Alcohol Fuels Tax Incentives

Order Code RL32979

CRS Report for Congress

Received through the CRS Web

Alcohol Fuels Tax Incentives

July 6, 2005

name redacted

Specialist in Public Finance

Resources, Science, and Industry Division

Congressional Research Service ˜ The Library of Congress

Alcohol Fuels Tax Incentives

Summary

Prior to January 1, 2005, alcohol fuel blenders qualified for a 5.2¢ tax

exemption against the excise taxes otherwise due on each gallon of blended mixtures

(mixtures of 10% ethanol, and 90% gasoline). This exemption, which was scheduled

to decline to 5.1¢ on January 1, 2005, reduced the gasoline excise tax for “gasohol,”

from 18.4¢ to 13.2¢/gallon. The reduction was realized at the time when the gasoline

tax was otherwise imposed: typically when the fuel was loaded from the terminal

onto trucks for distribution. The 5.2¢ exemption could also be claimed later, i.e.,

when blenders filed their income tax return, as a 52¢ excise tax credit per gallon of

alcohol used to make a fuel mixture (which was also scheduled to decline to 51¢ in

tandem with the exemption on January 1, 2005). This credit, however, was not as

valuable as the exemption because 1) it was taxable as income, 2) was not available

instantaneously as the fuel was blended — blenders had to wait until their income tax

returns were filed to reduce their tax liability by the amount of the credit, and 3) the

tax credit was not refundable — it was only available to the extent of tax liability.

Because the primary benefits from alcohol fuels were realized through an exemption

rather than a tax credit, revenue losses from the exemption (or reduced excise taxes)

accrued to the Highway Trust Fund (HTF).

The American Jobs Creation Act of 2004 (P.L. 108-357) restructured the basic

tax subsidies for alcohol fuels: 1) the blender’s income tax credits were eliminated

and 2) the blender’s excise tax exemption was replaced by an “instant” excise tax

credit of the same amount — 5.1¢/gallon of a 90:10 mixture, which is also equivalent

to 51¢ per gallon of ethanol in the mixture. These tax reforms went into effect on

January 1, 2005. As before, the excise tax credit is claimed against the 18.4¢ per

gallon excise tax on gasoline, so that the actual excise tax paid and remitted to the

Treasury is 13.3¢ — the tax is reduced by 5.1¢/gallon just as with the exemption.

When income tax effects are considered, however, the new excise tax credit has a

greater economic or subsidy value than the exemption before it because income tax

deductions are taken at 18.4¢ rather then 13.3¢. In other words, by labeling the tax

reduction as an excise tax credit rather than an excise tax exemption, the tax law

treats the blenders as paying the full excise tax of 18.4¢/ gallon rather than 13.3¢ per

gallon. At a 25% marginal income tax rate, the additional 5.1¢ deduction is valued

at 1.7¢/gallon of a blend or 17¢/gallon of ethanol, which means that the total after-tax

subsidy for alcohol fuel mixtures is effectively 68¢/gallon of ethanol rather than the

nominal rate of 51¢.

By nominally increasing the excise tax on gasohol by 5.1¢/gallon, an extra

$1,500 million in FY2006 is projected to be allocated into the HTF from the general

fund, which implies that HTF expenditures, and budget deficits can be expected to

be higher than under the exemption. In addition to the alcohol fuel mixture excise

tax credit there are three other federal tax subsidies that are available for the

production and use of alcohol transportation fuels (but are little used).

Comprehensive energy policy legislation H.R. 6, as passed by the Senate, includes

a renewable fuels standard that would, by 2010, more than double both the use of

ethanol and the revenue loss from the new alcohol fuels tax incentives.

Contents

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

The Alcohol Fuel Mixtures Excise Tax Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

The Credit for Methanol . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

How the New Tax Credit Works . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

The Structure of Motor Fuels Excise Taxes . . . . . . . . . . . . . . . . . . . . . 4

Excise Tax Exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Example . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Revenue and Highway Trust Fund Implications . . . . . . . . . . . . . . . . . . . . . . . . . 7

Revenue Effects of the New Alcohol Fuels Mixtures Tax Credit . . . . . . . . . 8

Revenue Losses Under the Proposed Renewable Fuels Standard . . . . . . . . . 9

Other Possible Tax Subsidies for Alcohol Fuels . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Tax Credits for Pure Alcohol Fuels . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Small Ethanol Producer Tax Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Income Tax Deduction for Alcohol-Fueled Vehicles . . . . . . . . . . . . . . . . . 10

Section 29 Production Tax Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Technical Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

List of Tables

Table 1. Comparison of the Net, After-Tax Subsidy Value of the

New Mixtures Tax Credit With the Old Excise Tax Exemption . . . . . . . . . 6

Table 2. Projections of Revenue Losses to the General Fund

(and Increases to the HTF) from the New Alcohol Fuels

Mixtures Excise Tax Credit ($millions) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Table 3. Projected Ethanol Use and Corresponding Revenue Losses

to the General Fund (and Increases to the HTF), Baseline vs.

