Subsidy reform: It’s going to happen. With the Senate’s rebuke of ethanol subsidies recently, the writing is on the wall. A time of reckoning has arrived for the entire jury-rigged, inconsistent structure of the nation’s energy-sector subsidies.

Democrats are calling on Republicans to put oil and gas tax breaks on the table in deficit reduction talks. Republicans want renewable-energy subsidies eliminated. And this time, something is going to happen. The only question would seem to be: Who’s ox is going to get gored?

And yet, here is another view: Notwithstanding the possibility of gridlock and rash slashing, the current moment holds out real hope for authentic reform, because something has to happen, everyone’s ox deserves goring, and a way forward can be discerned that is both fiscally sound and economically attractive.

Making true reform possible are a several unavoidable realities. First of all, rising concern about the national debt puts increased pressure on all federal expenditures and is forcing new scrutiny and new political outcomes (witness the ethanol vote). That means that all energy subsidies—whether for fossil fuels or renewable energies—will henceforth come under tough new scrutiny. That that scrutiny will be universal expands the potential for productive political trades and deals.

Secondly, the new pressure is making the manifest incoherence of the current mish-mash of energy-sector subsidies harder to defend.

Defenders of oil and gas industry tax breaks are clearly finding it harder to maintain support for tax and other provisions for a mature, highly profitable industry whose incumbency essentially locks in U.S. economic vulnerability and energy dependency and inhibits the emergence of alternative energy sourcing. The sheer cost of these provisions is one issue, given that the fossil fuel sector reeled in more than $72 billion in subsidies in a seven-year period in the 2000s, compared to the $29 billion received by the renewables sector, according to a 2009 analysis and cool graphic by the Environmental Law Institute. But even more vexing is the contradictory nature of these policies. On its face, the simultaneous existence of preferences for the fossil fuel industry and clean energy production represents a classic case of cross-purposes. Adding to the imbalance is the fact that while most of the largest subsidies to fossil fuel production are written into the U.S. Tax Code as permanent provisions, many subsidies for renewables are time-limited, implemented through energy bills, with expiration dates that continually limit create uncertainty for the industry and undercut deal-flow and deployment. This is a problem we will discuss in a forthcoming report on the clean economy due next month and it’s a major added problem. Cases in point here are the federal Production Tax Credit (PTC) and the Investment Tax Credit (ITC) which have been allowed to lapse multiple times before being granted short-term extensions.

At the same time, though, legitimate questions are being raised about the nature and purpose of the major renewable energy subsidies and incentives. These too are beginning to incur scrutiny, such as from Sen. Lamar Alexander (R-TN). Some complain about the extremely varied rates the government pays for a given amount of fossil fuel displacement (ethanol and biodiesel get roughly four times the support for a given unit of fossil fuel displaced than do wind, geothermal, or nuclear generation, according to a 2009 Joint Committee on Taxation report). Others—including myself and colleagues at the American Enterprise Institute and the Breakthrough Institute as well as at the Bipartisan Policy Center (BPC)—note that while the federal government showers subsidies across many energy options, from oil and coal to ethanol and wind power, none of these efforts are really designed to drive and reward innovation and ensure the prices of these technologies fall over time. In this regard, most renewable energy subsidies—like the fossil fuel opposite numbers—remain relatively static in their reward for production of more of the same product rather than of improved performance, and therefore greater American competitiveness. For example, while the ITC and PTC and related cash grants reward capital investments and expanded production, they are not designed to drive and reward innovation or ensure that the prices of the technologies and the electricity they generate fall over time. Instead, they incentivize maximum capital expenditures and steady production. In that sense, multiple clean economy subsidies help renewable technologies compete against conventional energy sources but they incorporate no systematic, predictable nudge toward innovation and cost-parity. And that is a legitimate problem with the nation’s clean energy subsidies—a basic problem on the renewable energy side to go along with the basic problems on fossil fuel side.

And so the time is right for a grand trade—forced by budget necessity—aimed at winnowing, rationalizing, and rethinking the whole incoherent slew of contradictory, expensive, and poorly designed energy sector tax provisions and incentives. In this respect, the moment’s rising deficit anxiety combined with the *expiration of multiple elements of the nation’s mish-mash of clean energy supports in fact represents an opportunity for reform.

