Tax Policy: Effects of the Alcohol Fuels Tax Incentives (Letter Report,
03/06/97, GAO/GGD-97-41).

Pursuant to a congressional request, GAO provided information relating
to tax incentives for alcohol fuels, focusing on: (1) whom the
incentives benefit and disadvantage economically; (2) what environmental
benefits, if any, the incentives have produced; (3) whether the
incentives increased the nation's energy independence; and (4) the
extent to which the partial exemption from the excise tax for alcohol
fuels has reduced the flow of revenue into the Highway Trust Fund.

GAO found that: (1) the value of the ethanol tax incentives is shared
among different groups in the economy, including alcohol fuel blenders,
ethanol producers, and corn farmers; (2) according to the analysts GAO
contacted or whose work GAO read, the tax incentives allow ethanol to be
priced to compete with substitute fuels; (3) without the incentives,
ethanol fuel production would largely discontinue; (4) by raising the
prices for corn and soybeans, the tax incentives may cause farmers who
raise livestock to pay higher prices for feed; (5) 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; (6)
the producers of some fuels 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; (7) the
price decrease that adversely affects producers will benefit the
consumers of these fuels; (8) the price increases that benefit farmers
may adversely affect the consumers of some food products; (9) available
evidence, including the views of analysts GAO interviewed, indicates
that the ethanol tax incentives have had little effect on the
environment; (10) 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; (11)
according to analysts GAO interviewed, if ethanol use were eliminated
there would likely be small changes in emissions in areas which already
meet existing air quality standards that would have both positive and
negative effects on air quality; (12) the effect on global environmental
quality through changes in greenhouse gas emissions that would occur if
ethanol fuel were not subsidized is likely to be minimal; (13) 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 and, therefore, the tax
incentives do not significantly contribute to U.S. energy independence;
(14) more importantly, ethanol tax incentives have not significantly
enhanced U.S. energy security because the tax incentives have not creat*

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  GGD-97-41
     TITLE:  Tax Policy: Effects of the Alcohol Fuels Tax Incentives
      DATE:  03/06/97
   SUBJECT:  Alcohol fuels
             Fuel taxes
             Gasoline
             Oil importing
             Economic analysis
             Air pollution control
             Energy consumption
             Agricultural industry
             Energy shortages
             Renewable energy sources
IDENTIFIER:  Highway Trust Fund
             Leaking Underground Storage Tank Fund
             
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Cover
================================================================ COVER


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

Tax Policy

(268734)


Abbreviations
=============================================================== ABBREV

  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

Letter
=============================================================== LETTER


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? 


--------------------
\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. 


   BACKGROUND
------------------------------------------------------------ Letter :1

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 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


--------------------
\3 See appendix I for a chronology of events and federal legislation
relating to alcohol fuel use. 

\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.)


      TAX INCENTIVES FOR ALCOHOL
      FUELS
---------------------------------------------------------- Letter :1.1

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 Fund\6 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 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. 


--------------------
\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. 


      CURRENT ALCOHOL FUEL USE
---------------------------------------------------------- Letter :1.2

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. 


--------------------
\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. 

\10 RFG, 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.)


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :2

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 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. 

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 (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 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. 


--------------------
\11 Ethanol 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. 

\12 EPA has developed the national ambient air quality standards
based on all of the known health effects from air pollutants. 

\13 The 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. 

\14 Energy Security:  Evaluating U.S.  Vulnerability to Oil Supply
Disruptions and Options for Mitigating Their Effects (GAO/RCED-97-6,
Dec.  12, 1996). 

\15 These 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. 


   OBJECTIVES, SCOPE, AND
   METHODOLOGY
------------------------------------------------------------ Letter :3

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 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 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. 


--------------------
\16 GAO/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). 


   THE ETHANOL TAX INCENTIVES MAY
   BENEFIT OR DISADVANTAGE CERTAIN
   GROUPS IN THE ECONOMY
------------------------------------------------------------ Letter :4

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.  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
---------------------------------------------------------- Letter :4.1

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. 

