Alcohol Fuels Tax Incentives

Publication Date: July 2005

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Energy

Type:

Abstract:

Prior to January 1, 2005, alcohol fuel blenders qualified for a 5.2 cent 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 cent on January 1, 2005, reduced the gasoline excise tax for "gasohol," from 18.4 cents to 13.2cents/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 cents exemption could also be claimed later, i.e., when blenders filed their income tax return, as a 52 cent excise tax credit per gallon of alcohol used to make a fuel mixture (which was also scheduled to decline to 51cent 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 -- 5.1cent gallon of a 90:10 mixture, which is also equivalent to 51cent 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 18.4cents per gallon excise tax on gasoline, so that the actual excise tax paid and remitted to the Treasury is 13.3cent -- the tax is reduced by 5.1cent/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 18.4cent rather then 13.3cent. 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 18.4cent/ gallon rather than 13.3cent per gallon. At a 25% marginal income tax rate, the additional 5.1cent deduction is valued at 1.7cent/gallon of a blend or 17cent/gallon of ethanol, which means that the total after-tax subsidy for alcohol fuel mixtures is effectively 68cent/gallon of ethanol rather than the nominal rate of 51cents.

By nominally increasing the excise tax on gasohol by 5.1cent/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.