What might such reform look like? Such reform should combine significant reductions of oil and gas tax expenditures with significant rethinking of the shaky array of renewable energy provisions.

On the oil and gas side, the need for revenue and the goal of supporting the competitiveness of clean energy each argue for trimming fossil fuel subsidies. The nation simply cannot afford them, and they don’t make sense.

As to a new approach to provisions for renewables, reform might well pair selected extensions of key production, investment, and manufacturing tax credits as well as the Treasury grant cash-back program with staged, technology-specific phase-outs. Along these lines, targeted and competitive deployment incentives could be created for various classes of energy technologies that would ensure that each has a chance to mature even as each is challenged to innovate and locate price declines. Incentive levels should fall at regular intervals, terminating if the technology class either fails to improve in price or reaches cost parity in the absence of further incentives. Structured in this manner, reformed national energy deployment incentives will not select winners and

losers, nor will it create permanently subsidized industries. Instead, smart public investments will instead provide opportunity for all emerging low-carbon energy technologies to demonstrate progress toward competitive costs while increasing the rate at which early-stage clean and affordable energy technologies are commercialized. The resulting reformed policy environment would at once provide new industries support, predictability, and a nudge toward innovation and cost-reduction. Alternatively, such a reform drive—which could be paired with a new look at reducing or eliminating subsidies to fossil fuel industries as well—might utilize competitive tendering processes like reverse auctions to contain subsidy expenditures and maximize the returns from given outlays, something BPC’s Nate Gorence Sasha Mackler have written about.

In any event, though, the time is right for a needed convergence of agendas linking fossil fuel subsidy reform and smarter renewables supports. Sheer fiscal necessity, the array of problems in need of response, and the need to decide what to do with so many expiring clean energy provisions are going to force a debate in the next two years. Given that, reform along the lines noted here might appeal at once to deficit hawks, proponents of renewables, and others focused on unleashing investment and job-creation. Such a grand trade in Washington would be an auspicious development for the energy economy, both traditional and new.

The United States is not going to put a price on carbon for many years. In the absence of a price on carbon, the United States will neither makes progress towards transitioning to a clean economy or in building competitive clean energy industries if it cannot lower the cost of clean energy. Even though most clean energy remains more expensive than fossil fuel generated energy, there are still compelling economic reasons why it should be supported. The harder question is what are the best mechanisms for this support?

The history of the energy industry and of innovation in many other industries is that new technologies go through a long, declining cost curve as they are refined and mass production is reached. Much of that refinement is done in response to demand that creates markets for products and high incentives for continued development of a product. Today, wind, solar and storage batteries have been dropping in price for a long period of time. In the energy industry, there is little reason to assume that brand new breakthrough energy technologies will spring forth from innovation labs at a price that makes them 100% competitive on the first day. Also the failure to put a price on carbon distorts market signals, making it far more difficult for new technologies to become competitive.

The Coalition for Green Capital (CGC) has been working to establish "green banks" that would provide low cost capital to clean energy and energy efficiency projects. The green banks would take scarce capital and leverage it to cover more projects. They would be financed in part by the government and in part by private equity, and all government funds would be repaid. The green banks would be technology neutral – they would fund all clean energy technologies.

Dan Esty, the Commissioner for the Department of the Environment in Connecticut (and as of July 1, the Department of Environment and Energy) just led the way to the passage of the first state green bank. The bank was approved as a key part of broader legislation that had overwhelming bipartisan support – it passed in the Connecticut Senate by 36-0 and in the House by 139-8.

The CGC estimates that the Connecticut green bank (called the Clean Energy Finance and Investment Authority) and other green banks will lower the cost of wind and solar projects by 15-20% at today's rate of conventional financing. To the extent tax credits or grants or other incentives and subsidies are still needed to make a clean energy project competitive, they could be provided at a much reduced level and thus reduce the cost per project and expand the reach of traditional credits and subsidies.

As lawmakers look for ways to cut spending in light of our crushing debt, federal subsidies should be scrutinized and cut back as quickly as possible. Renewables, which already receive a lion's share of the Federal budget energy expenditures, tend to be extremely expensive sources of electricity as I demonstrated in the figure in my blog.

