Alcohol Fuels Tax Incentives

CRS Report for Congress
Alcohol Fuels Tax Incentives
July 6, 2005
Salvatore Lazzari
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
In troduction ......................................................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 policy1
objectives. 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 exist2
or be substantially smaller.
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.

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 of3
alcohol and any other special motor fuel).
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.

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 Mary Tiemann.

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 earmarked8
for the Leaking Underground Storage Tank Trust Fund (LUST). 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 transportation10
fuels.
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...)

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.

Table 1. Comparison of the Net, After-Tax Subsidy Value of the
New Mixtures Tax Credit With the Old Excise Tax Exemption
New Alcohol
No Credit orOld Excise TaxFuel Mixtures
ExemptionExemptionExcise Tax
Credit
100% Gasoline90:10 Blends
Nominal (Statutory) Excise Tax$0.184$0.1840.184
Per Gallon
Reduction in Tax Liability Per0$0.051/gallon$0.051/gallon
Gallonexemptionexcise tax credit
Total Excise Taxes Paid to the$0.184$0.133$ 0.133
Treasury
Increases in Marginal Cost of $0.184$0.133$0.116
Supply
Difference in Marginal Cost Per0- $0.051- $0.068
Gallon Relative to the Non-
Subsidized Gasoline Tax
Value of the Subsidy/Gallon of0$0.051$0.068
90:10 Blend
Value of the Subsidy/Gallon of0$0.51$0.68
Ethanol
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.



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.

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)
YearOMB ProjectionsJCT 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.



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 DataRenewable Fuels Standard
Ethanol UseRevenueRFS
Baseline BaselineRevenue Unde r Losses Revenue
YearEthanol UseLossesSenate’sUnderLosses Over
(mil. gals.)($mil.)RFS Senate’s Baseline
(mil. gals.)RFS ($mil.)($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: Authors 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



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).

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 Salvatore Lazzari.

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 PQ CQ T Q=⋅− − ⋅() 1
where P is price, Q is output, C (Q) is a total cost function, and T1 is a unit excise tax.
Maximizing before-tax profitswith respect to output Q leads to theπb
following condition:
(2) δπ δb QPCQ T/'()=− − =1 0
which implies that,
(3) PCQ T=+'( ) 1
i.e., profit maximization leads the firm to produce at that point where price P is equal1
to the marginal cost C’(Q) and the excise tax T. 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 PQ CQ T Q t=⋅− −⋅ −[()]()1 1
(5) δπ δa QPCQT t/['()]()=− − −=1 10
which implies that,
(6) PCQ 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.



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 a PQ CQ T Q tPQ CQ T Q=⋅− −⋅− ⋅− − ⋅[()][ ()]12
(8) =⋅− −− −⋅[ ( )]( ) [ ]PQ CQ t QT t T1 12
Finding the level of Q that maximizes profits lead to the following condition:
(9) δπ δa QPCQ t TtT/ [ ' ( )]( ) [ ]=− −− −⋅ =1012
which reduces to:
(10) PCQ T tT t=+−⋅ −'( ) [ ] / ( )121
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) Tt tT11()/()−−=
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)