Response to Concerns About Alcohol Fuels Report

Published by the Government Accountability Office on 1997-06-23.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

United States
General Accounting Offxce
Washington, D.C. 20648

General Government Division


June 23,     1997
The Honorable Charles E. Grassley
Chairman,   Subcommittee  on Administrative
  Oversight   and the Courts
Committee on the Judiciary
U. S. Senate
Dear Mr. Chairman:
This responds to your June 6, 1997 letter      expressing
concerns about our March 6,   1997 report   to  the Chairman,
House Committee on Ways and Means, entitled       TAX POLICY:
Effects  of the Alcohol Fuels Tax Incentives      (GAO/GGD-97-41).
Your primary concern seems to be whether our report                            gives
the appearance of being a cost-benefit                     analysis    while it is
not.     In essence, our report           provides      a straightforward            and
balanced discussion          of the benefits          and costs of the alcohol
fuel incentives          for particular       groups:       ethanol    producers,
corn and other farmers,            and consumers and producers                 of food
and energy.          However, our report         is not a cost-benefit
analysis      of the overall       impact of the incentives               on the
national      economy and the text explicitly                states     the limits
of our work.          Such an analysis       would require          more
information        than we had, including            the effects      of oil and
gas subsidies         on ethanol     production.         In addition,        as the
report     states,     the benefits      and costs to particular               groups
would not necessarily           be included        in a cost-benefit           analysis
of the impact on the economy because some benefits                           to one
group, such as higher           corn prices        for farmers,       result      in
costs to another group, higher                food prices       to consumers.
We have reviewed our report          and its development           in light     of
your letter    and are satisfied        that the report        was prepared
in accordance with generally           accepted government           auditing
standards,    our own policies       and procedures,        and with sound
economic principles.         For example,       the staff     involved       in
preparing   the report      had expertise       in federal      farm policy,
energy security,     and environmental         protection       as well as in
economic analysis.        In addition      the draft      was subject        to
GAO's internal    review,     including      our Office     of the Chief
Economist and review by five executive               branch agencies.

                    GAOIGGD-97-145R   Response   to Concerns   About   Alcohol   Fuels   Report

                            /Sk       SF>

The enclosure  to this letter     provides   a detailed   response to
each of your questions.     I trust     that this information
addresses your concerns.      I would be glad to meet with you
if you have any further    questions.
Sincerely   yours,

Lynda D. Willis
Director,     Tax Policy   and
   Administration     Issues

ENCLOSURE                                                                               ENCLOSURE


Questions 1 and 2: Why did you choose to present the benefits of the ethanol tax
incentives by presenting them in terms of a percentage of a base value, yet chose
a different presentation   standard--1996 constant dollars--to describe the “costs” to
the federal treasury ? Did you not comprehend the obvious. . . that by using two
different standards that you were creating an exaggerated impression of the
costs, yet a deflated impression of the benefits? . . . a “Moreover, if the benefits
of ethanol production    and use had also been delineated in constant dollars, the
benefits of the program would be seen to far outweigh the costs.” (page 2).

We were asked to identify the various groups benefitted or disadvantaged by the alcohol
fuels tax incentives. In most cases we did not have sufficient data to make monetary
estimates of benefits and costs; the best we could do was to indicate the direction of the
effect. For two of the groups that benefit most directly from the incentives-ethanol
producers and corn farmers-the report provides considerable detail about why we could
not make monetary estimates of their benefits. (See pages 11 and 12 of the report.)

We provided dollar estimates of excise taxes forgone because the requester had a specific
interest in the impact on the Highway Trust Fund and it was possible to make reliable
estimates. It is our common practice, when reporting dollar amounts over a lengthy
period, to convert those amounts to constant-dollar values. Because inflation erodes the
purchasing power of a dollar, comparing dollar amounts over long periods of time
without making such an adjustment would be misleading.

