-----~~--

Federal Tax Pol icy 

and Recycling 

of Solid Waste 

Materials 

Office of Tax Analysis 

U.S. Treasury Department 

February 1979 
Executive Summary 

This study, underta ken in response to a Congressional 

directive in Pub! ic Law 94-568, examines the impact of Federal 

tax policies that may impede or discourage recycling of solid 

waste materials, and evaluates potential tax pol icy changes to 

encourage recycling. 

The study finds that existing tax subsidies to mining and 

timber growing, though substantial, do not significantly reduce 

the use of competing scrap metals and wastepaper in primary 

production. Therefore, these tax subsidies do not justify 

compensatory tax incentives for recycling. Additional arguments 

advanced to support subsidies for recycling are also faulty. 

However, if there is to be a subsidy for recycling, some methods 

are superior to others on administrative and economic grounds. 

The solid waste stream and virgin materials are alternative 

sources of material inputs for primary production. Der iving 

useful inputs from either source involves refining or processing. 

Efficient product ion requires using that combination of virgin 

and recyclable materials that minimizes the cost of inputs to 

production. A decentralized market economy will automatically 

achieve this efficient combination, unless public subsidies or 

regulations bias the choice between sources of materials. 

Tax subsidies to mining and timber growing are provisions of 

the Federal income tax specific to these industries that depart 

from normal methods of taxing income from investments. Such tax 

subsidies can be expressed as an equivalent cash grant that would 

provide the same incentive to production under normal methods of 

income tax accounting. 
- ii -

The tax subsidies to mining are percentage depletion; current 

expensing of some investments; and for some minerals, capital 

gains treatment of royalty income. These tax provisions are 

equivalent to cash grant subsidies of from 8 to 12 percent of the 

value of output for coal, copper, and iron ore mining. 

The tax subsidies to timber growing are capital gains 

treatment of income from the sale of timber; mismatching of 

income and expense; and deductibility against income from other 

operations of those expenses incurred in generating the revenues 

taxed as capital gains. These three provisions are equivalent to 

cash grant subsidies of from 35 to 45 percent of the v alue of 

standing timber before harvest. 

Available statistical evidence shows that these substantial 

subsidies to resources used in virgin materials can lead to 

increased domestic output from m1n1ng and timber growing, but 

they do not have a significant deterrent effect on the use of 

competing recyclable materials-- scrap steel, scrap copper, and 

wastepaper-- in primary production. Factors that dilute the 

impact of tax subsidies on recycling include: 

o The small share of total cost of virgin materials used as 

inputs in primary production accounted for by the 

subsidized input; 

o Rising unit costs of increasing output in mining and 

0 

timber growing; 

International trade 

impact on prices 

producers alone; 

in raw materials, which reduces the 

of materials of subsidies to U.S. 

o A small response of the supply of recyclables to changes 

in material prices, and 
- iii -

o Low substitutability in primary production between virgin 

and recyclable materials. 

The importance of these factors varies among materials. 

The analysis of the tax subsidies to virgin materials implies 

that tax incentives for recycling are not needed to correct 

existing biases in th Federal income tax. Other arguments for 

subsidizing recyclables are that it would: 

o Reduce the burden of solid waste management to local 

governments, 

o Reduce environmental degradation, and 

o Promote conservation of finite resources and energy. 

While these objectives are worthwhile, the 

additional recycling do not justify a Federal 

benefits from 

subsidy if the 

objective is to promote the best use of all scarce resources, 

including labor, capital, and the natural endowment. 

Private markets force individuals to confront the full costs 

of using natural resources; and states and localities, the full 

costs of solid waste disposal. Therefore, altering market 

signals by Federal subsidies to promote recycling would cause 

more social costs to be incurred in additional recycling than the 

costs saved through reduced virgin materials consumption and 

reduced waste disposal. Market prices largely reflect the full 

costs of energy. To the extent that energy is underpriced 

because of controls, it is far better to correct this distortion 

directly than to encourage much more costly production methods 

that use only slightly less energy. Meeting current waste 

disposal standards will relieve environmental degradation from 

inappropriate solid waste disposal by localities much more 

cheaply than would subsidizing recycling. 
- iv -

Many economic activities are subsidized because policy makers 

beLieve their outputs should be greater than those resulting from 

the operation of private markets. Recycling is no exception . In 

the 1978 Revenue Act, Congress enacted an extra 10 percent 

investment credit for already qualified equipment used in 

recycling. 

As noted, recycling subsidies encourage inefficient 

product ion methods. They also create ineff ic ienc ies in solid 

waste stream utilization by biasing resource recovery towards 

recycling and against conversion of solid waste into energy . 

However, if recycling is to be subsidized, some methods are 

preferable to others. 

The only practical point at which to inject a recycling 

subsidy is at the level of the primary producer. Otherwise, 

multiple exchanges of the same recycled product could all qualify 

for subsidy. A subsidy at the primary producer level still 

presents administrative problems: Jt would be necessary to 

measure the recycled " content" of materials that may be 

physically indistinguishable, to license qualified recyclers, and 

to employ inspectors to validate claims . 

The recycling subsidy could be in the form of an appropriated 

cash grant, or a tax reduction. The base of the subsidy could be 

value of materials recycled, or investment in recycling 

equipment. If cleared through the tax system, the subsidy could 

be in the form of special tax credits, extra tax deductions, or 

tax exemption of certain income. 

In general, appropriated subsidies are preferable to tax 

subsidies, because: 

o Agencies with expertise in the field are likely to 

administer the subsidy more efficiently than the IRS. 
- vo Costs are more controllable , because appropriated 

subsidies are accounted for in the budget of the 

responsible agency, and are subject to annual 

Congressional review, with the assistance of Congressional 

and agency staffs conversant with the subsidy program . 

o Tax subsidies generally understate budgetary costs 

relative to appropriated subsidies providing the same 

incentives, because they are usually measured in 

after-tax, rather than before-tax, dollars. 

o Tax subsidies usually enable taxpayers with above- average 

incomes to bear a lower share of the tax burden, while 

appropriated subsidies do not change the d i str ibut ion of 

tax burdens . 

