Welfare implications of the renewable fuel standard with an integrated tax-subsidy policy

Abstract

This paper derives the optimal integrated tax-subsidy policy where one input is taxed and revenues are used to subsidize the use of a substitute input to reduce greenhouse gas emissions given the existing policies under the Renewable Fuel Standard policies. We measure the welfare effects and impact on cellulosic ethanol production after implementing the tax-subsidy policy using a general equilibrium model. A revenue-neutral integrated tax-subsidy scheme leads to a small positive tax rate for crude oil and a large positive subsidy for cellulosic ethanol because the former has a larger emissions coefficient than the latter. The overall welfare effects of an integrated tax subsidy scheme are less than a 1% increase for the economy but the growth in the cellulosic ethanol industry could range from 28% to 238% because the revenues from taxing crude oil are directly used to subsidize cellulosic ethanol production.