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. 


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


      ETHANOL TAX INCENTIVES ARE
      LIKELY TO BENEFIT FARMERS
      WHO GROW CORN AND SOYBEANS
---------------------------------------------------------- Letter :4.2

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 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. 


--------------------
\18 GAO/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. 

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


      ETHANOL TAX INCENTIVES MAY
      BENEFIT CONSUMERS AND
      DISADVANTAGE PRODUCERS OF
      SUBSTITUTE FUELS
---------------------------------------------------------- Letter :4.3

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 used\21

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 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. 


--------------------
\20 However, 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. 

\21 Table III.3 in appendix III shows the amounts of gasoline, MTBE,
and ethanol that are consumed within and outside of air quality
nonattainment areas. 


   TAX INCENTIVES FOR ETHANOL FUEL
   ARE LIKELY TO HAVE HAD LITTLE
   EFFECT ON ENVIRONMENTAL QUALITY
------------------------------------------------------------ Letter :5

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
---------------------------------------------------------- Letter :5.1

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.  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
---------------------------------------------------------- Letter :5.2

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 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


--------------------
\22 Ethanol'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. 

\23 When 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. 

\24 For example, ethanol-blended fuel does not meet the stringent
summertime fuel volatility restrictions in ozone nonattainment areas
without adjustments to the gasoline fraction. 

\25 However, 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. 


      NO SIGNIFICANT EFFECT LIKELY
      THROUGH THE USE OF
      ALTERNATIVE-FUEL VEHICLES
---------------------------------------------------------- Letter :5.3

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. 


      NO SIGNIFICANT EFFECT IS
      LIKELY ON GLOBAL
      ENVIRONMENTAL QUALITY
---------------------------------------------------------- Letter :5.4

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. 

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. 


--------------------
\26 For 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. 

\27 To 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. 

\28 M.  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. 

\29 Ethanol 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. 

\30 The 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. 


   TAX INCENTIVES FOR ETHANOL FUEL
   ARE UNLIKELY TO HAVE
   SIGNIFICANTLY AFFECTED U.S. 
   ENERGY INDEPENDENCE OR ENERGY
   SECURITY
------------------------------------------------------------ Letter :6

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, ethanol\31 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 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. 


--------------------
\31 This 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. 

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

\33 Oil 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. 

\34 GAO/RCED-97-6. 


   THE PARTIAL EXEMPTION REDUCED
   HIGHWAY TRUST FUND REVENUES
   FROM FISCAL YEARS 1979 TO 1995
------------------------------------------------------------ Letter :7

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). 

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 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. 


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

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

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

\38 The 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. 

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


   AGENCY COMMENTS AND OUR
   EVALUATION
------------------------------------------------------------ Letter :8

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 balance\40 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. 


--------------------
\40 The 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. 


      BENEFITS AND COSTS OF THE
      TAX INCENTIVES
---------------------------------------------------------- Letter :8.1

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. 

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 account of pre-existing distortions in
resource allocation, such as those caused by other tax provisions. 


--------------------
\41 We 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. 

\42 Total production includes the production of intangibles, such as
energy security, and improvements in environmental quality. 


      POTENTIAL FUTURE BENEFITS
      FROM CELLULOSIC BIOMASS
      ETHANOL
---------------------------------------------------------- Letter :8.2

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
---------------------------------------------------------- Letter :8.3

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
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
---------------------------------------------------------- Letter :8.4

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."


--------------------
\43 Alternative Fuels:  Experiences of Brazil, Canada, and New
Zealand in Using Alternative Motor Fuels (GAO/RCED-92-119, May 7,
1992). 


      OXYGENATE SECURITY
---------------------------------------------------------- Letter :8.5

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 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. 


--------------------
\44 GAO/RCED-96-121. 


      ENERGY BALANCE OF ETHANOL
      COMPARED WITH OTHER FUELS
---------------------------------------------------------- Letter :8.6

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. 


