164

Price change with removal of VEETC (cts/gal)

-22.5

-22.5

Net Ethanol Price (cts/gal)

141.5

141.5

Percent Change

-13.7%

-13.7%

     

Ethanol Demand Elasticity

-0.43

-0.43

Potential Change in Ethanol Demand

5.9%

5.9%

Ethanol Supply Elasticity

0.37

0.75

Potential Change in Ethanol Production

-5%

-10%

Price Elasticity of Ethanol Supply

-0.37

-0.75

Increase in Price from Reduced Production

1.9%

7.7%

Net Change in Ethanol Price

-12%

-6%

Ethanol Price after VEETC Removal (cts/gal)

144

153

Tellingly, the results of the FAPRI study that I wrote about a few weeks ago fall right into this range. In the FAPRI analysis of what would happen if the VEETC and tariff both expired, domestic production of corn ethanol still increases in every year, but between now and 2015, it grows by about 10% less than the baseline. The price also drops by $0.19 per gallon or 10% from the baseline.

So, what happens if the supply only changes by about 10% rather than RFA’s hysterical 33%? Well to start, a lot less direct job loss. At 45 employees per 100 million gallon per year plant, 1.4 billion gallons would require about 630 people to produce. With a jobs multiplier of 3 to 4, that’s just 1,890 to 2,520 jobs in the entire economy that are being driven by the VEETC at a cost of about $5.5 billion per year. That’s $2.1-2.9 million per job every year just to retain those jobs!

What this demonstrates is that the VEETC is widely wasteful—by paying for every gallon, we grossly overpay for any marginal benefits. There is a huge loss incurred by U.S. taxpayers when our scarce public resources are used this inefficiently to support mature technologies instead of investing in new, better performing advanced biofuels. Given the billions of dollars at stake to support a subsidy that generates little ethanol production above and beyond quantities already mandated by the RFS, Congress needs to seriously weigh the costs and benefits of extending the VEETC and ask themselves: should we really be subsidizing corn ethanol forever? Is there a better way we could be spending scarce taxpayer resources that would help bring new, more competitive biofuels to market, create more jobs, give us more security and deliver better environmental performance? The answer, I think, is a resounding yes. NRDC’s Greener Biofuels Tax Credit would pay for environmental performance, support innovation, and speed our transition to a clean energy economy with next generation biofuels that can make a real contribution to the environment, our energy security and the U.S. economy.

About the Authors

Nathanael Greene

Director, Renewable Energy Policy, Energy & Transportation program

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