Wind, solar and biomass can certainly play a complementary role in U.S. energy supply, but because of their cost, the intermittency of wind and solar, (the sun doesn't always shine and the wind doesn't always blow) and need for a backup energy supplies it is foolish to think that they will replace large amounts of our more traditional energy sources in the next 10 to 20 years.

Heavy subsidies for renewable energy and alternative fuel vehicles when more cost-effective and efficient energy sources are available will further only delay our economic recovery.

As congress weighs the real value of energy subsidies, it should also pursue policies that will allow for expanded capacity like allowing increased access to both off-shore and on-shore areas for drilling and exploration. This would have a positive impact on U.S. energy supplies.

The current debate about energy subsidies is seriously flawed because it threatens to treat mature industries like fossil fuels the same as emerging energy industries like solar. They are not the same. Oil and gas have had over 100 years of government support and investment to reach the global scale they now possess. Solar is just getting started. And unlike oil and gas, support for solar is only necessary to temporarily bridge the difference between the cost of solar energy today and the rapidly approaching time when solar energy is priced at or below energy produced by fossil fuels.

By the end of this year, we expect parity between the price of electricity produced by solar photovoltaic (PV) panels and traditional sources of residential power in as many as 19 countries, including Italy and Spain, and the State of California. Moreover, Applied Materials forecasts that by the year 2020, more than 100 countries – representing 98 percent of the world's population, 99.7 percent of the world's Gross Domestic Product and 99.2 percent of energy-related CO2 emissions – will have access to solar power at the same cost as current residential power.

Tax incentives, renewable energy portfolio standards, and modest subsidies have built a global solar industry that is delivering year over year cost reductions at an astounding rate. In fact, the price of solar PV panels has dropped 70 percent since 2008, when it was priced at $4 per watt. We anticipate that the price will reach $1 per watt in the next couple of years, as a result of those stable, predictable policies that enable the industry to scale, attract capital and advance technology improvements. These global policies continue to deliver significant return on investment both in decreasing costs of solar energy and in economic development.

A survey released last week by the Solar Energy Industries Association (SEIA) found that the US solar industry is one of the fastest growing sectors of the economy. Globally, solar is a $70 billion market, with just $6 billion of that in the US. According to our third annual solar energy survey, which was announced this week, Applied Materials discovered that more than a quarter (27%) of Americans would consider installing solar panels on their home, but consumers were most likely to be motivated to take a closer look at solar power installations by the availability of government incentives to offset costs. Those incentives enable the industry to scale and continue to deliver cost reductions.

Sound, predictable federal and local policies supporting solar will insure that solar PV continues to become more affordable and accessible to the average homeowner. We’re almost to the finish line of grid parity – let’s not stop these important programs before they have a chance to deliver huge returns for the US economy, ratepayers and the planet.

Repealing direct ethanol subsidies would help reduce government support of an energy source with many potentially large drawbacks, while making room in the market for emerging, cleaner energy sources.

In the past, investment dollars flowed into ethanol plants in part because protective government policies and subsidies stacked the deck in their favor. It’s harder for promising alternative energy and efficiency technologies to compete for the same investment capital when government is throwing its weight behind more politically favored sectors.

This means that technologies that could change the way Americans live and use energy gathered dust without the investments needed to jumpstart them. Important innovations on the energy horizon include car batteries charged in garages that could help balance the electricity grid, smart metering that could improve efficiency for electricity consumption, and new information-intensive transmission systems that could tap into the enormous wind potential in the central United States.

In an ideal system, there would be no subsidies and these fledgling green developments could compete on a level playing field based on their merits.

But domestically and globally, energy subsidies are prolific. For example, no one is quite sure how much coal, oil and gas companies get in the form of tax breaks and subsidies. The tax code is riddled with loopholes and credits that pad the bottom line of a favored few businesses with a thick layer of taxpayer dollars. The New Republic reported last year that the “US government offered $72 billion in incentives for oil, gas, and coal producers between 2002 and 2008.” But the true numbers could be much higher.