--------------------
\45 For example, see Wang, GREET 1.0 -- Transportation Fuel Cycles
Model:  Methodology and Use, pages 40 to 43 and 46. 


      EFFECT OF THE TAX INCENTIVES
      ON FEDERAL OUTLAYS
---------------------------------------------------------- Letter :8.7

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. 

Second, as we noted in the ï¿½objectives, scope, and methodologyï¿½
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. 


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


      OTHER COMMENTS
---------------------------------------------------------- Letter :8.8

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. 


---------------------------------------------------------- Letter :8.9

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 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


CHRONOLOGY OF THE LEGISLATION AND
EVENTS AFFECTING ETHANOL FUEL USE
=========================================================== Appendix I

          Legislation/Event             Ethanol summary
Year      ----------------------------  ----------------------------------------
1967      Air Quality Act of 1967       Regulated ambient air quality.
          (P.L. 90-148)                 Established emissions standards and a
                                        basic fuel and fuel additive
                                        registration program.

1970      U.S. production of crude oil  Increased U.S. dependence on foreign
          peaked                        sources of crude oil, primarily from
                                        OPEC.

          Clean Air Amendments of       Established the National Ambient Air
          1970                          Quality Standards and began regulating
          (P.L. 91-604)                 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           Established government controls on
          Allocation                    domestic petroleum price and supply,
          Act of 1973                   replacing market forces.
          (P.L. 93-159)

1974      Supplier-Purchaser Rule,      Below-market petroleum prices and
          Buy-Sell Program, and Crude   allocated supplies caused lowered
          Oil Entitlement Program       incentives for oil exploration and
                                        production, increased incentives to
                                        import oil, and greater domestic oil
                                        demand.

          Unleaded motor gasoline was   Began the transition to unleaded
          introduced at gasoline        gasoline. Transition was enhanced by the
          stations                      compatibility of unleaded gasoline with
                                        the catalytic converter, which was
                                        developed to reduce tailpipe emissions.

1975      Energy Policy and             Established the Strategic Petroleum
          Conservation                  Reserve to deter and mitigate effects of
          Act of 1975                   future oil supply disruptions.
          (P.L. 94-163)

1978      U.S. demand for petroleum     Subsequent decline in demand contributed
          peaked                        to lower oil imports.

          Powerplant and Industrial     Restricted construction of electric
          Fuel                          powerplants with petroleum or natural
          Use Act of 1978               gas as their primary fuel.
          (P.L. 95-620)

          Energy Tax Act of 1978        Established a 4 cents per gallon (then
          (P.L. 95-618)                 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   Authorized funds for building alcohol
          (P.L. 96-294)                 fuel production plants.

          Crude Oil Windfall Profit     Extended the 4-cent exemption for
          Tax Act of 1980               gasohol to December 1, 1992, and
          (P.L. 96-223)                 established a blender's tax credit of 40
                                        cents per gallon of alcohol used in the
                                        production of gasoline/alcohol mixtures.

          Omnibus Reconciliation Tax    Placed a tariff on imported ethyl
          Act of 1980                   alcohol to be used in the production of
          (P.L. 96-499)                 gasoline/alcohol mixtures.

1981      Petroleum Price and           Reinstated market forces for petroleum
          Allocation Decontrol          prices. Domestic crude oil production
          (E.O. 12287)                  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.

1982      Surface Transportation        Raised the gasoline tax rate from 4 to 9
          Assistance                    cents per gallon and increased the
          Act of 1982                   exemption for gasohol from 4 to 5 cents
          (P.L. 97-424)                 per gallon. Set a 9 cents per gallon
                                        exemption for fuels containing 85
                                        percent or more alcohol.

1984      Tax Reform Act of 1984        Raised the exemption for gasohol from 5
          (P.L. 98-369)                 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        Reduced the exemption for 85-percent
          (P.L. 99-514)                 alcohol fuels from 9 to 6 cents per
                                        gallon.