Subsidies based on the value of recycled materials are better 

than subsidies to equipment used in recycling, because they serve 

more directly the objective of increased recycling, without 

biasing the choice between capital and labor in production. 

Subsidies in the form of tax credits, particularly credits 

included in taxable income , are preferable to subsidies in the 

form of extra deductions (either by percentage depletion or more 

rapid depreciation) or tax exemption. By understating taxable 

income, tax exemption confers relatively greater benefits on 

weal thy taxpayers, to whom tax exempt ion is more valuable, thus 

reduci ng the progressivity of the tax system. On the other hand, 

tax credits have the same economic effects as do cash grants if 

they are taxable and are not limited to tax liability. 
Table of Contents 

1. Solid Waste as a Source of Recyclable Material • • . . • 1 

Legislative Mandate .. . . . . . . . . . . . . . . . Introduction • • • • • • . • . . . . . . . . . . . . Report Objectives and Summary of Findings •. 

Locating the Solid Waste Stream and Recycling 

in the Economic Process .•• 

1 

2 

3 

6 

2. Federal Tax Subsidies to Virgin Materials . . . • • • • • 25 

Introduction ...•. 

Special Tax Provisions Affecting Mineral 

Industries and Timber .......•• 

Derivation of Supply Shift for Minerals . 

Derivation of Supply Shift for Timber .• 

Conclusions . . . . . . . . . . . . . . . 

3. Impact of Federal Tax Subsidies to Virgin 

Materials on the Amount of Recycling 

. . . . . . 

. . . . . . . 

25 

26 

36 

39 

46 

49 

Introduction . • • • • • • • • • • • • . . . . • . • . • 49 

4. 

Framework of Analysis . 

Scrap Steel Recycling ••••...•.••••••••• 

Scrap Copper Recycling • 

Wastepaper Recycling . . . . . . . . . . . . . . . . . . 

Conclusions ••••...•.....•••.•.•.•• 

Recycling Subsidy Options •••. 

Justification Commonly Cited for 

Subsidizing Recycling Activities 

Considerations in the Formulation of a 

Subsidy to Recycling .•••••.. 

- vii -

50 

60 

68 

70 

73 

77 

77 

88 
- viii -

Appendix to Chapter 2 -- Computation of Supply Shifts for 

Minerals and Timber from Tax Preferences •. 

Supply Price Equations for Minerals . 

Mineral Investment Profiles ... 

Supply Price Equations for Timber . 

Timber Profiles • . . • • • • . . . 

. . . . 

. . . 

Appendix to Chapter 3 • • . . . . . . . . . . . . . . . 

Effect of Tax Subsidy on Price of 

Virgin Materials •..•.. 

Effects of International Markets on 

Price Change from Tax Subsidy .. 

Effect of Change in Price of Virgin 

Input on Recycling •.•.•••. 

. . . . . 

. . . . . . . . . . 

. . . . . . . . . . 

129 

129 

131 

132 

135 

137 

137 

143 

150 
Figure 1.1 

Figure 1. 2 

Figure 1.3 

Figure 3.1 

Figure 3.2 

Figure 3.3 

Figure 3.4 

Figur e 3.5 

List of Figures 

Resource and Product Flows . . . . . . . . . . 

Relation of Quantity Available to the 

Price of Recyclable Materials . 

Quantity of Recyclable Materials 

Utilized ...•.. 

Effect of Tax Subsidie s on Virgin 

. . . . . 

Material Prices . . . . . . . . . . . 

Effect of Tax Subsidies on Virgin 

Material Prices: Alternative 

Elasticity Assumptions • 

Partial Equilibrium Effe ct of a 

Subsidy on an Exported Product 

Partial Equilibrium Effect of a 

Subsidy on an Imported Product 

Effect of Reduction in Virgin 

Material Prices on Recycling 

- i x -

8 

14 

18 

138 

140 

144 

147 

151 
Table 2.1 

Table 2.2 

Table 2.3 

Table 3.1 

Table 3.2 

Table 3.3 

Table 4.1 

Table 4.2 

Tabl e 2A.l 

Table 2A.2 

List of Tables 

Summary Calculations: Mining Profiles . . . • 40 

Summary Calculations: Profiles for 

Southern Loblolly Pine Stand Used for 

Pulp Production . 

Effects of Individual Preference Items: 

Timber Profile with 20-year Rotation . 

u.s. Production as a Percent of World 

Production: Selected Commodities • 

Virgin Mineral Inputs in Production of 

Pig Iron Input . . . • • . . • • • • 

Effect of Mineral Industry Subsidies 

on Price of Pig Iron .. 

Capital Subsidies Implied by Five-y ear 

Amortization . . . . . . . 

Capital Subsidies Implied by an 

44 

45 

55 

64 

65 

113 

Additional 10 Percent Investment Credit • . 119 

Data Derived from Mineral Industry 

Profiles • . . . . . . . . . . . . . . . . 133 

Model Southern Loblolly Pine Stand 135 

- xi -
Chapter 1 

Solid Waste As a Source of Recyclable Material 

I. Legislative Mandate. 

Section 4 of PL 94-568, enacted October 20, 1976, 

provides in part: 

"The Secretary of the Treasury, in cooperation 

with the Administrator of the Environmental 

Protection Agency, shall make a thorough and 

complete study and investigation of all provisions of the Internal Revenue Code of 1954 

which currently impede or discourage the recycling of solid waste materials, and shall 

determine what actions Congress may take under 

the Internal Reve nue laws to increase and 

encourage the recycling of solid waste materials." 