These tax breaks and subsidies come on top of the public health and environmental costs associated with fossil fuel consumption. Fossil fuels produce a range of pollutants, from heavy metals to participate matter to greenhouse gases, associated with a wide range of dire effects, including loss of cognitive functioning (mercury), premature mortality (particular matter), and our changing climate (carbon dioxide).

When polluting is free and the negative consequences are conveniently paid by the public, there is little incentive for companies to clean up their act.

Ultimately, setting a price on pollution would be the best way to balance these kinds of market distortions and facilitate the growth of efficiency and clean energy. A price that reflects the true cost of fossil fuels, ethanol, and wind and solar would generate the incentives for our country to use the right mix of each to meet its energy needs. But until the political will for that materializes, shifting subsidies away from dirty energy sources is a good first step towards reducing the price differential between fuels that pollute and those that don’t.

The recent Senate vote in favor of eliminating some (but not all) of the federal subsidies for ethanol was a welcome sign some of our political leaders are serious about restoring fiscal sanity and shifting toward a reasonable, market-driven energy policy. So, too, was Senator Lamar Alexander’s suggestion that the federal government eliminate all federal subsidies for “mature” energy technologies. While there are strong arguments for targeted federal interventions to encourage technological innovation, there is no reason for American taxpayers to prop up whole sectors of the energy economy. There is no need to subsidize specific parts of the energy sector. The time is long past for energy-policy-as-industrial-policy.

The phase-out of energy subsidies does not require that the federal government completely ignore energy policy. Climate change and other environmental concerns demand increased energy innovation. The lack of a price on carbon means would-be innovators lack sufficient incentives to invest in carbon-saving technologies, and such technologies – even if invented – have little hope in the marketplace. Direct research subsidies and tax credits for preferred technologies are a poor way to address this problem. Such policies may reward politically favored interest groups, but they do not encourage innovation. Indeed, the economic distortions they create can actually discourage investment in promising new technologies.

The best way to encourage technological innovation is to reward it, such as with <a href="http://www.law.harvard.edu/students/orgs/elr/vol35_1/HLE101.pdf">technology inducement prizes</a>. In simple terms, the federal government can encourage the development and diffusion of alternative energy technologies by rewarding their development with financial prizes and procurement contracts. Just as the patent system offers the potential of super-competitive rewards for successful innovation, technology inducement prizes can increase the rewards for innovative efforts and encourage greater investment. Prizes are also a better deal for the taxpayer than traditional subsidies as they are only paid if a would-be innovator’s efforts are actually successful. Existing energy subsidies, on the other hand, cost taxpayer and consumers without regard for any benefit they might produce.

It is also important to remember that direct subsidies and preferential tax treatment are not the only ways the federal government distorts energy markets to the advantage of politically preferred technologies. Regulatory mandates can also be used to subsidize otherwise uncompetitive technologies, as when the federal government imposes minimum renewable fuel content requirements. If Congress is serious about eliminating wasteful energy subsidies and encouraging energy innovation, it needs to take a broader view and consider regulatory policies as well. The best energy technologies should be chosen in a competitive marketplace, not a legislative chamber.

The vote last week to eliminate ethanol subsidies showed that bi-partisan majority of the Senate is ready to stand up and have frank conversations about our energy policy. It also showed that Congress may finally be willing to cut subsidies for industries that don’t need them. Hopefully that will some day include the oil and gas industry, which now enjoys billions of dollars in tax subsidies while enjoying enormous profits year in and year out.

These oil and gas subsidies bring with them the external costs to families and communities of poor air and water quality and related health problems like asthma. Leveling the playing field by cutting these wasteful and unmerited subsidies will help encourage more wind and solar development, can become economic drivers for a 21^st century clean energy economy.

The largest barrier to entry for wind and solar projects in the U.S. is money – specifically financing. Ensuring that federally backed loans – technically a subsidy, although one that gets repaid – are available for wind and solar projects will help the country move away from polluting energy sources, improve Americans’ health, and create jobs. If there was ever an energy source that should be supported, this is it.

Cutting back on ethanol subsidies is a responsible move, but only a small step towards an appropriate 21^st century energy policy for America. As Congress is debating what subsidies should be eliminated to help balance our federal budget, it should keep this in mind and preserve responsible support for the growing wind and solar industries so that we can have more American-produced clean energy.