          Superfund Revenue Act of      Raised the gasoline excise tax rate from
          1986                          9.0 to 9.1 cents per gallon.
          (P.L. 99-499)

1988      Alternative Motor Fuels Act   Addressed national energy policy
          of 1988                       concerns and created a program of
          (P.L. 100-494)                financial support for research,
                                        development, and demonstration of
                                        alternative motor vehicles and
                                        alternative fuels.

          Technical and Miscellaneous   Permitted gasohol blenders to purchase
          Revenue Act of 1988           gasoline and alcohol at different
          (P.L. 100-647)                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           Reduced evaporative emissions of smog-
          Regulations                   producing compounds in gasoline.

1990      Persian Gulf Crisis of 1990-  Unlike with previous oil supply
          91                            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                Raised the gasoline excise tax rate from
          Reconciliation                9.1 to 14.1 cents per gallon, reduced
          Act of 1990                   the gasohol exemption from 6.0 to 5.4
          (P.L. 101-508)                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   Initiated a mandated phaseout in the use
          1990                          of lead as a gasoline octane enhancer.
          (P.L. 101-549)                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     Extended gasohol excise tax exemption to
          (P.L. 102-486)                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      Required oxygenated gasoline use in
          began                         wintertime in air quality nonattainment
                                        areas for carbon monoxide.

1993      Omnibus Budget                Raised gasoline excise tax rate from
          Reconciliation                14.1 to 18.4 cents per gallon.
          Act of 1993
          (P.L. 103-66)

1994      EPA mandated 30-percent       Issued a ruling that at least 30 percent
          minimum renewable oxygenate   of each refinery's annual production of
          content for reformulated      reformulated gasoline in 1996 and for
          gasoline                      each year thereafter should be derived
                                        from renewable oxygenates.

1995      Courts struck down 30-        Struck down EPA's ruling of June 1994
          percent renewable oxygenate   mandating the use of at least 30-
          mandate                       percent renewable alcohol in
                                        reformulated gasoline, which would have
                                        significantly expanded demand for
                                        ethanol.

          Reformulated gasoline         Required reformulated gasoline use in
          program began                 the worst air quality nonattainment
                                        areas for ozone.
--------------------------------------------------------------------------------
\a Although 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. 


DETAILS AND ESTIMATES RELATING TO
THE TAX INCENTIVES FOR ALCOHOL
FUELS
========================================================== Appendix II


   FEDERAL TAX INCENTIVES FOR
   ALCOHOL FUELS
-------------------------------------------------------- Appendix II:1

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."










                                    Table II.1
                     
                        Rates of Excise Taxes, Excise Tax
                      Exemptions, and Income Tax Credits for
                           Selected Highway Motor Fuels

                  Combined motor                                        Rates of
                    fuels excise        Rates of        Rates of   alcohol fuels
                       tax rates       exemption       exemption     tax credits
                      (cents per      (cents per      (cents per      (cents per
                       gallon of       gallon of       gallon of       gallon of
Motor fuel               fuel)\a           fuel)      alcohol)\b    alcohol)\b,c
----------------  --------------  --------------  --------------  --------------
Gasoline                    18.3             0.0             N/A             N/A
Diesel fuel\d               24.3             0.0             N/A             N/A
Gasohol from
 ethanol:
At least 10-                12.9             5.4            54.0            54.0
 percent ethanol
At least 7.7-              14.14            4.16            54.0            54.0
 percent but
 less than 10-
 percent ethanol
At least 5.7-              15.22            3.08            54.0            54.0
 percent but
 less than 7.7-
 percent ethanol
Gasohol from
 methanol:
At least 10-                12.3             6.0            60.0            60.0
 percent
 methanol
At least 7.7-              13.68            4.62            60.0            60.0
 percent but
 less than 10-
 percent
 methanol
At least 5.7-              14.88            3.42            60.0            60.0
 percent but
 less than 7.7-
 percent
 methanol
10-percent                  18.9             5.4            54.0            54.0
 dieselhol
 from ethanol
10-percent                  18.3             6.0            60.0            60.0
 dieselhol
 from methanol
Qualified                   12.9             5.4            6.35            54.0
 ethanol fuels
 from other than
 petroleum or
 natural gas
Qualified                   12.3             6.0            7.06            60.0
 methanol fuels
 (other than
 ethanol) from
 other than
 petroleum or
 natural gas
Special motor               18.3             0.0             0.0              \e
 fuels
Partially exempt            11.3             7.0            8.24             N/A
 methanol and
 ethanol fuels
 from natural
 gas
--------------------------------------------------------------------------------
Legend:  N/A = not applicable. 

