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Yeah, there is all sorts of Wrong with your recommendations.
A critical point to note is that there already are lots of free ebooks available, many of which are high quality (and very popular) notably public domain books. It's unclear whether this beneficial public service has made any sort of dent in piracy rates.
For general interest books, the paper costs are only around 15% of the total costs. Basically, retailers and publishers have spent the last decade squeezing those costs as much as possible in order to increase their profit margins. Things like author's advances, editorial costs, marketing and other overhead make up most of the costs these days. (As a published author, go ahead and ask your publisher for a breakdown of the costs....)
Last I heard, Americans collectively spend around $35 billion on books per year (including all markets). At a minimum, your proposal means the total destruction of the entire book retailing industry, which is slightly ridiculous.
This also means the creation of a very expensive new entitlement, in an era where every federal and state government is slashing costs.
It also essentially means turning over content decisions to government agencies. How many members of Congress are likely to support spending Your Tax Dollars on books like Not Just an Orgy? How about The Chomsky-Foucault Debate? Or Mein Kampf?
There is also a limited market for readers; in the US it's around 65 million, or 1/5 of the US population. While offering free books will help grow this a bit, it's unlikely to, say, double it or double the amount of time that readers have or want to spend reading. I.e. you can't "make it up on volume" if there's a ceiling to the sales volume.
By the way, libraries do have an ebook option, it's offered by a company called Overdrive.
Finally…. I see little reason why this is going to thwart piracy. People will just break whatever DRM you put on the library ebooks and swap the titles, even if it costs them almost nothing to borrow the ebooks.
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