Welfare Impacts of Alternative Biofuel and Energy Policies

We employ an open economy general equilibrium model to investigate the effects of governmentenergy policy, with an emphasis on corn-based ethanol, on the U.S. economy. The modelspecification incorporates world and domestic markets, assumes pollution costs from fuelconsumption, and allows endogenous determination of equilibrium quantities and prices for oil,corn and ethanol. The model is calibrated to represent a recent benchmark data set for 2009 andis used to simulate the positive and normative effects of alternative policies. We find that asecond best policy of a fuel tax and ethanol subsidy approximates fairly closely the welfare gainsassociated with the first-best policy of an optimal carbon tax and tariffs on traded goods. Thelargest economic gains to the U.S. economy from these energy policies arise from the impact ofthe policies on U.S. terms of trade, particularly in the oil market. We also find that, conditionalon the current fuel tax, an optimal ethanol mandate is superior to an optimal ethanol subsidy. Inthe benchmark case, the optimal ethanol mandate is about 18 billion gallons.[...]