\a The combined tax rates encompass the Highway Trust Fund taxes and
the General Fund tax. 

\b The 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. 

\c The 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. 

\d There is a lower rate of tax for diesel fuel used for intercity
buses. 

\e Alcohol 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 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. 

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. 


--------------------
\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. 

\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. 

\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. 

\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. 


   ALLOCATION OF EXCISE TAX
   REVENUES TO THE HIGHWAY TRUST
   FUND
-------------------------------------------------------- Appendix II:2

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;
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. 


--------------------
\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. 


   REVENUE ESTIMATES FOR THE TAX
   INCENTIVES
-------------------------------------------------------- Appendix II:3

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. 



                               Table II.2
                
                 Estimates of the Amounts of Excise Tax
                  Revenues Forgone Due to the Partial
                 Exemptions for Alcohol Fuels, 1979-95

                                           Excise tax       Excise tax
                                             revenues         revenues
                                          forgone (in      forgone (in
                                          millions of      millions of
                                              current    constant 1996
Fiscal year                                  dollars)         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. 

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 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. 

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

                                                           Joint
                        Treasury        Treasury       Committee           Joint
                  projections of  projections of  projections of       Committee
                      excise tax      excise tax   total net tax  projections of
                         revenue         revenue         revenue   total net tax
                     losses\ (in     losses\ (in     losses\ (in  revenue losses
                     millions of     millions of     millions of    (in millions
                         current   constant 1996         current     of constant
Fiscal year             dollars)        dollars)        dollars)   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. 


--------------------
\10 In 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. 

\11 These 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). 

\12 We 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. 

\13 Treasury'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."

\14 When 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. 


DATA ON U.S.  FUEL CONSUMPTION AND
IMPORTS
========================================================= Appendix III



                              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                        108,25  108,49  110,27  111,71  113,67
                                     9       4       9       6       3
Diesel                          23,866  24,297  26,422  26,740  27,316
======================================================================
Total                           132,12  132,79  136,70  138,45  140,98
                                     5       1       1       6       9

Oxygenates:
----------------------------------------------------------------------
Ethanol\b                          701     760     846     919     914
MTBE\c                           1,175   2,069   2,019   2,973   3,330
TAME\d + ETBE\e                    N/A     N/A     N/A     201     N/A
======================================================================
Total                            1,876   2,829   2,865   4,093   4,244

Alternative fuels:
----------------------------------------------------------------------
E-85\f                           0.021   0.048   0.080   0.105       1
E-95\g                           0.085   0.080   0.140   0.140   0.140
M-85\h                               1       2       2       2       4
M-100\i                              3       3       3       3       3
Liquified Petroleum Gases          208     265     249     260     263
 (propane)\
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. 

\a Projected. 

\b Represents the ethanol used in all fuel blends that are 10-percent
or less ethanol and 90-percent or more gasoline. 

\c MTBE is methyl tertiary butyl ether, derived from fossil
materials. 

\d TAME is tertiary amyl methyl ether, derived from fossil materials. 

\e ETBE is ethyl tertiary butyl ether, derived from biomass. 

\f E-85 is a fuel mixture of 85-percent ethanol and 15-percent
gasoline. 

\g E-95 is a fuel mixture of 95-percent ethanol and 5-percent
gasoline. 

\h M-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. 



