Brazilian ethanol producers have long sought a level playing field on which to compete with their US counterparts, and this week they are launching a campaign to publicize their message that ethanol derived from sugar cane could be imported from Brazil at a lower cost than ethanol can be produced from corn in the US, if only the import tariff were reduced or eliminated. Legislation to reduce the tariff has been introduced in both the House and Senate. But while the modest step of cutting the tariff to match the domestic ethanol subsidy makes sense, eliminating it entirely would require substantial changes in the mechanism by which the federal government supports the use of domestic ethanol, to prevent taxpayer dollars directly subsidizing Brazilian cane growers and distillers. It is hard to imagine legislators wanting to open such a can of worms this year.

With the exception of imports under the Caribbean Basin Initiative, all ethanol imported into the US is subject to an import tariff and "secondary duty" worth about $0.60 per gallon. Although its original purpose may have been to protect domestic producers from foreign competition, it serves an important practical function, because of the way the US subsidizes domestic ethanol. Along with direct support to corn farmers and loan guarantees and other benefits for ethanol distillers, the government provides a credit of $0.51/gal. to companies that blend ethanol into gasoline, as a reduction to the fuel tax they would otherwise owe--though no longer at the expense of funding for road maintenance. The Farm Bill recently enacted over President Bush's veto reduced this "blenders' credit" to $0.45/gal, starting next year, but it will still amount to over $3 billion per year, based on 2007 volumes, which are slated to double by 2012.

Due to surging US ethanol production in 2007, imports from Brazil fell last year, compared to 2006. However, in the wake of the flooding that has devastated crops and paralyzed rail and barge transport in a large section of the Midwest, more imports might be necessary in order to meet the mandated volume of 9 billion gallons of ethanol for this year, under the Renewable Fuel Standard provisions of the Energy Independence and Security Act of 2007. If the tariff were repealed without changing the way the blenders' credit is paid, and if Brazilian imports merely matched their 2006 level, taxpayers could end up subsidizing Brazilian ethanol producers to the tune of $220 million this year.

I see two possible ways to avoid this outcome, while still taking advantage of lower-cost, higher-efficiency Brazilian ethanol: First, the law governing the ethanol credit could be modified to restrict its application to volumes produced in the US. Even if that passed muster under World Trade Organization rules, it would require the creation of a two-tier ethanol subsidy system and the means of monitoring it. In the process, it would increase the incentives for ethanol smuggling. That might sound like a relic of Prohibition, but given their established involvement in evading gasoline taxes, organized crime might find it a lucrative new line of business.

The other, more drastic alternative would be to shift the point of subsidy payment from the blender to the ethanol producer. This would impose its own regulatory and accounting burden and create other opportunities for abuse. However, it would also raise a more awkward question for ethanol producers. The original choice to subsidize blenders was hardly accidental; it was designed to encourage greater use of a domestic fuel during the previous energy crisis, and it has certainly achieved that goal. But with refiners and other blenders of gasoline now required by law to blend specified quantities of ethanol into gasoline, and with wholesale ethanol now generally selling for less at the distillery gate than wholesale gasoline, the justification for providing blenders with additional financial incentives to use this fuel has been greatly diminished.

Considering all these factors, ending the tariff and duty applied to imports of ethanol from Brazil and elsewhere would hardly be the simple matter suggested by the supporters of this idea. It would force a choice between extending ethanol subsidies to foreign producers--imagine that coming up in a presidential debate--and confronting the larger question of continuing ethanol subsidies at a time when our ethanol use is widely perceived to contribute to higher food prices. Unless the logistical problems caused by the Midwest flooding result in a severe enough shortage of domestic ethanol to drive up gasoline prices, I would be surprised if this idea got any traction this year.
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