(These comments were submitted by Ryan Alexander, president of Taxpayers for Common Sense.)

Last week’s Senate vote to end the ethanol tax credit and tariff is the first concrete signal from Congress that everything must be on the table to tackle the nation’s budget deficit and increasing debt. For nearly a century, U.S. taxpayers have been subsidizing the energy industry with hundreds of billions of dollars in incentives helping much of this industry to prosper mightily. Over the years many of these subsidies have skirted scrutiny, but with today’s fiscal crisis these giveaways are no longer safe.

Energy subsidies take many forms-- running the gamut from direct spending and grants, tax breaks, and loan guarantees, to mandates, price guarantees, long-term contracts, subsidized risk and accident insurance, and sticking the taxpayer with clean-up liability. All of these incentives must be on the table and all beneficiaries should share in cuts, starting with the industries that have received the largest subsidies over time.

Most energy sectors have benefitted from taxpayer subsidies in one of these forms-- be it for the last year, decade, or century. For example, oil and gas industry receives many subsidies including lucrative tax breaks, like the intangible drilling costs and percentage depletion allowance that date back to the early 1900s. The wind industry receives grants and solar benefits from market distorting loan guarantees. The nuclear industry has invaluable accident insurance, production tax breaks, and more than $20 billion in federal loan guarantees. The ethanol industry benefits from a generous purchasing mandate coupled with a massive tax break and protective tariff.

Any way you look at it Congress has created a tangle of energy subsidies and it’s time we unravel this market distorting and illogical set of taxpayer subsidies. We need to end the taxpayer handouts, level the playing field, and let the most efficient and competitive technologies thrive. We need full cost accounting and we need industry to bear those costs. Taxpayers can no longer take on the risks and costs while industry pockets the profits. Right now taxpayers cannot afford anything less.

Last November, the members of this forum were asked to respond to the question, “Can tax incentives save renewable Energy?” In part, my reply was “in order for renewables to be a concrete, lasting part of our overall energy mix, they will need to be self sustaining on their own merits. Not to some greater authority’s view of who should win and who should lose.” It would appear that what has just happened at the Senate is aligned with my view. . . But that’s not quite the case.

In my prior submission, I warned that looking only at the short term imperatives of the “budget world” would jeopardize the potential long term solutions that we as a society need. There is a very big, very real issue here that still needs a proper policy solution: What do we envision the future to look like in our world of no subsidies? Will any new energy solution need to, from day one, displace our fully developed legacy infrastructure before we consider an alternative to be valuable? Doesn’t technology, even at its most disruptive, need some kind of market entry strategy that incorporates a time element in order to survive the natural marginal cost analysis that would be imposed? By not subsidizing any new technology, are we dooming ourselves to inaction until the executioner’s axe is swinging down toward our necks?

Not subsidizing any new technology so as to enable the development of economies of scope and scale is a myopic strategy at best. What Congress really needs to do is properly address our energy future as one that is independent of local self interests and free of short term electioneering and budget shortfalls. There are some out there that will say I’m just not appreciative of the constraints that the tea party believers and their conservative brethren place on our elected law making body, but that’s an incorrect view. What I do believe is that the conservative wing of the legislative organization really wants to be associated with a winning strategy. That strategy has to be flexible enough for us to try, on a commercial scale, various solutions to our energy dilemma such that we learn which path in the energy policy maze is the correct one.

Last November, when I closed my statement with the notion that if we do not maintain some level of subsidies we run the risk of falling back to old habits and therefore missing some great opportunity that comes knocking at our door, I was thinking about the research and development process. Now, I think we should extend that thought to Congress as well. It seems that we have fallen back to our habits all right, at the expense of good judgment, just so we could say at least we made a decision. That is like saying at least we jumped off the bridge; we just forgot the bungee cord. Let’s not do that as it makes for an even greater mess.

Government subsidies for ethanol are a misguided policy that wastes taxpayer dollars, increases the price of food, and encourage destructive agricultural practices. Corn ethanol is not a plausible solution to our dependence on oil and hopefully last week’s vote in the United States Senate is a sign that the ethanol tax credit and tariff will expire in the next budget deal.