the Renewable Fuels Standard (RFS), FY2006-2012 . . . . . . . . . . . . . . . . . . 9

Alcohol Fuels Tax Incentives After the 2004

Reforms

Introduction

President Carter’s 1978 Energy Tax Act introduced the excise tax exemption for

alcohol fuel blends (at 100% of the gasoline tax, which was then 4¢/gallon) to

achieve energy and, more recently, certain environmental and agricultural policy

objectives.1 In 2004 this exemption, which was 5.2¢/gallon and was scheduled to

decline to 5.1¢ on January 1, 2005, reduced the gasoline excise tax for “gasohol,”

from 18.4¢ to 13.2¢/gallon. The reduction was realized at the time when the gasoline

tax was otherwise imposed: typically when the fuel was loaded from the terminal

onto trucks for distribution. The 5.2¢ exemption could also be claimed later (i.e.,

when blenders filed their income tax return) as a 52¢ excise tax credit per gallon of

alcohol used to make a fuel mixture, which was also scheduled to decline to 51¢ in

tandem with the exemption on January 1, 2005. From 1978-2004, this exemption

from the motor fuels excise taxes provided the major subsidy to the ethanol fuel

industry — without the exemption the ethanol fuels industry would either not exist

or be substantially smaller.2

The exemption, however, which effectively lowered the excise tax on the

blended fuel, reduced revenues for the Highway Trust Fund by an estimated $14, 000

million through FY2004. As a consequence, the Congress enacted the American Jobs

Creation Act of 2004 (P.L. 108-357), also known as the “Jobs Bill,” which

restructured the basic tax subsidy for alcohol fuels. It replaced the excise tax

exemption with a new excise tax credit: the “alcohol fuel mixtures excise tax credit.”

Although, the two incentives are equivalent in gross, before-tax terms — they are

both equal to 51¢ per gallon of ethanol — interactions between the excise tax credit

and the income tax system increase the value of the incentives under this restructured

or reformed system. In addition to the new “alcohol fuel mixtures excise tax credit,”

current federal tax law provides for a small ethanol producer credit, and several other

tax incentives that, although little used, might further benefit alcohol fuels in the

future.

The Senate version of H.R. 6, the Energy Policy Act of 2005, proposes to not

only expand the small ethanol producer credit, but to introduce a renewable fuels

1

The Energy Tax Act of 1978 (P.L. 95-618), was one part of President Carter’s National

Energy Plan, intended to address what was perceived as severe problems in the country’s

energy markets.

2

More recently, regulatory subsidies for ethanol fuels — the federal oxygenates and

reformulated fuels requirements under the Clean Air Act — as well as numerous state

subsidies have been added, which have also increased the market for ethanol fuel. Still, the

excise tax exemption has provided much of the economic stimulus to the industry.

CRS-2

standard (which is effectively an ethanol standard), a requirement that gasoline

suppliers (refiners and blenders) blend at least 8 billion gallons of renewable fuels

per year in producing gasoline. Such a requirement, if enacted, would more than

double the amount of ethanol blended with gasoline above the current projected

baseline level of ethanol use, and significantly increase federal tax revenue losses.

This report explains the provisions of the new alcohol fuels mixtures tax credit

and compares the tax benefits under the new credit with the tax benefits under the old

exemption. An example illustrates the mechanics of the new credit and compares it

with the old exemption. The second section examines the revenue and Highway Trust

Fund implications of the new tax incentive both with and without a renewable fuels

standard. The final section discusses the remaining three tax subsidies for alcohol

fuels, which, although little used, are nevertheless part of the current federal tax laws

and might be used in the future.

The Alcohol Fuel Mixtures Excise Tax Credit

Under the new alcohol fuels mixtures tax credit, §40 of the Internal Revenue

Code (IRC), gasohol blenders may claim a 51¢/gallon tax credit for alcohol used to

produce a qualified mixture (a mixture of alcohol and gasoline, or a mixture of

alcohol and any other special motor fuel).3

Unlike most tax credits, which are claimed against income tax liability (because

the income tax otherwise owed is reduced or “credited” by the amount of the credit),

the new alcohol mixtures credit is claimed against the motor fuels (gasoline) excise

tax. However, both approaches reduce the effective excise tax burden on each gallon

of ethanol used to make a 90:10 gallon of a mixture by the same amount — 5.1¢/

gallon of a blend or 51¢/gallon of ethanol — regardless of whether the reduction is

called a tax credit or excise tax exemption. This new excise tax credit, which became

effective on January 1, 2005, will replace the old excise tax exemption as the basic

tax incentive claimed on most sales of fuel ethanol — it will provide the biggest

subsidy to the industry.4

As under the previous exemption, to qualify for the full 51¢ tax credit, the

alcohol must be at least 190 proof (95% pure alcohol, determined without regard to

any added denaturants or impurities). The credit is 37.78¢ per gallon if the ethanol

is between 150 and 190 proof; no credit is provided for alcohol below 150 proof.

