Alternative Fuel Tax Credit Promotes Wasteful Use of Diesel in Paper Industry

April 7, 2009

Tax policy experts on both left and right often agree that the tax code should not be used for purposes other than raising revenue. When the tax code is used as a mechanism for rewarding good behavior and punishing bad behavior, it increases complexity while shielding problematic and controversial provisions from the oversight that a spending program would get. Unfortunately, the belief that a tax reduction for one company if it does something is somehow better than a subsidy or government spending program continues to pervade.

The political process is rife with unintended consequences, and using the tax code to shape behavior is no exception. Christopher Hayes at The Nation has an excellent write-up about an innocent-enough tax provision: the alternative fuel tax credit. If you use a mixture of regular diesel with a renewable fuel source, you get a tax credit.

The oops is that the paper mill industry, which previously used only renewable fuels, is now incentivized to add diesel to create a mixture that qualifies for the credit:

By adding diesel fuel to the black liquor, paper companies produce a mixture that qualifies for the mixed-fuel tax credit, allowing them to burn “black liquor into gold,” as a JPMorgan report put it. It’s unclear who first came up with the idea–Wrobleski told me it was “outside consultants”–but at some point last fall IP and Verso, another paper company, formerly a part of IP, began adding diesel to its black liquor and applied to the IRS for the credit. (Verso nabbed $29.7 million at just one of its mills in the final quarter of 2008 for its use of mixed fuel.[…]

Others are less charitable. “You use the toilet every day,” said one hedge fund analyst who’s been closely following the issue. “Imagine if you could start pouring a little gasoline into the bowl and get fifty cents a gallon every time you flushed.”

For the struggling paper industry, it’s almost a new business line to be qualifying for these taxes. The credit was estimated to be a $61 million hit for the U.S. Treasury, but is now projected to be around $2 billion. Unfortunately, I worry that people will view those numbers as evidence of “success”—for those on the left, it means that the credit is achieving environmental improvement, and for those on the right, it means lots of “tax cuts.”

(Hat tip Reason Hit & Run)

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