This paper develops a general framework to evaluate the effects on agricultural and gasoline markets of a consumption mandate and excise-tax exemption, the two most prominent public biofuel policies. Although market prices for biofuels increase under each policy, consumer fuel prices always decline with a tax exemption and increase with a mandate except under special circumstances when oil supply is inelastic relative to the supply of biofuels. A tax exemption alone is a biofuel consumption subsidy but most of the benefits go to biofuel producers because biofuels are a small share of total fuel consumption. Fuel consumers benefit indirectly to the extent gasoline prices decline with increased biofuel production. With a binding mandate in place, the tax exemption acts as a subsidy to fuel consumers instead. Biofuel producers only gain indirectly with the increased biofuel demand resulting from the increase in total fuel consumption. Most of the market effects are due to the mandate with the tax exemption only exacerbating the biofuel price increase and causing an increase in the oil price but a decrease in the consumer fuel price. An important implication is that the effects of each policy are not additive when used in combination. To illustrate the complexity and importance of the interaction between biofuel mandates and tax exemptions, we calibrate a stylized empirical model of the U.S. ethanol market. The results confirm the theoretical findings, including the special case of a mandate reducing consumer prices. The model is well suited to form a basis for evaluating the social benefits of the mandate versus the tax exemption in reducing local pollution, global warming and reliance on oil, and in enhancing farm incomes, reducing tax costs of farm subsidies and promoting rural development.
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number
5503.