On October 21, 19/6, the Resource Conservation and 

Recovery Act of 1976 (P.L. 94-580) was enacted. Section 

80021j) of the Act established the Resource Conservation 

Commit tee composed of the Secretaries of 'Treasury, Labor, 

Commerce, and Interior, the Chairman of the Council on 

Environmental Quality, a representative of the Office of 

Management and Budget, and the Administrator of the Env ironmental Protect ion Agency, designated Chairman. Among 

other things, the Resource Conservation Committee was 

directed to 
-2-

" •.• conduct a full and complete investigation 

and study of all aspects of the economic, 

social and environmental consequences of resource conservation with respect to --

the effect of existing public policies (including subsidies and economic incentives and 

disincentives, percentage depletion allowances, capital gains treatment and other tax 

incentives and disincentives) upon resource 

conservation, and the likely effect of the 

modification or elimination of such incentives 

and disincentives upon resource conservat ion ... " . 

This report is formally a response to the directive of 

PL 94-568. By agreement with the Resource Conservation Committee, its preparation has been coordinated with the studies 

of the Committe e. 

II. Introduction 

The economic process is a web of interrelated ac tivities 

by which indiv iduals contribute labor services and savings to 

produce a flow of goods and services that constitutes their 

standard of living. In an economic system predicated on private dec is ion making and private rights to property, ind ividual judgments expressed in voluntary exchanges determine 

the outcome of the process. By their decisions to work--

doing what and for how long--and to save rather than to 

consume, individuals determine the labor and capital which 

will be available to produce those goods and services they 

are willing to buy. It is the characteristic of such a vol-
-3-

untary system of exchange that the incomes of persons and the 

value of the system's output are simultaneously determined by 

a set of interdependent prices. These prices thus reflect 

the preferences of the participants in the system for goods 

and services, given the natural endowment and stock of knowledge and the willingness of individuals to work and to save. 

If decisionmakers in the economic process confront 

prices which fully reflect costs of producing the goods and 

services they elect to purchase, the result of their decisions is commonly described as "efficient": no greater value 

of goods and services could be produced with the resources 

available. Such a result can also be called "conservationperfect," for, if a maximum value product is produced, there 

can be no "waste" of resources, whether natural, personal, or 

capital. 

It is frequently contended that the market prices of 

goods and services are distorted. Institutional failures may 

prevent market prices from reflecting certain significant 

social costs, such as environmental degradation, and public 

policies may subsidize particular economic activities, thereby reducing market prices of the favored products and services art if ic ially. If, for either set of reasons, some 

market prices are too low or too high, the value of the output of the economic process is lower than it might be, and 

resources are wasted. Producers and consumers, not confronted directly with the true social cost of subsidized 

resources, produce and consume too much of the favored output, diverting resources from higher value uses and thereby 

lowering the total value of all output. 
-4-

III . Report objectives and summary of findings 

A. Identification of tax subsidies to virgin materials 

production. 

The language of Section 2 of P.L. 94-568 suggests there 

are provisions in the Internal Revenue Code that favor the 

domestic production of minerals and timber. 'Ihat such tax 

preferences prevail constitutes ~-E.E.!:~.E.! evidence that resources are being wasted. 

Chapter 2 reviews these tax preferences and provides 

estimates of the effects of these preferences on the availability of certain domestic virgin materials. The estimates 

show that the special tax preferences are equivalent to a 

direct cash subsidy of from 8 to 12 percent of the value of 

output of coal , iron ore and copper mining and of 35 to 43 

percent of the value of standing timber. 

B. Quantifying the degree to which resource wastage due 

to tax subsidies is manifested in too little recycling of 

solid waste. 

PL 94-568 refers to these tax provisions as "imped irnents" to recycling of solid waste , implying that the resource wastage due to the tax preferences for minerals and 

timber manifests itself in excessive and environmentally 

costly disposal of materials which could be recycled. In 

order that this be true , the effects of tax preferences would 

have to be to lower artificially the domestic prices of virgin materials and thereby make uneconomic the derivation of 

recyclable material from the solid waste stream. The pertinent issues involved in this recycling deterrence hypothesis 

are examined in Chapter 3 . 'Ihe analysis of this chapter concludes that the significant resource wastage due to tax pre-
-5-

ferences for virgin materials does not take the form of solid 

waste disposition rather than recycling. Tax preferences for 

production of virgin materials do not reduce the volume of 

recycled materials by more than one or two percent. Rather, 

the analysis concludes that resource wastage induced by tax 

preferences takes the form of excessive domestic production 

of virgin materials: too low a level of imports, or too 

large exports, of those materials traded in world markets, or 

simply excessive usage of certain materials locally produced 

and used for which recyclable materials are not readily substitutable. 

C. Evaluation of alternative subsidies to recycling. 

The final charge for this Report in PL 94-568 is a review of "actions Congress may take under the internal revenue 

laws to increase and encourage the recycling of solid waste 

materials." Chapters 2 and 3 generally set forth the basis 

for the conclusion that Federal tax laws do 1 it tle to prejudice the choice between recycling materials from solid 

waste and production of virgin materials. World trade flows 

and the basic characteristics of markets for recyclables are 

such that, without tax preferences for virgin materials, 

there would be little change in the volume of recycling. On 

this ground, Chapter 4 concludes that there is no justification for considering a set of countervailing tax preferences for recycling activities. Chapter 4 also reviews 

additional justifications frequently set forth by proponents 

of tax subsidies for recycling: that recycling will "conserve" finite resources, save energy, and reduce the costs of 

disposal of municipal solid waste. The conclusion reached is 

that these justifications for recycling subsidies are either 

faulty or establish objectives which might be achieved more 

effectively by Federal programs less costly than recycling 

subsidies. 
-6-

Finally, Chapter 4 evaluates the possible forms of tax 

subsidies to recycling in light of the market characteristics 

of recyclables and concludes that these would be economically 

inefficient and administratively difficult to implement. Included among those subsidies to recycling evaluated are the 

tax subsidies presently provided in the form of tax-exempt 

bond financing for solid waste disposal facilities and the 

recently enacted additional investment credit for recycling 

equipment. 