Summarizing the above, we chose the units in which to present our answers on the basis
of the scope of our work and the availability of data. Since no overall comparison of
costs and benefits was intended, it was not necessary to express in comparable terms the
estimates of costs and benefits to particular groups. Our choices and our subsequent
work neither exaggerated the costs nor deflated the benefits of the alcohol fuels tax

Our report does not reach a conclusion regarding whether the overall benefits to the
economy of the incentives outweigh their costs. The benefits to the economy from the
alcohol fuels incentives would include the direct value to consumers of the additional fuel
produced minus production costs, the value of any environmental benefits, the value of
any increase in energy security, and the value of reducing any distortions caused by other
subsidies, such as subsidies to the oil and gas industry. We did not reach a conclusion
about overall benefits and costs for several reasons, one being that we did not examine

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the value of reducing any distortions caused by other subsidies. Furthermore, many of
the benefits to particular groups described in the report take the form of price changes,
for example corn farmers benefit from increased corn prices. Such price changes are not
net benefits to the economy because such a change, while a benefit to corn farmers, is a
cost to consumers of corn.

‘The report is most egregiously    flawed by giving the appearance              of being a cost-
benefit analysis when it clearly   is not.” (page 2)

The requestor’s four questions are explicit and none of the four ask for a cost-benefit
analysis. Further, our response to the questions does not include a comprehensive
measurement of benefits and costs to the U.S. economy; rather, our report described the
benefits and costs of the alcohol fuel incentives for particular groups-ethanol producers,
corn farmers, other fanners, and consumers and producers of food and energy-and
pointed out that benefits to one group could constitute costs to another. Our responses
to the requestor’s questions did contain information on the cost of producing ethanol,
relative to substitute alcohol fuels, and on the environmental and energy security impacts
of the incentives, which could be used in a cost-benefit analysis; however, in providing
that information, we stated that a cost-benefit analysis would have to include additional
information, such as the size of preexisting distortions in resource allocation caused by
tax incentives for petroleum.

Question 3: Why did you totally ignore GAO’s many previous reports which
concluded net savings to the U.S. government resulting from increased farm
income and reduced farm program costs ? “The GAO has previously performed
comprehensive cost-benefit       analyses concluding net savings of more than $8
billion. . .‘I (page 2). . . . Question 4: Was it your intention to deceive Congress
and the public, or was this the unavoidable outcome given the narrow, specific
nature of the questions you were required to answer?

We cited and used five previous GAO studies, four of which focused on alcohol fuels. In
referring to the 1995 report we did for you (Ethanol Tax Exemption, GAO/RCED-95273R),
we explained in detail why our previously estimated impacts of removing the incentives
would likely be different today due to the passage of the Federal Agricultural
Improvement and Reform (FAIR) Act of 1996.

 In our 1995 report mentioned above, we developed estimates, based on certain
 assumptions, of the potential fiscal effect on the U.S. Treasury of eliminating the tax
 incentives for alcohol fuels. The scope of that study was also limited in that we produced

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estimates for only two scenarios under specific assumptions about actions the Secretary
of Agricuiture might take affecting corn acreage. We noted that the two scenarios did not
portray the fuii range of options then available to the Secretary and that different
assumptions would have produced different results.

We do not believe that the questions we answered in our most recent report were so
narrow as to bias the outcome of our analysis. The issues that we reported on included
which particular groups were benefitted or disadvantaged by the alcohol fuels tax
incentives, the availability of lower cost substitutes, the environmental and energy
security benefits, and the cost to the Highway Trust Fund.

“First, the report repeatedly refers to foregone revenues and not HTF [Highway
Trust Fund] revenues. Second your report fails to note the mitigating       effects of
the current HTF surplus or the ISTEA formulas which protect states from losses
of highway construction    monies resulting from the use of ethanol-blended
gasoline.” (page 2).

Section headings in the body of our report and in Appendix II refer specifica3ly to the
Highway Trust Fund. The term Highway Trust Fund is used throughout our report. Our
scope was restricted to revenue flows into the Highway Trust Fund. We did not address
spending out of the Highway Trust Fund.

Questions 5 and 6: Why did you bury your admission on page 23 that this report
“should not be viewed as a cost-benefit  analysis,” instead of highlighting this
crucial point at the beginning? Why did this admission only come through the
prodding of and in response to Agency comments ? “Moreover, while you stated
that you agreed with the Agency comments that the report was not a cost-benefit
analysis, and that clarifying statements were added, it is not apparent that any
such clarifying statements were, in fact, added to the final report.”

