Unintended consequences

Writing in Tax Notes Today ($) Martin Sullivan discusses one of the best examples I've seen of Congressional good intentions gone awry. It's yet another cautionary tale before we transfer health care management to the feds. The background:

On May 22, 2008, Congress overrode the president's veto and enacted the long-debated farm bill. Among the goodies in the legislation was an increase in the tax credit for cellulosic ethanol to $1.01 per gallon, paid for with a reduction in corn ethanol's subsidy from 51 cents to 45 cents a gallon. The intended beneficiaries of the $1.01-per-gallon credit were companies that use expensive, cutting-edge technologies to produce ethanol from cellulosic plant materials instead of corn.

Congress tilted tax credits to cellulosic from corn ethanol because the explosion of production of ethanol distilled from corn was driving up food prices and because greenhouse gas emissions from cellulosic ethanol were considerably less than those from corn ethanol.

Seems like a good idea. And cheap--the original credit for cellulosic ethanol was projected to cost a scant $100 million per year.

But it turns out that the paper industry has been running its factories in part with recovered pulping byproducts, something they call "black liquor." This product meets the tax definitions, making the companies eligible for the tax credit for a practice they've had in place since World War II, according to an IRS analysis! So the projected cost of the credit has now ballooned to $25 billion—and that's without stimulating the targeted industry or substituting any domestic fuel for imported oil!

If that isn't enough "Alice Through the Looking Glass" for you, now that we know about the loophole that was inadvertently created, it counts in the budget process (though it never did before). Sullivan reports that closing the loophole will count as $25 billion toward deficit reduction—even though nothing has changed.