Federal Tax Policy Has Only Modest Impact on Recycling, Environmental Law Institute Study Concludes

Economist Robert C. Anderson and other members of the Environmental Law Institute staff recently completed a sixteen-month long study of the impact of the federal tax code on the recycling of scrap materials.¹ The report, done under contract for the Environmental Protection Agency, measures the size of income tax subsidies enjoyed by certain virgin raw materials as compared with recycled materials, calculates the impact which these subsidies may have on the market price of virgin-based products, and estimates the impacts of these price effects on the amount of recycled resources in use. It concludes that tax subsidies alone have little impact on recycling and conservation of depletable resources.²

Many other economic factors appear to favor the use of primary or virgin raw materials over secondary or recycled materials.³ These include freight rates, souce labeling requirements, former federal procurement policies, federal mineral discovery policy, and municipal waste removal subsidies.

Railroad freight rates, which are controlled by the ICC, are lower for virgin materials than for an equal volume of scrap.⁴ As for labeling, several products derived from scrap materials are required to be so labeled,⁵ such labels may discourage consumption by those who associate the words "recycled" or "waste" with inferior products. The federal mining laws, which give away valuable mineral rights to stimulate exploration for virgin mineral supplies, create incentives favoring investments in virgin over scrap industries. The tax exempt status of municipal trash collection systems, combined with financing out of general revenues rather than user charges, lowers the cost to users of waste disposal and thus tends to stimulate greater waste production than would result if charges were based on use and reflected full social costs of disposal. Finally, federal procurement policies, at least in the past, have favored virgin materials over secondary sources.

Net Tax Burdens Compared

The first section of the report uses data from Securities and Exchange Commission (SEC) Form 10-K documents to compare the tax burden in various natural resource industries with that of recycling firms. Because most recycling concerns are small enough to escape SEC reporting requirements, the report relied on tax burdens in general manufacturing as a proxy for income tax rates incurred by the recyclers. The effective rate of taxation as reported to the SEC was used as the basis for comparison. This rate is computed as the ratio of all state, federal, and foreign income taxes to the pretax income of the firm. Effective tax rates in 1973 were as follows:

Number

of Firms Effective

Industry in Sample Tax Rate

Paper and Forest Products 18 40.6%

Mining 12 25.5%

Manufacturing [proxy for

recyclers[ 15 45.9%

The principal tax subsidy of the paper and forest product industry is the capital gains treatment accorded to profits obtained as trees grow to maturity. The Treasury Department has estimated that this subsidy amounted to $145 million in fiscal 1975.

The mining industry enjoys tax subsidization through the percent depletion allowance, the treatment of exploration and development expenditures as current costs rather than capital investments, and the capital gains treatment of certain coal and iron ore royalty payments. The Treasury has not estimated the magnitude of these subsidies to mining concerns other than to note that the capital gains subsidy amounts to a mere $5 million. Sampling indicates that the total subsidy may exceed $500 million in years when mineral prices are high. Offsetting these subsidies to some extent are state severance taxes on mineral output.

Price Impact of Tax Subsidies

The second section of the report estimates the maximum impact these subsidies could have on the price of primary materials. Without delving into the details of the computations, it is sufficient to note that the estimates of price impacts used represent upper limits. This is because (1) all taxes were assumed to be passed forward into product prices rather than backward into land values, and (2) it was assumed that no substitution of labor for capital would occur if capital became more expensive due to the elimination of a tax subsidy.

The report calculates that the capital gains treatment of the profits of stumpage decreases the price of pulpwood — a product which competes with wastepaper as an input to the manufacture of tissue, paperboard and newsprint — by one to four percent. For the copper and lead industries, tax subsidies may lower product prices by as much as six or seven percent. For steel the impact [6 ELR 10042] is on the order of three percent; for aluminum, between one and two percent.

The final portion of the report deals with the determinants of the flow of material within the scrap sector of each industry. Supply and demand curves for scrap were estimated through multivariate analysis of time series data on quantities of scrap recycled and factors such as the price of scrap, the price of virgin material scrap substitutes, and the level of industrial activity which affect supply and demand.

In the short-run, using existing technology and equipment, the impact of lower virgin material prices on the flow of recycled materials appears to be slight. Although more difficult to estimate, longer-run effects are likely to be considerably larger as machines and technology are adapted to handle larger proportions of scrap materials in the mix of inputs. The report estimates that the long-run impact of current virgin material tax subsidies may reduce the quantities of materials which would otherwise be recycled by as much as the following: paper — 1.5 percent, steel — 3 to 6 percent, copper — 0.9 percent, lead — 0.8 percent, and aluminum — 1.7 percent.

Conclusion

Focusing as it does on only one element of a complex, de facto policy of material use, the report should be accepted with caution. Though this one element of the overall policy may not be of overwhelming import, taken collectively, the factors summarized at the outset may have a highly significant impact on materials use.

Moreover, though the results proved modest in the present study, the statistical models of scrap markets developed in this report will be quite useful in other contexts. The market models provide a valuable foundation for simulating market responses to a wide array of materials policies toward scrap industries, including direct subsidies to scrap users, disposal taxes on producers and consumers of virgin based products, and subsidies to scrap suppliers. The models permit easy calculation of changes in the flow of recycled waste materials which result from an inferred shift in either the scrap market supply or demand functions. The Institute presently has under consideration further studies which would use these new tools for analysis of the resource market.

1. The study, "Federal Tax Policy and Depletable Resources: Impacts and Alternatives for Recycling and Conservation," is described in Comment, New ELI Project Assesses Impact of Tax Code Provisions on Use of Depletable Resources and Recycling, 5 ELR 10014 (Jan. 1975).

2. This conclusion is at odds with the views of others. See, e.g., "Taxes that Bite into Recycling Savings," Christian Science Monitor, Jan. 5, 1976, p. 11.

3. Other economists argue that national materials use is strongly biased twoard the use of virgin raw materials over recycled or secondary materials, and that a policy based upon a thorough analysis of social benefits and costs would favor more intensive use of recycled materials. Private incentives with respect to materials use may not reflect social desires for a variety of reasons: (1) private profits are independent of social costs associated with the disposal of materials which are not recycled; (2) environmental disruption associated with primary production is normally not a cost to primary producers; and (3) the needs of future generations may receive too little attention if virgin material production is guided by current and projected prices rather than by an attempt to explicitly maximize intergenerational welfare.

4. See Resource Planning Institute, Raw Material Transportation Costs and Their Influence on the Use of Waste Paper and Scrap Iron and Steel (Apr. 1974). This discrimination was the basis of the SCRAP litigation, which recently made its second appearance in the Supreme Court. See Comment, SCRAP II: No Excuse for NEPA Foot-Dragging, 5 ELR 10126 (Aug. 1975).

5. E.g., waste oil.