Because our requester did not ask for a cost-benefit analysis and our responses did not
provide one, we did not think that the report would be considered one. The questions we
addressed were listed on page one of the report. We added clarifying language to make
clearer that benefits to one group in the economy may be more or less offset by costs
imposed on other groups.

Questions   7 and 8: Why did you decide to ignore these comments                     [Agency
comments    encouraging GAO to take into account the considerable                     consumers

5                         GAO/GGD-97-145R   Response to Concerns   About   Alcohol    Fuels Report
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savings attributable to alcohol fuel tax incentives], and to summarily dismiss the
benefits to consumers? . . . . Why did you fail to do the math and report to
Congress and the public that even using API’s low estimate, that savings to
consumers would equal $270 million per year?

The report explains that consumers both benefit and incur costs from the alcohol fuel
incentives. As we discussed in our response to your questions 1 and 2, we did not have
data to reliably and completely account for these offsetting effects.

Question 9: Why did you fail to report that the elimination   of the alcohol fuels tax
incentives would create additional consumer costs in the reformulated      gasoline
markets? . . . . “Other estimates . . . suggest that the consumer impact on RFG
would be much higher (between $0.03 and $0.05) including a GAO report issued
just last fall (GAO/RCED-96-121).

On page 13 of our most recent report, we describe the effects of the tax incentives on the
prices faced by both consumers and producers of reformulated gasoline and other
substitute fuels. We report an estimate by the Energy Information Administration that
removing the incentive would increase the difference in price between reformulated
gasoline (RFG) and conventional gasoline by about 1 cent per gallon. Page 5 of the cited
prior GAO report states that the price of RFG in 1996 was as much as $0.05 higher than
conventional gasoline and could be as little as $0.03 higher. The report did not address
the issue of how much more RFG would cost if ethanol were unavailable.

“In certain areas, Such as Las Vegas, Nevada, oxygen content requirements    exceed
the level provided by MTBE and other oxygenates.    Only lo-percent  ethanol
blends can provide the level of carbon monoxide reduction required by law.”
(page 4).

According to fuel emissions analysts at the Environmental Protection Agency (EPA), non-
ethanol oxygenate blends could be used to meet the air quality standards in these areas.

 “Santa Monica, California has a serious groundwater     contamination problem
 caused by MTBE and the State of California   has initiated mandatory testing                           for
 MTBE in groundwater supplies.” (page 4).

 Santa Monica does have a serious groundwater contamination problem caused by MTBE.
 According to EPA, the city has detected MTBE concentrations of up to 610 parts per

 6                         GAO/GGD-97-145R   Response   to Concerns   About   Alcohol    Fuels Report
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billion in the five wells in its main groundwater source and lesser concentrations in
another groundwater source. The suspected sources of the MTBE contamination are
underground fuel storage tanks and pipelines for oil products.

The state of California has recently tested for MTBE under a voluntary measure to obtain
a representative sampling of state groundwater supplies. The preliminary results show
that MTBE contamination in groundwater supplies currently is not a significant threat to
public health, as very few sites around the state produced measurable levels of MTBE.

EPA does not require monitoring and reporting of MTBE in drinking water. However, in
late June, EPA officials told us that, based on limited information voluntarily supplied to
EPA by state agencies, four of the 51 groundwater systems that reported one or more
MTBE detections to EPA reported concentrations at or above the lowest level in EPA’s
draft health advisory.

‘While similar benefits may be achieved by using other clean-burning fuel
components, it is still inescapable that there are clear and demonstrable air
quality benefits attributable   to the use of fuel ethanol.”

There are air quality benefits attributable to fuel ethanol. However, it is generally
acknowledged that air quality benefits approximately equivalent to those from using
ethanol-blended fuels may be achieved by using similar clean-burning fuel components.
Our report states that although use of ethanol may have been beneficial, the use of (non-
subsidized) substitutes to meet air quality standards are likely to have been equally

Question 10: Why did GAO fail to acknowledge the well-established                        air quality
benefits attributable to the use of fuel ethanol?