This mixture credit is available only to the blender, who must not only produce the

mixture but must either use the mixture as a motor fuel in a trade or business or sell

it for use as a fuel. The blender may be the producer, the terminal operator, or the

3

The “Jobs Bill” also introduced a parallel or equivalent system of incentives for biodiesel.

Section 40A of the IRC also provides for excise tax credits against the 24.4¢/gallon tax on

diesel fuel for mixtures of biodiesel. This excise tax credit is 50¢/gallon of recycled

biodiesel and $1.00/gallon for virgin agri-biodiesel. Section 40A also provides a 50¢/gallon

income tax credit ($1.00 for agri-biodiesel) for use or retail sale of pure 100% biodiesel.

4

Moreover, the proposed renewable fuels mandate — a new regulatory subsidy — will, if

enacted in H.R. 6, also provide a larger benefit than the tax subsidy.

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wholesaler, distributor, or marketer. Technically, both ethanol and methanol qualify

for the exemption as long as they are not derived from petroleum, natural gas, coal,

or peat. In practice, however, virtually all fuel alcohol is ethanol produced from corn;

very little, if any, methanol is produced from wood and other biomass (or renewable)

sources because it is generally uneconomic.5 Currently most methanol is produced

from natural gas, is too expensive as a blended motor fuel and does not qualify for

the tax breaks.

As did the exemption before it, the new federal tax credit for alcohol fuels also

applies to certain fuel additives called oxygenates, provided they are produced from

renewables such as corn and not from fossil fuels such as natural gas. ETBE is a

compound derived from a chemical reaction between ethanol and isobutylene (a

byproduct of both the petroleum refining process and natural gas liquids).6 In this

reaction, the ethanol is chemically transformed and is not present as a separate

chemical in the final product. In 1995, the IRS ruled that blends of ETBE (ethyl

tertiary butyl ether) and gasoline would also qualify for the reduced partial excise tax

exemption. In effect these rulings ensured that the oxygenate required under the

Clean Air Act would also qualify for the tax subsidies. Allowing ETBE to qualify

for this tax exemption was intended to further stimulate the production of ethanol.

Allowing ETBE to qualify for the federal tax subsidies reduces the growth of MTBE

(methyl tertiary butyl ether), its main competitor. ETBE costs more to produce and

therefore, without the tax subsidies, could not otherwise compete with the less costly

MTBE. The recent banning and phasing-out of MTBE by many states (California,

New York, and Connecticut, and others) reduces the competitive advantage of MTBE

and also increases the demand for ethanol as an oxygenate.7

The Credit for Methanol. The mixtures credit is also available for methanol

blended with gasoline at the rate of 60¢ per gallon of methanol — the equivalent of

6.0¢ on 90:10 blends — if the alcohol is at least 190 proof, and 45¢ if the methanol

is between 150 and 190 proof. No credit is available for either ethanol or methanol

that is less than 150 proof. As noted above, the alcohol in methanol cannot be

produced from any fossil fuels — it must be produced from organic or biomass

materials.

How the New Tax Credit Works

As already discussed, the new alcohol fuels mixtures excise tax credit is claimed

against the excise tax, primarily the gasoline excise tax — it reduces the excise tax

otherwise owed and remitted to the federal government. So, despite the reforms of

5

Although blends of gasoline with biomass — derived methanol would also qualify under

the tax code, such blends are disqualified under the Clean Air Act because of the associated

increase of emissions of ozone — forming pollutants.

6

Natural gas liquids are those components of wellhead gas — ethane, propane, butanes,

pentanes, natural gasoline, condensate, etc. — that are liquefied at the surface in lease

separators, field facilities, or gas processing plants.

7

Currently, nineteen states have either banned, limited, or are phasing-out MTBE. See CRS

Report RL32787, MTBE in Gasoline: Clean Air and Drinking Water Issues, by James

McCarthy and (name redacted).

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the alcohol fuels tax incentives in 2004, the basic incentive — the 51¢/gallon tax

credit — is still connected with the gasoline excise tax (and other motor fuels excise

taxes); understanding how the tax credit works requires a brief explanation of the

structure of the current federal excise taxes on motor fuels.