However, it is critical to distinguish between two types of energy subsidies. On the one hand, there are a broad array of dirty energy subsidies that essentially amount to corporate graft, in which large energy producers hire lobbyists in Washington to grant them special loopholes and exemptions from corporate taxes in order to increase their own profit with little thought to the common good. These tax expenditures or direct subsidies include the ethanol tax credit that largely goes to agricultural giants like Arthur Daniels Midland and Monsanto, the $45 billion in tax subsidies to oil companies, or the billions given for coal to liquids or "clean" coal. With lawmakers in both parties looking for ways to reduce the deficit, cutting this kind of corporate graft is the lowest of the low hanging fruit: budget cuts that will actually improve our environment and our economy.

On the other hand, our country needs to transition away from fossil fuels and towards clean energy. We need to do this, first and foremost, because global warming is a threat to our way of life and the health of our planet, and also because fossil fuel use imposes numerous costs to our public health and the quality of our air and water, as well as our economic strength and national security. The transition to clean energy will require the continued encouragement and investment of the federal government in one form or another.

Ideally, we could transition away from fossil fuels and reduce the deficit at the same time by putting a price on the emission of global warming pollution, either through a carbon tax, or by setting an emissions cap and selling allowances to companies that emit global warming pollution. Such a policy would be good for our environment, our budget and our economy at the same time: instead of taxing economically productive activities like employment (payroll taxes), income or sales, we could balance the budget by taxing energy sources that impose present and long-term costs on our environment and economy.

Short of establishing a price on global warming pollution, continuing to encourage the development of a strong clean energy economy is vital for the future of our economy and environment. Tax subsidies that encourage the production of wind or solar energy or electric vehicles have been critical in scaling up these technologies, which have reduced the initial costs and made clean energy technologies economically viable competitors to coal and oil. Moreover, given the massive externalities created by fossil fuels – the National Research Council estimates that fossil fuel dependence creates $120 billion in hidden costs to public health even before considering the impact on global warming - these subsidies are clearly justifiable.

In the long run, as the economic and environmental costs of oil and coal rise, the transition to these forms of energy will be essential to our nation’s future. Cutting programs that help shift our economy towards clean energy in the ultimate in penny wise, pound foolish policies that will harm our economic and environmental future.

The United States cannot continue to rely on foreign petroleum for affordable transportation fuel. Continued reliance on foreign petroleum, uncertainty over future energy supplies and high prices threaten U.S. energy and national security and the nation’s economic recovery. But some policy makers appear to want to gloss over or ignore this.

U.S. addiction to oil is also a costly proposition for both taxpayers and our economy. Nevertheless demand for liquid transportation fuels is projected to grow significantly over the coming decades. Biofuels are necessary to help meet this growing demand, and the country that seizes the lead in their scientific and commercial development will gain an advantage in energy security and future economic growth. Currently the U.S. holds the lead in biotech innovation and we can turn this lead into an advantage when it comes to producing advanced biofuels.

Following supportive federal policy, companies -- including some forward-looking oil companies -- have made significant investments in researching and developing advanced biofuels. U.S. scientists have developed biotech tools to continue improving biofuel production and to bring advanced biofuels from algae, agricultural residues, and purpose-grown energy crops to the market. To translate this into commercial production, companies now need to raise capital to build new large-scale biorefineries, a task made more difficult by the recent recession and continued economic uncertainty.

Stable and well-funded federal policies that support predictable market conditions for advanced biofuels are crucial.

Tax incentives should help young technologies and industries attract investment capital to compete in the market and speed commercialization of advanced biofuels. Any discussion of tax policy for energy should also focus on economic and environmental sustainability.

The United States has built a lead in developing advanced biofuels. We need to maintain our momentum and redouble our commitment to reach the goal of greater energy and economic security. As Congress undertakes tax reform and debt reduction it needs to be careful not to throw the baby out with the bathwater.

Finally, policies that prop up biofuels production are in the crosshairs, and not a moment too soon. Because over the last decade, the biofuels industry has grown accustomed to getting whatever it wants, with no questions asked. Those days, at long last, appear to be over.