Our evaluation of the air quality benefits of fuel ethanol was based on the empirical
literature on fuel characteristics and emissions and air quality and also on interviews with
air quality and energy experts. Our major sources of information were the Environmental
Protection Agency (EPA) and the Department of Energy (DOE). Both EPA and DOE
experts told us they believed that, if alcohol fuels had not been subsidized, air quality
would not have been affected. They further said that they believed that there would be
no effect on air quality if alcohol fuels were no longer subsidized. We believe that our
evaluation accurately reflects the best evidence available.

7                          GAO/GGD-97-145R   Response   to Concerns   About   Alcohol   Fuels Report
ENCLOSURE                                                                              ENCLOSURE

Question 11: Why did GAO fail to warn of the serious questions regarding the
health risks involved with MTBE, which undermines GAO’s premise that MTBE
can replace ethanol without risk of environmental degradation?

Earlier investigations into possible adverse health effects of MTBE did not find any health
effects. As reported in the Department of Energy’s publication, The Energv Information
Administration’s Assessment of Reformulated Gasoline (October 1994): “The EPA has
continued to support the use of MTBE as a fuel oxygenate citing the lack of any
substantial evidence that MTBE poses a threat to health.” This conclusion was based on
studies of short-term health effects (for example, dizziness or nausea from breathing
gasoline oxygenated with MTBE).

Since our report was issued, we learned from EPA that the White House Office of Science
and Technology Policy (OSTP) has completed a draft report assessing the wintertime
oxygenated fuels program. It is our understanding that OSTP plans to release its report
in July of 1997.

Questions 12,13 and 14: Given the large and growing imports of MTBE--which
GAO argues will replace ethanol in the absence of tax incentives--why   did GAO
decide to measure ethanol’s energy security benefit against the much larger crude
oil supplies instead of the smaller MTBE supplies? Did you not realize that by
framing your discussion of energy impact by measuring ethanol’s energy security
benefit in relation to its displacement of crude oil instead of MTBE, that you
would be obscuring the importance of ethanol in reducing the need for MTBE
imports? . . . . Why did GAO fail to issue a statement describing our increasing
dependence on imported MTBE, the cost associated with that dependency, and the
energy security benefit of displacing imported MTBE with domestically     produced,
renewable ethanol?

We reported on ethanol’s current displacement of petroleum and its potential to substitute
for petroleum in the future because one of the original justifications for the tax incentives
was to encourage such substitution. As we note in our report, the U.S. vulnerability to
disruptions in MTBE supply is not comparable to its vulnerability to disruptions in oil
supply. A disruption of MTBE supply is probably less likely than an oil supply disruption
because MTBE has more widely varied potential sources of supply. Moreover, because
the volume of MTBE consumed in the United States is dwarfed by petroleum
consumption, the effects on the U.S. economy of a disruption in MTBE supply would be
minimal compared to those of a petroleum supply disruption.

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Question 15: Since GAO &d attempt to diminish the value of ethanol by
comparing it to crude oil, why did GAO choose not to include in this most recent
report the work it has produced in recent years detailing the billions of dollars of
indirect oil tax subsidies that take the form of defense expenditures  and foreign
assistance to protect our oil supply lines from the Middle East?

We concluded in our report that the alcohol fuels incentives do not significantly reduce
petroleum imports. Therefore, defense expenditures and foreign assistance to protect oil
supply lines from the Middle East were appropriately beyond the scope of this report.

Question 16: What purpose was served by Appendix               I, Chronology           of the
Legislation and Events Affecting Ethanol Fuel Use?

The purpose of that appendix was simply to provide readers with background information
on factors, other than just the tax incentives, that have affected ethanol use over the
years. Much of the information in that appendix came from chronologies published
periodically by the Department of Energy.

Question 17: Was the decision to include this material influenced                      by information
from or recommendations  by the American Petroleum Institute?

No. The decision to include this material was in no way influenced by the American
Petroleum Institute.


9                         GAOIGGD-97-145R   Response   to Concerns   About   Alcohol    Fuels Report
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