The Structure of Motor Fuels Excise Taxes. Virtually all transportation

fuels are taxed under a complicated structure of tax rates and exemptions that vary

by type of fuel (gasoline, diesel, propane, etc.) and transportation mode or how the

fuel is used (cars, trains, buses, airplanes, etc.). Gasoline used in highway

transportation — the fuel used more than any other — is taxed at a rate of 18.4¢ per

gallon, composed of: an 18.3¢ Highway Trust Fund rate, which generates most of the

revenue for the federal highway trust fund (HTF); and a 0.1¢ rate that is earmarked

for the Leaking Underground Storage Tank Trust Fund (LUST).8 Diesel fuel for

highway use — the fuel used mostly by trucks — is taxed at 24.4¢ per gallon, also

consisting of two components: a 24.3¢ rate that is allocated into the HTF, and 0.1¢

that goes into the LUST fund. In addition, special motor fuels (gasoline substitutes),

jet fuel, railway diesel fuel, motorboat fuel, and virtually every other transportation

motor fuel that is not specifically exempt, are also subject to tax.9 Compressed

natural gas (CNG) has, since 1993, been subject to an excise tax of 48.54¢ per MCF

(thousand cubic feet) — marking the onset of the taxation of gaseous transportation

fuels.10

Excise Tax Exemption. The tax subsidies for alcohol fuels were

restructured — the excise tax exemption became an excise tax credit — under the

American Jobs Creation Act of 2004 (P.L. 108-357), enacted on October 22, 2004.

The reforms became effective on January 1, 2005.

Before the restructuring of the alcohol fuels tax incentives in 2004, the most

important tax incentive for alcohol fuels — the one most responsible for the

development of the alcohol fuels market — was the partial exemption from the

otherwise standard excise tax rates on gasoline, diesel, and other transportation fuels.

This exemption was 5.2¢ per gallon in 2004 and scheduled to decline to 5.1¢

beginning on January 1, 2005, before it is was replaced by the “alcohol mixtures

excise tax credit.” Thus, mixtures of 90% gasoline and 10% alcohol (typically called

gasohol) were taxed at 13.2¢ per gallon — they were exempt from 5.2¢ of the tax 11

8

The LUST fund finances the cost of cleaning up spills from underground fuel storage

tanks. All taxable transportation fuels are assessed the 0.1¢ LUST fund tax except for

liquefied petroleum gas or propane.

9

A variety of off-highway fuel uses (e.g., farming), business uses (e.g., construction

equipment), and government uses (e.g., police departments and school districts) are tax

exempt.

10

Before 1993, only liquid fuels were subject to the various transportation fuels taxes —

fuels that were liquid at the time they entered into the tank of the vehicle. The Omnibus

Budget Reconciliation Act of 1993 (P.L. 103-66) introduced a tax on CNG.

11

Also from Jan. 1, 1993 to Dec. 31, 2004, mixtures of 7.7% or 5.7% alcohol (either ethanol

or methanol) received a prorated exemption: 7.7% ethanol blends qualified for a 4.004¢

exemption (they are taxed at 14.396¢ per gallon); and 5.7% ethanol blends qualify for a

(continued...)

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In all these cases, the exemption equated to 52¢ per gallon of ethanol, for 2004,

which is the same as a 52¢/gallon income tax credit.12

Example

Table 1 compares the net, after-tax value of the new 51¢/ gallon alcohol fuel

mixture excise tax credit (column 3) as it is applied on 90:10 blends (90% gasoline,

10% ethanol), with the old 5.1¢/gallon excise tax exemption (column 2) on those

same blends. For perspective, these are compared with the tax on a gallon of pure

gasoline. The example assumes the ethanol is 190 proof. Subsidy value is measured

in terms of its effects on the marginal costs of supplying fuel relative to the

unsubsidized shift in the marginal cost curve under the 18.4¢/gallon gasoline tax.

The model is described in the Appendix in greater detail.

Note first that there is no difference between the new excise tax credit and the

old excise tax exemption in the actual excise tax paid or remitted to the Treasury

(row 3): whether the reduction in taxes per gallon of a 90:10 blend is provided by the

an excise tax exemption and or excise tax credit, the amount actually paid to the

Treasury is 13.3¢/gallon. There is a difference, however, in the subsidy value

between the two ways of reducing the excise taxes. In particular, Table 1 shows that

the new alcohol fuels excise tax credit has a higher subsidy value than the excise tax

exemption in effect under the pre-2005 tax law. As the sixth row, third column

shows, the net-after tax subsidy value of the new excise tax credit per-gallon of a

90:10 blend is 6.8¢/gallon as compared to 5.1¢/gallon under the exemption. Thus,

the value of the excise tax credit is 1.7¢ greater, or 33.3% greater, than the value of

the exemption. Per gallon of ethanol the subsidy value would be 10 times that

amount or 68¢/gallon, rather than 51¢/gallon.