The rest of this chapter sets out a framework for the 

subsequent analyses of the effects of tax preferences on the 

domestic production and/ or prices of virgin materials. A 

glossary of terms used in the discussion of solid waste flows 

and recycling is included. This material is intended to 

guide the reader through the intricacies of an economic system that must be understood to analyze solid waste policy 

issues. 

IV. Locating the Solid Waste Stream and Recycling in the 

Economic Process 

A. The Economic Process 

The 215 million persons comprising the population of the 

United States supply a labor force of 98 million workers and 

a capital stock valued at, perhaps, $9 trillion. Labor supply and consumption de cisions are made by 70 million households; and economic activ ity is carried out in about 10 mill ion enterprises in the private sector and in tens of thousands of decisionmaking units operated in the government sector. All the se units make decisions that interact with each 

other. While it is unrealistic to attempt to describe such a 

highly decentralized system of tens of millions of decision-
-7-

making units as a singular system of flows, the relationships 

pertinent to the issues addressed in this report c an be usefully described in simplified terms. These relationships are 

illustrated in Figure 1.1. 

This diagram portrays the end result of the economic 

process as consumption, the use of goods and services for 

personal purposes. The outcome of the economic process is a 

varied set of goods and services, the quantities and qualities of which constitute the society's standard of living. 

This is shown by the box labelled "consumption" at the right 

side of Figure 1.1. 'Ihese goods and services flow pr incipally from the box labelled "domestic fabrication," but are 

supplemented by imports of goods and services from other 

national economies paid for by exports of goods and services. 

The "fabrication" box is intended to represent all the private and governmental sector activities that produce and distribute the goods and services that are purchased (or paid 

for in taxes) by individuals as consumers. As noted in the 

diagram, some output from "fabrication" is exported. 

The economic units labelled "primary product production" 

produce the basic materials, such as metals, textiles, plastics and paper, which feed the "fabrication" stage. Again, 

the domestic flow of primary products is supplemented by imports and is diminished by exports. Materials to feed primary production are d iagramrned as corning from two sources, 

"mining and forestry, etc." and "recyclables," the domestic 

flows are again supplemented by imports and diminished by exports. 

Finally, the recyclables are derived from "solid waste," 

a by-product of all stages of the economic process. The 

solid waste that is disposed of rather than recycled is 

indicated by boxes labeled "burn and landfill or sewage." 
Primary Metals 

Products Paper 

Plastics 

Fibers 

etc. 

-8-

-----.----tJI~ Finished ------,.•~ Consumption 

Goods 

Figure 1.1 Resource and Product Flows 
-9-

The diagrammed boxes are highly simplified groupings of 

economic activities, each of which is a combination of resources. The flow of services to productive activities is 

explicitly shown only for primary product production but similar productive service flows apply to fabrication , consumption , to the activities identified as mining and forestry , 

and to the several stages of solid waste collection, disposal , and recycling . 

This schematic diagram is drawn to portray directions of 

flow of goods and services, i ncl ud ing the debris from the 

process called "solid waste." Corresponding to these flows, 

but opposite in direct i on, are money payments flows . Consumers of goods pay prices to fabricators, which enable the 

fabricators to pay their suppliers of materials, labor and 

capital . This enables the primary product producers to pay 

their raw materials and recyclables suppliers , as well as 

suppliers of labor and capital used in production . The total 

of all payments received by persons who have supplied labor 

and capital becomes the means by which the output of the economic process, consumption , is financed. The dual ity of product and payment flows applies as well to the solid waste 

stream: in order to effect the "removal" of solid waste 

an inherent accompaniment to maintenance of a standard of 

1 i v ing -- and its disposition or reuse , labor , capital , and 

n atural resources have to be employed, and payment for their 

services must be rendered . 

The boxes that iden tify stages of the economic process 

also serve another purpose. The arrowheads signify exchanges 

and , hence, markets in which evaluations are made and prices 

cor respond ingly determined. If the relative flows of solid 

waste into recycling and disposition by burning , landfill, or 

sewage , are to be optimal, then the prices at all stages 
-10-

should fully reflect the value of resources consumed in 

carrying out the activities. If, in the right-hand bot torn 

corner of the diagram, the full resource costs of burning and 

preparing landfills are not reflected in the prices, including taxes, paid for disposing of solid waste, too 1 it tle 

solid waste will enter the recyclables stream, because disposition, rather than recycling, will appear to be "cheaper" 

to the pertinent decisionrnakers. Similarly in the left-hand 

bottom corner of the diagram, if, in the market feeding inputs to the primary product stage, prices of virgin materials 

do not fully reflect the cost of resources used in mining and 

forestry, too little recyclable material will be utilized 

than is optimal, and too much will be disposed. Chapter 4 

will consider the degree to which "prices" of solid waste 

disposition are fully reflective of all resource costs; and 

the remainder of this chapter will examine the same question 

with respect to the industrial input side of the economic 

process. 

B. The economic process from the point of view of 

recycling. 

Before considering the issues concerning the status of 

recyclables as industrial inputs, it is necessary to gain 

some perspective on the significance of price distortions for 

the physical size of recyclable flows. As noted, getting recyclable material out of the solid waste stream is not a 

costless activity. Recyclables contained in the solid waste 

streams must be separated and, frequently, decontaminated if 

they are to be reused. As used here, .. decontamination" is 

the removal of foreign matter from already separated, or 

physically classified, objects in the solid waste stream. 
-11-

Recycling may be viewed as a form of mining. Separation 

is analogous to beneficiation or concentration of ores in a 

mining process; and decontamination is analogous to smelting, 

or refining of ores. Solid waste available for recycling 

originates where production and consumption occur. Thus, if 

recyclable material is to be extracted from the solid waste 

stream and be available for reuse, transport costs must be 

incurred. 'I·he "market" for recyclables is functionally the 

same as the "market" for virgin materials, and the marketpi ace is, conceptually at least, the loading dock of enterprises engaged in the production of pr irnary products. This 

is where the choice of materials to use in producing primary 

products must be made. 

