Welfare Effects of Biofuels Trade Policy in the Presence of Environmental Externalities

45 Pages Posted: 25 Mar 2009

See all articles by Christine L. Crago

Christine L. Crago

University of Illinois Urbana-Champaign; Energy Biosciences Institute

Madhu Khanna

University of Illinois at Urbana-Champaign - Department of Agricultural and Consumer Economics

Date Written: March 23, 2009

Abstract

We develop a stylized model of fuel markets in an open economy and derive the optimal mix of trade and environmental policy instruments for biofuels and gasoline that maximizes social surplus and internalizes externalities from miles and greenhouse gas (GHG) emissions. We use this optimal scenario as a benchmark to compare existing and alternative biofuel policies including the import tariff and the tax credit for ethanol. We show that the optimal tax for fuels is directly related to their GHG emissions intensity while the optimal tariff is inversely related to the excess supply elasticity of imported ethanol. The effect of the tax credit on social surplus is clearly negative, while the impact of the tariff depends on the ability of the US to influence ethanol prices in the world market. Our numerical simulation for the US shows that current ethanol policy of an ethanol tax credit and import tariff increases miles externalities and greenhouse gases and decreases social surplus by $3.6 B relative to non-intervention and by $228 B relative to the optimal scenario.

Keywords: biofuel, transport externalities, optimal taxation

Suggested Citation

Crago, Christine Lasco and Crago, Christine Lasco and Khanna, Madhu, Welfare Effects of Biofuels Trade Policy in the Presence of Environmental Externalities (March 23, 2009). Available at SSRN: https://ssrn.com/abstract=1367101 or http://dx.doi.org/10.2139/ssrn.1367101

Christine Lasco Crago (Contact Author)

University of Illinois Urbana-Champaign ( email )

Department of Agricultural and Applied Economics
1301 W Gregory Drive
Urbana, IL 61801
United States

Energy Biosciences Institute ( email )

Institute for Genomic Biology
1206 West Gregory Drive
Urbana, IL 61801
United States

Madhu Khanna

University of Illinois at Urbana-Champaign - Department of Agricultural and Consumer Economics ( email )

1301 W. Gregory Drive
Urbana, IL 61801
United States
217-333-5176 (Phone)
217-333-5502 (Fax)

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