Second-best biofuel policies and the welfare effects of quantity mandates and subsidies

The quest for biorenewable energy sources is held to justify a number of government interventions, including support policies for biofuels such as those responsible for the recent rapid growth of US ethanol production. This article provides an analytical assessment of such policies. We construct a general equilibrium, open economy model that captures the rationale typically invoked to justify government intervention in this setting: to alleviate the environmental impact of energy consumption and to decrease US energy dependence on foreign sources. The model is used to study both the positive and normative implications of alternative policy instruments, including the subsidies and mandates specified by the 2007 Energy Independence and Security Act. From a positive perspective, we find that biofuels mandates are equivalent to a combination of fuel taxes and biofuels subsidies that are revenue neutral. From a welfare perspective, we show that biofuels mandates dominate biofuels subsidies, and that combining fuel taxes with mandates would be welfare enhancing.