If we figuratively take these numerous individual markets for recyclable materials collectively subsumed in the 

"primary product production" box as the point from which to 

consider the terms on which tonnages of recyclable materials 

will be available to producers of primary products, reference 

to the diagram suggests three broad sources of recyclable 

materials should be distinguished. 

fl) ~~rne_2£~· 

Some amount of "scrap" material will be generated by t he primary product producer himself. 

Defective batches of iron and steel, for example, are inevitable by-products of steel 

production, and these are immediately available 

for reprocessing. This class of solid waste is 

commonly called "horne scrap." An obvious characteristic of horne scrap as a source of recyclable material is that it is available to 

would-be users--the very same enterprises which 

generate it--at little additional cost. It is 
-12-

already on the premises and is almost always 

directly reusable in the original production 

process without costly preparation, or decontamination. 

(2) Pro~!~~· 

Fabrication activities provide another source 

of recyclables. This class of solid waste is 

the cuttings and shavings of metals, paper, 

textiles, and other primary products generated 

by the fabrication process; it also includes 

discards of defective, unsalable products. 

This class of solid waste is called "prompt 

scrap." As compared with horne scrap, prompt 

scrap is available to would-be users in the 

primary product ion stages at the cost of collection, occasional decontamination, and transportation from a relatively few fabrication 

sites. 

(3) Obsolete, or EOSt-consurner, sera£ . 

Finally, recyclable materials can be derived 

from the solid waste stream emanating from 

final consumption . This class of solid waste 

includes the discard of fabricated products, 

and their packaging , when the perceived usefulness of the objects has come to an end. For 

this reason, this class of materials is commonly referred to as "obsolete scrap," or 

"pos t-consurner scrap." Obsolete scrap differs 

from horne and prompt scrap in that its sources 

are more numerous and dis per sed, and its content is more heterogeneous, or contaminated. 

If obsolete, or post-consumer scrap is to become available as recyclable material to pr i-
-13-

mary product producers, more resources need to 

be devoted to collecting it, sorting it and 

otherwise decontaminating the desired materials, and shipping it longer distances. 

These observations on the terms on which recyclable 

materials are available to primary product producers, the 

prices they must pay to obtain them, are summarized in panels 

A, B, and C of Figure 1.2 . Panel A shows that, at a cost- -

purchase price--of virtually zero , any amount up to Qhs tons 

of recyclable home scrap would be available to primary product producers. As a concomitant of production, the maximum 

quantity , Qhs' is simply determined by the output of primary 

products. Amounts up to Qhs are available for reuse at virtually no cost because the only resources used in making it 

available , or recyclable, are space for holding the home 

scrap and for handling it. 

Panel E, shows that some tonnage of recyclables from 

prompt scrap would be available at prices only slightly 

higher than those of home scrap but that higher prices are 

required to bring additional tonnage to market . These higher 

prices are required to cover the higher resource cost of collecting and shipping prompt scrap from fabricating plants 

that are increasingly distant from the priffiary product producers, as well as the costs of decontaminating the prompt 

scrap that is unfit for direct reuse. Additionally, the 

curve tracing out the quantities of prompt scrap that would 

be available at higher prices rises sharply and becomes vertical at a tonnage of Qps , the maximum prompt scrap available, given the level of fabricating a ctivity. 

Panel C depicts the availability of recyclable materials 

from post-consumer scrap. Re fleeting the higher cost of 

bringing recyclable post-consumer scrap to market, the curve 

tracing avail able quantities of recyclable material from this 
0 Ohs 0 

Quantity available 

0 

-14-

Ops Opst 

Quantity available 

Otot 

Quantity available 

0 Opes 

Quantity available 

Figure 1.2 Relation of Quantity Available to the Price of Recyclable Materials 

Opcst 
-15-

source is located higher on the price scale than the corresponding curves for home and prompt scrap. Like the curve for 

prompt scrap, the curve for post-consumer scrap shows that 

increases in available recyclable tonnage require higher 

prices to cover higher costs: for lengthier transportation 

and more intensive collection, separation, and decontamination efforts. Again, like the prompt scrap curve, the postconsumer scrap curve reaches a maximum availability, Opes 

reflecting the level of consumption which generates solid 

waste. 

It should also be noted that the positions of the curves 

in Panels E and C describing the availability of recyclable 

materials at different prices offered for them is dependent 

on the cost of solid waste disposal. If the cost of disposal 

underlying the curves in Panels 8 and C rises, for example, 

because sites become scarcer, the amount of recyclables 

available from either prompt or post-consumer scrap sources 

would be greater at any price offered for them. ~his is because the higher cost of disposal can be avoided by recycling 

more of the solid waste. In this case the curves pictured in 

Panels 8 and C would shift downward and to the right. Conversely, when costs of disposal are lowered, because nearby 

sites become more numerous and have no alternative uses, or 

because disposal subsidies are provided, the availability of 

recyclable materials at each price offered for it would be 

decreased. In Panels 8 and C, the pictured curves would 

shift upward and to the left. 

Of course, recyclables from all of these sources are 

ultimately interchangeable for each other since we are including decontamination as part of the process of making recyclable material available; that is to say the combined 

flows of recyclables constitute a single "market." Therefore, in Panel D the availabilities of recyclables from all 
-16-

sources are added together. Since all four panels are drawn 

with the same price and quantity scales it is easy to see 

that, if the price pr irnary product producers are willing to 

pay is P0 , the total quantity of recyclables that would be 

made available and reused would be Qtot' and this is equal to 

the sum of Qhs (horne scrap), Qps (quantity of prompt scrap), 

and Opes (quantity of post-consumer scrap) available at that 

price (P0 ). At the pictured price of P

0 , all horne scrap, 

nearly two-thirds of prompt scrap, and only one-third of 

post-consumer scrap is recycled; the remainders of prompt and 

post-consumer scrap must be disposed of by landfill or incineration. 