11

(...continued)

2.964¢ per gallon exemption (they are taxed at 15.436¢ per gallon). The 5.7% and 7.7%

blends correspond, respectively, to the 2.0% and 2.7% oxygen content standard for gasoline

sold in ozone nonattainment areas and carbon monoxide nonattainment areas under the

Clean Air Act (CAA), as amended in 1990. The CAA requires that all gasoline sold in the

winter months in the 40 carbon monoxide (CO) non-attainment areas contain at least 2.7%

oxygenate. Oxygenates add oxygen to gasoline and make the fuel burn more completely and

more cleanly. This part of the program began on Nov. 1, 1992. The CAA also requires that

all gasoline sold in 9 ozone non-attainment areas be reformulated gasoline, containing at

least 2% oxygenates. Reformulated gasoline involves a more complex and extensive change

to the chemical properties of fuel to 1) reduce emissions of volatile organic compounds

(which form ozone), 2) reduce emissions of toxic compounds (such as formaldehyde), and

3) keep emissions of nitrogen oxide from increasing.

12

Alcohol blended with diesel fuel or any one of the other special motor fuels is also

partially exempt from tax. The exemption for “gasohol” blends also applies to blends of

diesel and biomass — derived alcohol and blends of a special motor fuel and biomass —

derived alcohol, whether ethanol or methanol.

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Table 1. Comparison of the Net, After-Tax Subsidy Value of the

New Mixtures Tax Credit With the Old Excise Tax Exemption

No Credit or

Exemption

100% Gasoline

Old Excise Tax

Exemption

New Alcohol

Fuel Mixtures

Excise Tax

Credit

90:10 Blends

Nominal (Statutory) Excise Tax

Per Gallon

$0.184

$0.184

0.184

Reduction in Tax Liability Per

Gallon

0

$0.051/gallon

exemption

$0.051/gallon

excise tax credit

Total Excise Taxes Paid to the

Treasury

$0.184

$0.133

$ 0.133

Increases in Marginal Cost of

Supply

$0.184

$0.133

$0.116

Difference in Marginal Cost Per

Gallon Relative to the NonSubsidized Gasoline Tax

0

- $0.051

- $0.068

Value of the Subsidy/Gallon of

90:10 Blend

0

$0.051

$0.068

Value of the Subsidy/Gallon of

Ethanol

0

$0.51

$0.68

Notes: *Value of tax subsidy includes the tax benefits from the deductibility of the excise taxes against

income tax liability — a higher excise tax results in greater tax deductions and a smaller tax. This

figure assumes a 25% marginal income tax rate. See the Appendix for more detail.

The higher subsidy value under the excise tax credit is due to the deductibility

of excise taxes as an expense against the income tax. The 2004 reforms changed the

terminology of a tax subsidy: Rather than claiming an instant exemption of

5.1¢/gallon, blenders can now claim an instant credit of 5.1¢/gallon. However, the

substitution of a tax credit for an equivalent exemption means that blenders are

treated nominally as paying the full 18.4¢/gallon excise tax; they will get higher

income tax deductions, which increases the effective amount of the new tax credit.

Assuming a marginal income tax rate of 25% — the rate usually assumed by the Joint

Tax Committee and other analysts — the value of the new tax credit increases by

1.7¢ per gallon (or by 33.3%). Thus, the effective value of the tax credit is not

51¢/gallon but 68¢/gallon.

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Revenue and Highway Trust Fund Implications

From FY1932, when it was first enacted, until FY2003, the gasoline tax has

generated over $400,000 million in gross tax revenues; billions more have been

generated from the tax on diesel and other special highway motor fuels.13 Net

revenues have been about 25%, or about $100,000 million, less due to the

deductibility of the excise taxes as a cost of doing business, leaving a net total of

about $300,000 million.

In FY2003, the year for which the latest data are available, the gasoline tax

alone generated $20,100 million in tax revenues for the Highway Trust Fund; $8.6

billion more were generated from the excise tax on diesel; and millions more were

generated from the excise taxes on other highway motor fuels. In total, the HTF

collected $33,700 billion in excise tax receipts in FY2003, about 90% from motor

fuels taxes and most of that from the gasoline tax.14 These totals include receipts

generated from the taxation of gasoline blended with alcohol, almost all ethanol,

which totaled in gross terms about $4,100 million in FY2003 (about $3,000 million

net due to about $1,000 million in income tax offsets).

But, while the excise tax on gasoline alcohol blends generated billions in tax

revenue, the lower tax rate due to the exemptions (a tax rate of 13.1¢ in 2003 due to

an exemption of 5.3¢; a tax rate of 13.2¢ in 2004 due to an exemption of 5.2¢) meant

that these blends did not generate as much revenue for the HTF as they would have

otherwise had the ethanol blends been taxed at the same rate as pure (unblended)

gasoline. From 1978, when the excise tax exemption for alcohol fuels was first

enacted, to FY2004, it is estimated that the exemption cost the federal treasury

approximately $14,000 million in foregone federal revenues in net terms (i.e., gross

excise tax receipts less income tax receipts). Gross receipts (i.e, losses to the HTF)

would have been about $18,600 million. For FY2003, for example, had ethanol

blends been taxed at 18.4¢/gallon (instead of the actual 13.1¢/gallon because the

exemption was 5.3¢/gallon), gross revenues for the HTF would have been about

$1,400 million higher. The net revenue loss was $350 million or 25% less, again

because the lower tax rate implied a smaller income tax offset.