                                   Table III.2
                     
                     Gasoline, MTBE, TAME, Ethanol, and ETBE
                      Used in the United States in 1995, by
                                 Air Quality Area

                                                        Quantity of   Percent of
                                                          gasoline-        total
            Percent of                                   equivalent    gasoline-
Fuel/        that fuel    Quantity of      Gasoline  fuel (millions   equivalent
Source    type used in      fuel used        energy    of gasoline-         fuel
materia           area   (millions of    equivalent      equivalent         used
l            (percent)       gallons)     (percent)        gallons)    (percent)
-------  -------------  -------------  ------------  --------------  -----------
All areas meeting air quality standards:
--------------------------------------------------------------------------------
Gasolin            58%         63,802          100%          63,802        55.0%
 e\a
MTBE                 0              0            82               0            0
TAME                 0              0            88               0            0
Ethanol             38            495            67             332          0.3

All air quality nonattainment areas:
--------------------------------------------------------------------------------
Gasolin             42         47,057           100          47,057         40.7
 e\a
MTBE               100          4,745            82           3,891          3.4
TAME               100            123            88             108          0.1
Ethanol           62\b            742            67             497          0.4
ETBE               N/A             63            85              54         0.05

All areas:
--------------------------------------------------------------------------------
Gasolin            100        110,859           100         110,859         95.8
 e\a/
 Fossil
MTBE/              100          4,745            82           3,891          3.4
 Fossil
TAME/              100            123            88             108          0.1
 Fossil
Ethanol            100          1,237            67             829          0.7
 /
 Biomas
 s
ETBE/              100             63            85              54         0.05
 Biomass
--------------------------------------------------------------------------------
Legend:  N/A = not applicable. 

\a Gasoline category does not include MTBE, TAME, ethanol, or ETBE. 

\b Includes 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. 



                                   Table III.3
                     
                     U.S. Energy and Petroleum, Consumed and
                      Imported (Actual and Projected), 1973-
                                       2015

                  Energy\b consumed                  Petroleum\c consumed
          ----------------------------------  ----------------------------------
            (quadrillion Btu)     (percent)     (quadrillion Btu)     (percent)
          ----------------------  ----------  ----------------------  ----------
Year\a         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
--------------------------------------------------------------------------------
Note:  Imports are net of exports. 

\a Figures 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. 

\b Energy includes natural gas, coal, nuclear, and renewable, in
addition to petroleum. 

\c Petroleum 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. 


DESCRIPTION OF GROUPS IN THE
ECONOMY THAT THE ETHANOL TAX
INCENTIVES AFFECT
========================================================== Appendix IV

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
-------------------------------------------------------- Appendix IV:1

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 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.  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
-------------------------------------------------------- Appendix IV:2

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
------------------------------------------------------ Appendix IV:2.1

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. 


      ETHANOL PRODUCERS
------------------------------------------------------ Appendix IV:2.2

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 report\15 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 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. 


--------------------
\15 Anderson, Lareau, and Wollstadt, The Economics of Gasoline
Ethanol Blends. 

\16 Hohman, 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. 


         THE EFFECT ON THE ETHANOL
         INDUSTRY OF REMOVING THE
         TAX INCENTIVES
---------------------------------------------------- Appendix IV:2.2.1

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.  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. 


--------------------
\17 GAO/RCED-95-273R. 

\18 The 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. 


      PRODUCERS OF ALTERNATIVE
      GASOLINE ADDITIVES
------------------------------------------------------ Appendix IV:2.3

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 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
------------------------------------------------------ Appendix IV:2.4

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. 

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


--------------------
\19 In 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. 


         THE EFFECT OF THE ETHANOL
         TAX INCENTIVES ON FARM
         PRICES AND INCOMES
---------------------------------------------------- Appendix IV:2.4.1

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 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. 


--------------------
\20 FAPRI 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. 

\21 The 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. 

\22 Farmers 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. 


      CONSUMERS
------------------------------------------------------ Appendix IV:2.5

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. 

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. 

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. 


MAJOR CONTRIBUTORS TO THIS REPORT
=========================================================== Appendix V

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


*** End of document. ***