Resident Scholar Kevin A. Hassett

President George W. Bush used his State of the Union address to lay out an ambitious energy policy that significantly expands a number of existing programs. The centerpiece of his plan will increase our reliance on biofuels by a factor of five.

In other words, he announced a policy that makes no sense whatsoever.

Of all of the embarrassing corners of government policy, our approach to energy may be the most shamefully indefensible. And now the indefensible is going to get bigger.

Policymakers have been waging a verbal war against our reliance on oil ever since the 1970s. In the beginning, the argument was that we needed to wean ourselves off a fuel that exposes us to political risks, since so much of it is produced by our unstable enemies.

These arguments seem even more real today. Iranian President Mahmoud Ahmadinejad seems like just the kind of fellow who might use the nuclear weapons that his oil dollars are financing.

The verbal war against oil has grown in intensity, as those worried about global warming have become ever more uncomfortable with carbon emissions. Republicans, on balance, seem to be convinced by the political argument. Democrats are convinced by the environmental case. So every year we see bipartisan cooperation on energy policy. The results have been disastrous.

Our two main policies have been heavy subsidies for the production of corn-based ethanol and heavy subsidies for the domestic production of oil. Neither of these makes any sense.

The Worst Subsidies

Ethanol subsidies are the worst kind of government program. Ethanol is a costly fuel source that takes so much energy to produce that it has little impact on our reliance on other sources of energy. Indeed, some estimates suggest that our energy consumption might go down if we banned ethanol altogether.

Why the big subsidies? Ethanol is more popular in Midwestern states than ``American Idol'' because it drives up corn prices. This side of our energy policy is welfare for farmers and nothing else.

Domestic oil production might seem like a nice thing, but subsidizing it has little impact on the concerns mentioned above. A subsidy for production lowers costs and increases consumption. It is hard to imagine that higher oil consumption is what the global warming crowd has in mind.

Not Buying Security

Subsidies for domestic production also buy little security. Even if the U.S. were to produce all the oil it consumes, it would still be vulnerable to oil-price fluctuations. A supply reduction in the Middle East would raise prices of domestic oil just as readily as it raises prices of imported oil.

Reducing our own demand from countries such as Iran has no effect, since that country can just sell oil to other customers. Who could possibly argue with this point? We have purchased no oil from Iran since 1991, but they were the world's fourth-largest net oil exporter in 2004.

While politicians have talked a good game, the truth is we have been in denial. The outcome of our terrible policy has been predictable. Despite all our "best" efforts, the share of oil in U.S. primary energy consumption has risen steadily from 38.1 percent in 1995 to 40.2 percent in 2004.

It's regrettable that oil has been made a bogeyman. It is an incredibly cheap and efficient energy source. It continues to hold a large share of our energy consumption because it has so many advantages over its competitors.

But if policies are to be justified with a smear campaign against oil, then those policies should at least be rational. They are not.

Textbook Solution

If our leaders are serious about weaning us off of oil, then the economic textbooks provide guidance on how to do it. Government should tax things that produce pollution. If you are worried about global warming and energy security, then you should support a carbon tax.

Consider a tax of $15 per metric ton of carbon dioxide--a tax rate comparable to the current carbon price in the European Emissions Trading System. Focusing only on carbon and assuming a short-term reduction in carbon emissions of 10 percent in response to the tax, a $15-per-ton tax rate would collect almost $80 billion a year, an amount that represents 28 percent of all corporate taxes collected in the U.S. in 2005.

The price changes aren't huge. The price of gasoline would increase by 13 cents a gallon, the cost of electricity generated by natural gas by 0.6 cents per kilowatt-hour, and the cost of electricity generated by coal by 1.4 cents per kwh. And all that revenue could be used to reduce corporate taxes, perhaps even stimulating higher economic growth.

Incentives for Alternatives

If we had such a tax change, it would drive up the price of carbon-based energy. That would provide incentives for the production of alternative-energy forms. The beauty of that is there would be no reason to have any other subsidies.

With a $15-per-metric-ton tax, wind and biomass become cost-competitive with natural gas. Unlike subsidies, however, the tax would raise revenue that could finance reductions in other taxes and would not play favorites. If ethanol is the best alternative, it will flourish. If not, corn flakes will be cheaper.

If the president and congressional leaders are serious about energy security and global warming, they should zero out all our energy programs and replace them with a carbon tax. Since the resulting revenue can be used to finance tax cuts elsewhere, the policy shouldn't be harmful economically.

But they aren't serious. That is good news for farmers, and bad news for everyone else.

Kevin A. Hassett is a senior fellow and director of economic policy studies at AEI.