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Senators McCain and Barrasso Just Don’t Get Ethanol Trade Policy

January 14, 2011


According to reports, during a meeting with officials in Brazil, former presidential candidate, Senator John McCain (R-AZ), and his colleague Senator John Barrasso (R-WY) made bold claims about the legality of U.S. ethanol policy under World Trade Organization (WTO) obligations.  Such claims are simply unjustified. To date, the 45 cent excise tax credit for ethanol (VEETC) and the 54 cent offsetting tariff on imported ethanol has not been subject of any WTO challenge or official complaint despite lofty threats made by lobbyists for Brazilian sugar barons.  Neither the trade experts nor U.S. trade officials believe that any real WTO challenge regarding VEETC or the tariff can be sustained.  This is confirmed in a 2008 letter to Senator Feinstein from U.S. Trade Representative, Susan Schwab, stating that the trade office was "unaware of any WTO obligation that the U.S. should reduce the tariff or other charge on imported ethanol." In response to the senators' statements, it is necessary to consider the true facts, law and trade precedent surrounding this issue.  As explained below, it is the unique, market-based structure of the tax incentive to blend ethanol, and the secondary tariff designed to offset tax benefits received by foreign imports of the fuel, that has precluded any claim or challenge to the U.S. ethanol program under the WTO. Volumetric Ethanol Excise Tax Credit ("VEETC") VEETC is the central tax incentive for the U.S. ethanol industry.  Most importantly, VEETC is a market-based incentive that is paid to the blenders and marketers of fuel.  This market-based approach is the strongest defense to any claim that tax incentive is in violation of WTO regulation. As designed by Congress, VEETC provides downstream blenders and marketers of gasoline with a 45 cent credit for each gallon of ethanol that they blend into the current fuel stock.  VEETC is available to all ethanol regardless its country of origin.  Ethanol from Brazil and ethanol from Iowa are treated equally under this tax policy. In any WTO dispute settlement proceeding, the central point is who receives the financial contribution or subsidy.  Because the recipient of the VEETC is the downstream blender, it would be very difficult for a complaining country to establish that their domestic industry is being adversely impacted by the U.S. tax incentive.  Moreover, it would be nearly impossible to show that the complaining country's industry was being sufficiently prejudiced by policy.  Such a showing is required under WTO regulations. In light of VEETC's structure, any complainant would have to argue that the industry received an indirect benefit.  While it is difficult to show "serious prejudice" or "adverse effects" in any case, it is especially difficult in an indirect benefit case, such as when a blender, downstream from the producer, is the recipient of the credit. Finally, in response to a potential case, the U.S. would be entitled to raise a number of powerful defenses to any WTO challenge against VEETC, including the U.S. interests in conserving fossil fuel, or the fact that that it is available to both domestic and imported ethanol.  Unless the credit is deemed to be an arbitrary or unjustifiable discrimination between countries, or a disguised restriction on international trade, it will survive any WTO challenge. Secondary Tariff on Imported Ethanol The secondary tariff is designed to offset the benefit available to imported ethanol eligible for VEETC.  In any potential WTO challenge to this policy, three issues must be recognized. First, the secondary tariff is not a subsidy.  It does not go to producers of ethanol, but instead it goes to the U.S. Treasury.  Second, because VEETC is available to both imported and domestically produced ethanol, the secondary tariff is necessary to ensure that U.S. taxpayers are not subsidizing foreign ethanol producers.  Third, the secondary tariff has been properly notified and scheduled according to WTO procedures. It is also important to recognize that loopholes exists that allow for the direct import of ethanol without being subject to the tariff.  For example, the Caribbean Basin Initiative (CBI) allows for countries covered under the trade agreement to import ethanol to the U.S. duty-free.  Each year, a quota equal to 7% of the U.S. total ethanol production the prior year is established for such imports.  Never has this quota been met.  Other such provisions exist in various free trade agreements. Given the analysis above, there simply is no justifiable reason to believe that VEETC, the offsetting tariff, or any other part of the U.S. ethanol program are in violation of WTO strictures and protocol.