The above effects on the HTF exclude additional losses in receipts due to a tax

code provision, enacted in 1990 and repealed by the 2004 jobs bill, which allocated

2.5¢ of the taxable portion of the excise tax on ethanol blends (the 13.1¢ in 2003) to

remain in the general fund. IRC §9503 (b) provided that part of the taxable portion

of the tax on gasohol blends (the 13.1¢ for 90:10 blends, the 14.342¢ for 92.3:7.7

blends, and the 15.422¢ for 94.3:5.7 blends) was not allocated to the HTF in 2003,

but was instead allocated into the general fund. More specifically, for the 90/10

13

Brian Francis, Gasoline Excise Taxes, 1933-2000, Statistics of Income Bulletin; Internal

Revenue Service, Federal Excise Taxes Reported to or Collected by the IRS, Alcohol and

Tobacco Tax and Trade Bureau, and Customs Service: 1997-2004, Table 21.

14

Three of the six separate excise taxes that finance the HTF are imposed on highway motor

fuels. The other three excise taxes, which generated $3.1 billion in tax receipts in FY2003,

are: the retail excise tax on heavy trucks, tractors, and trailers, the tax on truck tires, and the

heavy vehicle use tax.

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blends, the law in 2003 provided that 3.1¢ of the 13.1¢ tax remain in the general

fund; for blends containing less than 10% ethanol, 2.5¢ remains in the general fund

and is not allocated into the HTF. For 2003 about $700 million was allocated to the

general fund instead of the HTF under this provision. Thus the total HTF revenue

loss resulting from the alcohol fuels exemption was about $2,100 million for

FY2003.

Revenue Effects of the New Alcohol Fuels Mixtures Tax

Credit

The substitution of a tax credit for an exemption against the excise taxes will

increase revenues to the HTF, and reduce revenues by the same amount for the

general fund. Based on current projections by both the Office of Management and

Budget (OMB) and the Joint Committee on Taxation, foregone revenues from the

excise tax credit is projected to be about $1,5000 million for FY2006. Table 2 shows

the two revenue loss projections.

Table 2. Projections of Revenue Losses to the General Fund

(and Increases to the HTF) from the New Alcohol Fuels Mixtures

Excise Tax Credit ($millions)

Year

OMB Projections

JCT Projections

2004

$1,450

$1,100

2005

$1,490

$1,400

2006

$1,550

$1,400

2007

$1,590

$1,400

2008

$1,620

$1,500

2009

$1,650

$1,500

2010

$1,680

$1,500

Sources: Executive Office of the President. Office of Management and Budget. Budget Document

of the United States: Analytical Perspectives, FY2006, p. 323; Joint Committee on Taxation.

Estimates of Federal Tax Expenditures for Fiscal years 2005-2009. (JCS-1-05), Jan. 12, 2005.

However, because the income tax offset or deductibility takes place at the 18.4¢ rate,

the net income offsets are higher relative to the non-subsidized full gasoline tax rate

— there are additional net revenue loss due to this higher income tax deduction. At

the assumed 25% marginal income tax rate, these offsets are estimated at 1/4 of the

gross revenue losses in Table 2. Thus, for FY2006, using the OMB estimated gross

revenue losses of $1,550 million, income tax offsets (i.e., foregone income tax

receipts into the general fund) are estimated at $387.5 million.

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Revenue Losses Under the Proposed Renewable Fuels

Standard

Combined with the renewable fuels standard (RFS) proposed in the Senate’s

comprehensive energy policy bill, the new tax credit for alcohol fuels mixtures is

projected to raise revenue losses significantly over those baselines already projected

by the OMB. This is illustrated in Table 3. As shown in column (3), revenue losses

from the new excise tax credit are projected to more than double by 2010 if the RFS

under the Senate’s version of H.R. 6 is enacted.

Table 3. Projected Ethanol Use and Corresponding Revenue

Losses to the General Fund (and Increases to the HTF),

Baseline vs. the Renewable Fuels Standard (RFS), FY2006-2012

Baseline OMB Data

Renewable Fuels Standard

Ethanol Use

Revenue

RFS

Under

Losses

Revenue

Senate’s

Under

Losses Over

RFS

Senate’s

Baseline

(mil. gals.) RFS ($mil.)

($mil.)

Year

Baseline

Ethanol Use

(mil. gals.)