Last week, the U.S. House of Representatives voted 283-128 to prohibit the federal government from using taxpayer dollars to pay for the new ethanol pumps, storage tanks, and other infrastructure the industry needs (but would prefer not to pay for). Hours later the Senate voted by nearly a three-to-one margin to pull the plug on a tax credit that benefits ethanol makers. The legislative developments came on the heels of a report by international agencies including the United Nations, the World Bank, and the World Trade Organization urging G20 member countries to repeal national-level measures “that subsidize (or mandate) biofuels production or consumption.” In Europe, meanwhile, the European Commission finally acknowledged that research it requested (but then attempted to hide) indicates that an expansion of EU biofuels policy will exacerbate deforestation and other climate-harmful land use practices.

So, given all of the reasons biofuels policies are now under attack, what took policymakers so long to act? Last week’s Senate vote to terminate the Volumetric Ethanol Excise Tax Credit – or VEETC – was largely motivated by concerns over the subsidy’s exorbitant cost ($6 billion in 2011; $21.5 billion over the past five years). VEETC pays refiners 45 cents for every gallon of ethanol they blend into gasoline, even though another federal law – the Renewable Fuels Standard – already requires Americans to consume that ethanol. “We are staring down the barrel of a $1.65 trillion deficit - we cannot afford to continue to line the pockets of this profitable industry with tax breaks or any other form of subsidy,” said Taxpayers for Common Sense, which along with the Clean Air Task Force is part of a coalition of taxpayer advocates, hunger and development organizations, agricultural groups, free-market groups, religious organizations, environmental groups, budget hawks, and public interest organizations calling on Congress to kill VEETC.

The sharp increase in food prices is the driving force behind the forthcoming report by the UN and others calling on G20 countries to eliminate their biofuel subsidies. According to the Financial Times, “The report confirms a growing backlash against biofuels, which were once hailed as a saviour for fossil fuel-dependent economies but are now increasingly blamed for pushing up food prices by diverting corn and other crops from the dinner table to fuel tanks.” In April, an analyst for the Food and Agricultural Organization told The New York Times, “We have to move away from the thinking that producing an energy crop doesn’t compete with food. It almost inevitably does.”

Finally, bioenergy policies’ impact on land use patterns, and how those changes accelerate global warming, is at the heart of the controversy over the recent report to the European Commission. As supply margins for corn, soy, and other biofuel feedstocks tighten, they fetch higher prices. The increase in food prices encourages farmers around the world to cultivate previously unfarmed land – a process that results in substantial losses of soil- and plant-carbon to the atmosphere. A biofuel must “pay back” this “carbon debt” (by sequestering carbon dioxide through the growth of energy crops in subsequent years) before it can be credited with any net climate benefits as compared to petroleum-based fuels. Researchers have found that the payback periods can range from several years to several hundred years, depending on the biofuels feedstock. The European Commission acknowledged this effect, but is struggling to make the necessary course correction.

In the United States, canceling VEETC would be a big step in the right direction. As soon as possible, the House of Representatives should follow the Senate’s lead and vote to end the subsidy. Once that is accomplished, though, policymakers should turn their attention to the bigger problem: the Renewable Fuel Standard. The Renewable Fuel Standard is forcing a massive increase in U.S. biofuels consumption, from just under 5 billion gallons a year in 2006 to 36 billion gallons in 2022. Forty percent of the U.S. corn crop is now diverted to ethanol production, with undeniably grave implications for food prices and climate change. Analysis by the Clean Air Task Force found that the net carbon dioxide emissions from the corn ethanol mandated by the Renewable Fuels Standard in 2010 are 28 percent higher than the emissions from an energy equivalent amount of gasoline.

Biofuels are a creature of policy. Absent the support lavished on them over decades by hoodwinked taxpayers, they would not exist. Even with public support, they offer few discernible benefits while undermining food security and accelerating climate change. It’s time to pull the plug on VEETC and other policies that support conventional biofuels.

The lesson of federal ethanol subsidies is one of misguided policy and unintended consequences. One bad idea backed by a strong constituency—the farm lobby, in this case—begets more bad ideas.

