An environmental tax to promote and sustain biofuels and climate policy: The potential for a double dividend in agriculture-dependent economies

This study investigates the potential of an environmental tax on gasoline as a temporary source of biofuel and climate financing for low-income countries. Using a general equilibrium framework, we analyze the effects of recycling tax revenues as subsidies for ethanol consumption, feedstock production, or both. Our findings suggest that recycling these revenues through either an ethanol or feedstock subsidy can effectively generate a double dividend. The first dividend is reflected in a reduction in emissions, and the second is manifested in improved employment, total output, and overall welfare. While the feedstock subsidy allows consumers to share in the benefits received by both feedstock and ethanol producers, it requires a larger subsidy budget to produce the same volume of ethanol as the ethanol consumption subsidy. In contrast, the ethanol consumption subsidy imposes a lower economic burden on taxpayers but can only sustainably increase ethanol production at lower blending levels. As blending levels rise, urban household welfare declines. Nevertheless, this efficiency cost dissipates with more elastic feedstock supply or when tax revenues are recycled back into the system through both subsidies. Our findings make a strong case for both supply-side and demand-side policies in promoting renewable energy while minimizing the negative impact on household welfare. It is evident that effective agricultural support must be implemented alongside a targeted ethanol policy to avoid clean fuel benefits at the expense of household welfare.