Baseline

Revenue

Losses

($mil.)

2006

3039

1550

4000

2040

490

2007

3118

1590

4700

2397

807

2008

3176

1620

5400

2754

1134

2009

3235

1650

6100

3111

1461

2010

3294

1680

6800

3468

1788

2011

N.A.

7400

3774

2012

N.A.

8000

4080

Sources: Author’s calculations based on OMB data and data in H.R. 6. OMB data is from Executive

Office of the President, Office of Management and Budget, Budget Document of the United States:

Analytical Perspectives, FY2006, p. 323;

Other Possible Tax Subsidies for Alcohol Fuels

Although the new alcohol fuels mixtures excise tax credit will, as the exemption

before it, become the major tax incentive for ethanol fuels, there are also others.

Tax Credits for Pure Alcohol Fuels

An income tax credit is also available for straight (or “neat”) alcohol (known as

E85 or, in the case of methanol, M85) used as fuel — fuels that contain a minimum

of 85% alcohol, and are thus not mixtures. The amounts of tax credits is 60¢/gallon

of either ethanol and methanol. This credit is available only to the user directly (who

CRS-10

must use it in a trade or business), or to the seller who must sell it at retail to the

ultimate user (as long as it is placed in the fuel tank of the buyer’s vehicle). In all

these cases, the alcohol may be either ethanol or methanol but must not be produced

from fossil fuels, effectively limiting the tax credit to ethanol from corn. The market

for these straight, or neat fuels, is very small. The credit for straight alcohol fuels

was not amended by the jobs bill.

Small Ethanol Producer Tax Credit

Current law provides for an income tax credit of 10¢ per gallon ($4.20 per

barrel) for up to 15 million gallons of annual ethanol production by a small ethanol

producer, defined as one with ethanol production capacity of 30 million gallons per

year or less (about 2,000 barrels per day). This credit, which was enacted as part of

the Omnibus Budget Reconciliation Act of 1990 (P.L. 101-508), is strictly a

production tax credit available only to the manufacturer who sells the alcohol to

another person for blending into a qualified mixture in the buyer’s trade or business,

for use as a fuel in the buyer’s trade or business, or for sale at retail where such fuel

is placed in the fuel tank of the retail customer. Casual off-farm production of ethanol

does not qualify for this credit. The small ethanol producer credit is limited in the

same way as the blender’s tax credit. The amount of the credit is reduced to take into

account any excise tax exemption claimed on ethanol output and sales. The 2004

“Jobs Bill” allowed the flow- or pass-through of the small ethanol producer credit to

the patrons of a cooperative, thus allowing farmer cooperatives that produce ethanol

to also benefit from the provision.15

Income Tax Deduction for Alcohol-Fueled Vehicles

Individuals or businesses that purchase alternative fuel vehicles (AFVs) can

claim a tax deduction from adjusted gross income for the incremental costs of new

vehicles and upgrades to existing conventionally fueled vehicles. The maximum tax

deduction for cars is $2,000, but for trucks it can go as high as $50,000. A tax

deduction is also available, up to $100,000, for investments in any equipment needed

in dispensing the alternative fuels — for storing and dispensing the clean fuel and

otherwise refueling clean fuel burning vehicles. For both of these tax incentives,

alternative fuels are defined as compressed natural gas, liquefied petroleum gas,

liquefied natural gas, hydrogen, and electricity, and they include 85% (neat) alcohol

fuels, ether, or any combination of these produced from biomass. The deduction is

reduced by 75% in 2006 — the $2,000 deduction would become $500 — for clean

15

Under IRC§521 farmers cooperatives are exempt from income taxes as long as any

cooperative income flows through to the patrons as “patronage dividends” — basically net

income (profits) are allocated back to the cooperative patrons (members), and in effect,

federal tax law treats cooperatives as partnerships (rather than corporations). Prior to the

2004 “Jobs Bill,” the only credits that were allowed to be passed through to the patrons were

the rehabilitation credit, the energy credit, and the reforestation tax credit. The 2004

amendments added the small ethanol producer credit to the list of credits allocable to the

patrons, which effectively reduces each patron’s dividends by a proportionate share of the

credits based on the patron’s share of ethanol production or total business done with the

cooperative (or some other allocation criteria).

CRS-11

fuel vehicles (or refueling property) purchased during 2006, and by 100% thereafter

i.e., it is eliminated after December 31, 2006. This deduction is currently little used.

Section 29 Production Tax Credit

An income tax credit is also available for the production of a broad variety of

fuels derived from various alternative energy resources (such as oil from tar sands or

shale, gas from coalbeds, brine or tight formations, synthetic fuels, etc.). This is the

alternative fuels production tax credit, also known as the §29 tax credit (because it

is part of Internal Revenue Code section 29), which in 2004 was $6.47 per barrel of

oil equivalent. Certain types of alcohol fuels — either ethanol or methanol produced

synthetically from coal or lignite — could qualify for this non-refundable tax credit.