P0 , the price of recyclables primary producers are willing to pay for the quantity Qtot' is the price of virgin 

materials which could otherwise be used to produce pr irnary 

products. If P 

0 is not artificially depressed, disposition 

of the unrecycled solid waste by incineration or sanitary 

landfill is a socially efficient procedure. To recycle more 

than two-thirds of prompt scrap or one-third of post-consumer 

scrap would use more resources than would be required to dispose of the solid waste. That is, the curve in Panel D is 

drawn to reflect the availability of recyclable materials, 

and this already takes into account the alternative of disposition. For example, if it had cost more than P

0 

to dispose of solid waste, those who are presently burying or 

burning solid waste at higher cost would cease doing so and 

would, in fact, sort, decontaminate and ship the recyclable 

materials to primary product producers, or pay someone to do 

this. In this event, more than Qtot would be available for 

recycling at a price of Po. Thus, under real world cond itions when the quantity of recyclable materials available for 

reuse entails costs that tend to increase with quanti ties 

available, it will always be the case that at all finite 

prices for virgin materials (different values of P) at least 
-17-

some solid waste will be disposed of and not recycled, for to 

do otherwise would waste resources. 

The relation between the quantity of recyclable material 

available for reuse and the price users would pay for recyclable materials in the market is technically referred to as 

"market supply." 

as we have noted 

The market supply of recyclable materials, 

in detail above, has the characteristic 

shape of most supply curves. In order to elicit larger supplies, higher prices must be offered. This is implicitly the 

reason why proponents of additional recycling recommend that 

subsidies be provided. In Figure 1.3, which reproduces Panel 

D of Figure 1.2, but with the scales adjusted appropriately, 

if, in addition to the price P0 paid by purchasers, a subsidy 

of s is provided enterprises which supply recyclable materials then a tonnage of more than Qtot will be forthcoming. 

In Figure 1.3, the subsidy of s per ton (on top of P0 ) will 

bring forth a supply of Qtot + q. From the point of view of 

purchasers of recyclables, who continue to pay P0 per ton, it 

will appear as if the supply available had been increased by 

q tons. Alternatively, if the subsidy is paid to purchasers 

of recyclable materials, from the point of view of recyclables suppliers it will appear that demand has increased; 

they find they can sell Qtot + q tons of recyclables at a 

price of P and would therefore be willing to supply that 

0 

amount. 

The responsiveness of recyclables tonnage available to a 

subsidy of s per ton may be quantitatively described as the 

percentage change in quantity, q/Qtot in this instance, relative to the percentage change in price received by suppliers 

of recyclable materials, s/P 0 in this instance. This ratio 

of percentage change in quantity to percentage change in 

price is technically referred to as "price elasticity of supply" •

11 Thus defined, the interpretation of elasticity is 
Price 

per ton 

-18-

Otot Otot + q 

Quantity available 

Figure 1.3 Quantity of Recyclable Materials Utilized 
-19-

straightforward: If recyclable material elasticity of supply 

is 1, a one-percent price subsidy will be accompanied by a 1 

percent increase in quantity of recyclables supplied. If 

conditions of supply are such that the elasticity equals 0.5, 

a one-percent price subsidy will bring about a change in 

quantity ~E£plie~ of only 0.5 percent. 

The supply curve portrayed in Figure 1.3 illustrates the 

variability of elastic i ty at different points along the supply curve. At the very lowest recyclables price levels, when 

only home scrap is available, elasticity of supply is infinite: at any price equal to (or above) the nominal holding 

cost of home scrap, any amount up to the total of home scrap 

generated by the level of output of primary product producers 

is available. At higher prices, which bring in supplies from 

prompt and obsolete scrap, supply elasticity drops as increasing costs for collection, sorting, decontamination and 

transportation are incurred to bring additional recyclable 

materials to market. 

For any particular recyclable material, the elasticity 

of supply, the gain in recyclable material availability and 

use corresponding to an increase in the price for the material, is a highly complex empirical issue. For example, the 

elasticity of supply for any particular recyclable material 

depends not only on the facts surrounding the character of 

the solid waste streams from which it is to be derived--its 

physical location and degree of contamination and the technology for converting objects in the solid waste stream into 

recyclable materials--but also on the prices primary product 

producers are willing to pay. This last factor determines the 

segment of the particular recyclable material's supply curve 

on which enterprises engaged in using and supplying the material will be operating. The price which recyclable material 

users will pay, in turn, depends on the price at which virgin 
--- -------------------------------------

-20-

material is availabl e ; and this depends on the quality of the 

natural endowment and technology for extracting the materials 

(producing renewable material resources, such as timber and 

fiber), given the demand for final prod ucts. 

Notwithstanding the large number of determinants of recyc l able materials supply elasticities, and hence the imprecision of empirical elasticities that may be derived , the 

weight of the evidence is that they are gene r ally low . This 

appears to be the case because, at the margin , the principal 

source of additional recyclable materials is the post- consumer solid waste stream . 

Technical note : 

The entire discussion of this section has hinged on the 

supply of recyclable materials avail able for use in primary 

product p r oduct ion . 'Ih is implicitly has assumed that a l l 

" offensive " impurities have been removed so that the recyclable material is perfectly substit utable for virgin materials. Technically, this has enabled us to assume the demand 

for recyclables is infinite: at any slight reduct ion 1n 

price of recyclable materials , as much as is offered by recyclables suppliers will be used, displacing virgin materials. 

Readers with knowledge of actual markets will recognize 

this as a highly art if ic ial con struct ion. They are awa r e, 

for example , that primary production activities are not homogeneous. For example , not all paper products are produced 

from the same set of raw materials, i.e. , paperboard inputs 

could not, without extensive preprocessing, produce writing 

papers . Simil arly , the charge to a n electric steel furnace 

to produce concrete reinforcing bars could not , without extensive modification, be used to produce high- grade steel. 
-21-

It thus turns out that "recyclable" materials in the form of 

scrap paper, for example, which may readily be used as a substitute for woodpulp in the production of paperboard, is un1 ikely to be used in the product ion of writing papers; and 

that, in fact, there are many grades of scrap paper corresponding to their "purity" which fetch different prices. Similarly, there are many grades of scrap iron also reflecting 

their mineral content which are marketed at different prices 

and used for different production processes. 

