Welfare Impacts of Alternative Biofuel and Energy Policies

An open-economy equilibrium model is derived to investigate the effects of energy policy on the U.S. economy, with emphasis on corn-based ethanol. A second best policy of a fuel tax and ethanol subsidy is found to approximate fairly closely the welfare gains associated with the first best policy of an optimal carbon tax and tariffs on traded goods. The largest economic gains to the U.S. economy from these energy policies arise from their impact on U.S. terms of trade, particularly in the oil market. Conditional on the current fuel tax, an optimal ethanol mandate is superior to an optimal ethanol subsidy.