Alcohol fuels produced from biomass do not qualify for this credit, although gas

produced from biomass does qualify. There is little if any production of liquid

synthetic fuels from coal in the United States so that, based on current information,

this credit is not claimed on alcohol fuels used in transportation.16

16

For a more detailed description and an analysis see CRS Report 97-679, Economic

Analysis of the §29 Tax Credit for Unconventional Fuels, by (name redacted).

CRS-12

Technical Appendix

This technical appendix calculates the economic or subsidy value of the new

alcohol fuels excise tax credit as compared to the old excise tax exemption and the

non-subsidized 100% gasoline. That subsidy value is measured as the difference in

marginal costs for a profit-maximizing gasoline supplier.

Pre-income tax profits, with a unit excise tax, such as a gasoline tax, is:

(1) π

b

= P ⋅ Q − C ( Q) − T 1 ⋅ Q

where P is price, Q is output, C (Q) is a total cost function, and T1 is a unit excise tax.

Maximizing before-tax profits π with respect to output Q leads to the

following condition:

b

(2) δπ

b

/ δQ = P − C' (Q) − T 1 = 0

which implies that,

(3) P = C '(Q) + T

1

i.e., profit maximization leads the firm to produce at that point where price P is equal

to the marginal cost C’(Q) and the excise tax T1. In other words, in a competitive

market, a profit maximizing firm facing a unit tax on gasoline faces a higher marginal

cost curve by the amount of the tax — the marginal cost curve shifts up (or is higher

than the non-taxed marginal costs) by 18.4¢/gallon.

A pure income or profits tax t is completely neutral (it does not affect the profit

maximizing level of output) under these conditions, as is shown next.

(4) π

a

(5) δπ

= [ P ⋅ Q − C(Q) − T 1 ⋅ Q](1 − t )

a

/ δQ = [ P − C'(Q) − T 1 ](1 − t ) = 0

which implies that,

(6) P = C '(Q) + T

1

Equation (6) is the same as equation (3) because the (1 - t) term cancels — the

equilibrium level of output and price is unaffected by the pure business income tax

even with the imposition of a unit tax, such as the 18.4¢ gasoline tax.

CRS-13

Now, however, assume that there are two unit excise taxes, T1 is the excise tax

per gallon actually paid, and T2 is the excise tax rate deductible for purposes of the

income tax. Then, the after-tax profit function becomes:

(7) π

= [ P ⋅ Q − C ( Q) − T 1 ⋅ Q] − t [ P ⋅ Q − C ( Q) − T 2 ⋅ Q]

a

(8) = [ P ⋅ Q − C (Q)](1 − t ) − Q[T

1

− t ⋅ T2]

Finding the level of Q that maximizes profits lead to the following condition:

(9) δπ

a

/ δQ = [ P − C'(Q)](1 − t ) − [T 1 − t ⋅ T 2 ] = 0

which reduces to:

(10) P = C '(Q) + [T

1

− t ⋅ T 2 ] / (1 − t )

Where P and C’(Q) are, as before, price and marginal costs, and [ T1 - t " T2 ]/(1- t)

is the shift in the marginal cost curve after allowance for the deductibility of excise

taxes as an expense against the income tax.

To illustrate, when a gasoline distributor is paying 18.4¢/ gallon ( T1 = 18.4¢),

and deducting the same amount against the income tax (T2 = 18.4¢) then the tax

terms in equation (10) become:

(11) T (1 − t ) / (1 − t ) = T

1

1

Note that because T1 = T2 the (1 - t ) terms cancel and the shift in marginal cost is

simply T1 = 18.4¢. This is also true when a gasoline blender is paying 13.3¢ because

of the exemption — the blender is also deducting 13.3¢ against the income tax and

the shift or increase in marginal costs equals the amount of the tax, 13.3¢.

However, when T1 and T2 differ, as they do under the new restructured alcohol

fuels tax incentives, then the shift in marginal costs is defined by equation (10).

Under present law, i.e., since January 1, 2005, T1 = 13.3¢, but T2 = 18.4¢. Thus,

assuming the marginal corporate income tax rate is 25% (t = .25), the tax term in

equation (10) — the shift or increase in marginal costs — becomes:

(12)13.3¢ - .25 (18.4¢)/ (1 - .25 )

(13) = 13.3¢-4.6¢/.75

(14) = 11.6¢

That represents the increase in marginal costs under the new alcohol fuels excise tax

credit (row 4, column 3 in Table 1). This is 6.8¢ less than the increase under the

gasoline tax, and 1.7¢ less then the increase in costs under the old exemption (the

subsidy value is 6.8¢/gallon rather than 5.1¢/gallon)

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