Thus, for any general category of solid waste, such as 

"paper," "ferrous" or "nonferrous" metals, etc., there are 

many sub-markets corresponding to the grades of solid waste. 

These grades of solid waste materials roughly correspond to 

the degree of contamination present, and are suitable for 

particular industrial processes, as already noted. If we 

aggregate classes of solid waste for purposes of describing a 

real world "supply function", we should also specify the demand sides of these specialized markets. In this event, the 

"demands" for specific classes of scrap could not be reasonably described by assuming infinite price elasticity: to 

induce more scrap paper to be used in displacement of virgin 

materials, the price of the recyclable paper relative to 

other materials must be reduced to offset the higher primary 

product production costs. 

Put another way, if "decontamination" costs of solid 

waste can be avoided by using the "contaminated" material in 

production of certain primary products, ~~!-E~!~ll, then 

recyclables will be marketed in less than "pure" states, and 

the demand for this material will not exhibit the characteristic of "infinite elasticity." To penetrate markets for 

materials to be used in producing primary products, the "demand price" of the recyclable (price payable by a potential 

user) must be lower to overcome the higher cost of using the 

"contaminated" material, i·!·' to compensate the recyclables 

user for his accomplishing the "decontamination." 
-22-

To have introduced demand functions, along with supply 

functions, would have complicated the presentation without 

adding anything essential to under standing the economics of 

recycling. In order to get more paper, or any similar class, 

from the solid waste stream recycled, higher costs have to be 

incurred--to decontaminate--whether by the primary product 

producer or by the wastepaper supplier. If the cost is to be 

borne by the primary product producer, this determines the 

shape of his demand function; if the cost is to be borne by 

the recyclables supplier, this determines the shape of his 

supply function. By "homogenizing" recyclables as ready for 

reuse, all the costs are assigned to supply, and demand elasticity becomes infinite at the price of interchangeable virgin materials. Since it makes no difference in the final 

outcome whether injecting more solid waste into the recycling 

stream is viewed as overcoming higher primary product producer costs, given a quality of solid waste mater icU s made 

available in existing markets, or higher recyclable materials 

supply costs, given a structure of prices for virgin materials for which the recyclable materials are perfect substitutes, we have opted for the latter presentation in this 

general discussion. In Chapter 3, however, where recourse is 

made to empirical market data, this simplification needs to 

be abandoned. 

Indeed, there is a positive gain in understanding if the 

solid waste stream is treated in the same way as the natural 

endowment as a potential source of materials input. In both 

cases the sources are characterized by heterogeneity: cellulose for paper manufacture can come from numerous "natural" 

and solid waste stream sources; iron for steel manufacture 

can similarly come from numerous "natural" and solid waste 

sources. Whether the source is "natural", or solid waste, 

the cellulose or the iron is mixed with extraneous matter the 
\ 

-23-

existence of which must be dealt with in the production process. As a consequence, the "purer" the source of the material the higher will be the price it will fetch, and whether 

the process of enhancing "purity" is regarded as part of 

"mining" or solid waste "recycling," the cost of deriving the 

"pure" rna ter ial rises as the distance to the source and/ or 

its "impurity" increases. 

Nor has it seemed necessary to introduce the notion of 

elasticity in derived demand for materials, virgin or recyclables. In principle, the demand for materials to produce 

primary products is derived from demands for metals, paper, 

textiles, etc., to be used in producing final goods and services. In turn, the quantities of final products are determined in their respective markets. Thus, prices at which 

materials may be supplied to primary products producers determine the costs, and hence the prices, at which these inputs to final product manufacture will be available and, 

therefore, the costs, and hence the prices at which these 

products will be ava i lable. Through this chain of relationships, variation in materials prices exert some influence on 

the price, and hence quantity, of final goods purchased, 

"determining" the quantity of materials which will be demanded at particular materials prices. 

It has seemed unnecessary to deal with the characteristics of derived demand for materials in this context for 

two reasons. First, as has been noted above, most of the 

recyclable materials of interest are materials which are 

world-traded and, as will be developed in Chapter 3, this 

greatly reduces the amplitude of likely variations in U.S. 

materials prices associated with the conditions of domestic 

production. Secondly, given the likely range of variation in 

materials prices, the principal derivative effects on demand 

for recyclables will be in substitution for virgin materials, 

not changes in overall materials demand. 
-24-

Footnotes to Chapter 1 

l / Since the P's and Q's are discrete, the relative changes 

implied by s and q are better measured by s ~ (P0 +P0 +s) / 2 

and q ~ (Qtot +Qtot +q) / 2 respectively. The reader is 

also cautioned that the supply elasticity described here 

is a special case. 

below. 

See Technical Note to this chapter, 
Chapter 2 

Federal Tax Subsidies to Virgin Materials 

I. Introduction 

Federal tax subsi dies to mining and timber-producing reduce the private net costs of using virgin materials in production processes. This reduction discourages the use of 

substitutable recyclable materials, though the analysis in 

Chapter 3 indicate s that the quantitative effect on recycling 

is small. However, tax subsidies do reduce significantly the 

cost of producing a given amount of virgin materials. We estimate that the tax subsidies to mineral industries shift the 

supply curves for coal, iron ore, and copper down by between 

8 and 12 percent, and shift the relevant supply curve of timber used to make pulp and paper down by between 35 and 43 

percent. 