Originally intended to reduce our country’s reliance on foreign oil when introduced in 1978<http://usgovinfo.about.com/od/moneymatters/a/The-Federal-Ethanol-Subsidy.htm>, the ethanol subsidy became just another way for lawmakers to funnel money to special interests. In 1990, the Clean Air Act (CAA) amendments gave a further boost by writing into law a requirement for additives that oxygenate fuel—namely, ethanol.

Though failing to meet both their energy (imports) and environmental (emissions) objectives, these subsidies now cost Americans about $6 billion annually<http://money.cnn.com/2011/01/25/news/economy/renewable_energy_obama/index.htm>. Along with their staggering price tag, the policies have driven up the cost of food around the globe<http://reason.com/archives/2010/11/16/congress-let-ethanol-subsidies>.

The Obama Administration is not deterred<http://fuelfix.com/blog/2011/04/11/obama%E2%80%99s-response-to-growing-u-s-deficit-includes-subsidizing-120000-ethanol-fueling-pumps/> by these realities. Instead, EPA ramped up the ethanol limit in gasoline from 10% to 15%<http://www.ft.com/cms/s/0/4f7e3d58-d6fd-11df-aaab-00144feabdc0.html#axzz1JEClRrES> for newer cars last year. And the Secretary of Agriculture just announced<http://online.wsj.com/article/SB10001424052748704503104576251023724394758.html> last month that the federal government will give grants (aka “subsidies”) to fueling station owners to cover the cost of installing gasoline pumps capable of handling higher blends of ethanol in gasoline that cost in excess of $100,000 each.

Though a step in the right direction, it remains to be seen whether last week’s Senate action against ethanol subsidies was a sign of things to come or just political art. Unfortunately, there is no guarantee the bill will be enacted. The House rejected similar legislation, and the White House obviously opposes the repeal because its dependence on farm state votes for the 2012 election.

The political quagmire in which we now find ourselves isn’t limited to ethanol subsidies. The same rule applies to other political attempts to manipulate the U.S. tax system to selectively hurt or help a particular good or service at the expense of consumer choice and market efficiency.

Despite the fact that these maneuvers repeatedly fail and also distort the productive use of our resources, they are nearly impossible to repeal. If there is a political miracle and this subsidy is brought to an end, Congress should also end the mandate to use ethanol. Otherwise, refiners will face higher costs—some of which will be passed onto consumers.

The right thing to do is also to eliminate the CAA requirement for Reformulated Gasoline (RFG) so that refiners and automakers can jointly meet emission limits in the most cost-effective manner. Eliminating the RFG requirement would also permit a rationalization of the nation’s gasoline and distribution system. The at least 11 different blends of gasoline we currently have complicate the distribution system and make fuel more expensive.

According to a 2005 GAO study<http://www.gao.gov/htext/d05421.html> of gasoline markets and special blends:

In the case of oxygenates, there appears to be agreement that the addition of oxygenates reduces emissions from older vehicles. However, improvements in automobile technology in newer vehicles now automatically reduce emissions of carbon monoxide and other pollutants and, for these vehicles, may have negated many of the benefits of adding oxygenates to gasoline. Some studies have also found that use of ethanol can increase emissions of pollutants that can increase ozone levels. Regarding air quality, EPA and other experts have concluded that improvements in air quality seen in some parts of the country are at least partly attributable to the use of special gasoline blends. However, studies on the impact of individual emissions reduction efforts--such as special gasoline blends--are limited and incomplete, in part because of difficulty isolating the effect of gasoline blends from other factors that affect air quality such as weather and emissions from other sources.

The proliferation of special gasoline blends has made it more complicated to supply gasoline and has raised costs, significantly affecting operations at refineries, pipelines, and storage terminals. At refineries, making these blends can require additional investment such as installing new processing equipment and the use of larger amounts of valuable components in the blending process--making it more costly to produce special gasoline blends.

In other words, the environmental benefits of ethanol subsidies are probably negligible but the price effect isn’t.

If Congress is serious about reducing the deficit and improving our energy security, it will eliminate all subsidies intended to produce a politically desired outcome and work with the Administration to create an investment environment that will promote greater use of our own abundant energy sources.