This chapter presents detailed quantitative estimates of 

the effects of special provisions of the Federal tax code on 

the supply curves for coal, iron ore (taconite), copper 1 and 

timber. Coal and iron ore account for a significant fraction 

of the cost of producing pig iron 1 which can be substituted 

for scrap steel as an input in steel furnaces. Virgin and 

scrap copper are regarded as almost perfect substitutes in 

most uses. Wastepaper is a substitute for virgin pulp in 

manufacturing paper. Virgin pulp can be produced at a lower 

private cost because of tax subsidies to timber growers. 
-26-

The estimated supply curve shifts show the maximum 

effect of the special tax prov1s1ons on mineral and timber 

prices. They show the percentage reduct ion in production 

cost that would occur for a typical mine or timber stand if 

output remained fixed. The percentage reduction in the production cost would be reflected in an equal percentage 

reduction in price only if supply is perfectly elastic, meaning that output could expand indefinitely without any increase in unit product ion costs. When minerals are traded 

internationally, changes in U.S. production cost may have a 

minimal impact on the world price. Then, the major effect of 

the tax subsidies is to increase domestic output, with the 

price of the virgin mineral left virtually unchanged. Even 

in the case of virgin pulp, less affected by international 

trade than most minerals, tax subsidies may mostly rs;tise 

rents to owners of timber land, rather than lowering prices 

and increasing output of wood products. 

II. Special Tax Provisions Affecting Mineral Industries and 

Timber 

For the purpose of these estimates, 

sidy is regarded as a provision of the 

specific either to mining or to timber 

a special 

Federal 

growing. 

tax 

tax 

The 

subcode 

investment tax credit and accelerated depreciation, which may 

sometimes be regarded as tax subsidies to capital, are not 

counted among the special tax preferences given mining and 

timber growing. Because these and other provisions are generally available to all industries and for recycling efforts, 

they do not create special incentives to develop mines or to 

plant trees. 

The special tax provisions affecting mineral industries 

are: 1) percentage depletion, 2) e xpensing of exploration 

and development costs, and 3) taxation of royalty payments to 
-27-

landowners leasing land for mineral product ion at capital 

gains rates. The special tax provisions benefiting timber 

growers are: 1} tax at ion of income from the sale of timber 

at capital gains rates, 2} mismatching of income and expense, 

and 3} deduction of expenses against other ordinary income. 

Tax Subsidies to Mineral Industries 

1. Percentage Depletion 

To compute taxable income, mining firms are required to 

deduct the greater of cost or percentage depletion. Cost 

depletion in general is determined by dividing the adjusted 

basis of the property (from exploration and development 

expenses} by an estimate of the number of units that make up 

the deposit. The resulting quotient, equal to the cost 

depletion per unit, is then multiplied by the number of units 

extracted and sold during any year to determine the allowable 

cost depletion deduction. Cost depletion for mines is 

analogous to depreciation for machinery and equipment; it 

allows the firm to write off the cost of the investment over 

the entire life of the asset in determining taxable income. 

Timber companies are permitted only cost depletion. 

Under percentage depletion, firms in mining operations 

may deduct a flat percentage of gross income from mining to 

compute their tax base. This deduction is not limited to the 

cost basis in mining assets. The percentage depletion allowance is 22 percent for lead and zinc ores, 15 percent for 

copper and iron ore, 14 percent for limestone, and 10 percent 

for coal. These percentages apply to domestically produced 

ores. Foreign produced ores are eligible for lesser or no 

percentage depletion. Percentage depletion may not exceed 50 

percent of otherwise taxable income. 
-28-

Although problems arise in developing appropriate estimates of the fraction of a mine "depleted" in any year, 

cost depletion deductions are necessary to provide a reasonable measure of the annual net income from a mine. The deductions taken for cost depletion roughly reflect the decline 

in value of the property due to reduction in the size of the 

deposit. Under current law, these deductions over the life 

of the mine may not exceed the total adjusted basis in the 

property. 

As stated, firms take the greater of cost or percentage 

depletion. The percentage depletion subsidy operates by 

reducing the present value of taxable income. This reduction 

in the present value of taxable income equals the present 

value of the difference, over the life of the investment, 

between deduct ions actually taken (both cost and percentage 

depletion) and deduct ions taken using only cost depletion. 

Because the sum of percentage depletion deductions may exceed 

the cost basis of the investment, the difference between percentage and cost depletion can be and frequently is very 

large. 

Percentage depletion accounts for at least half of the 

value of all specific tax subsidies for every mineral 

studied. In all cases except one (Eastern coal) , allowable 

percentage depletion for the typical investment was 1 imited 

by the requirement that it not exceed 50 percent of otherwise 

taxable income. This means that percentage depletion in 

these cases halves the tax rate applied to income from mining 

investments. 

2. Expensing of Exploration and Development Costs 

Domestic mining companies may take an immediate deduction for exploration expenses provided that the amount so 

deducted is recaptured as taxable income once the mine 
-29-

reaches product ion stage, or is sold. In addition, development expenses may also be deducted when made, though they 

must be subtracted later from allowable depletion. l/ 

These tax subsidies also operate by reducing the present 

value of taxable income. For exploration, this reduction 

equals the present value of expensed exploration costs less 

the present value of their future recapture. For development, this reduction in the present value of taxable income 

equals the present value of expensed development less the 

present value of cost depletion of development. 

In the data we examined, the favorable tax treatment of 

exploration and development expenses does not have a significant effect on the supply price of coal, iron ore, or 

copper. 

3. Taxation of Royalty Payments at Capital Gains Rates 

Certain transactions that might normally be regarded as 

giving rise to ordinary income can be treated as if they were 

sales or exchanges of capital assets. Royalty payments to 

landowners leasing land for product ion of coal and iron ore 

are eligible for this treatment. Thus, to the extent that 

net income from operating a dome stic coal mine or iron ore 

mine accrues to such taxpayers as royalty payments, a portion 

of the net income of the mine is converted from ordinary 

income to capital gain for tax purposes. The resulting lower 

tax rate, usually half of the ordinary tax rate for individuals and 28% instead of 46% for corporations, is regarded as 

a special tax subsidy to coal and iron ore mining because 

that type of transaction would normally be defined as ordinary income. The effect of the capital gains treatment is to 

lower the supply price of capital to those mining industries 

covered by the provision. If these royalty payments were 

taxed as ordinary income, the developer of the mine would 
-30-

have to pay greater pre-tax royalty payments to the landowner 

to enable him to earn the same after-tax return on his 

property. 21 

4. Other Tax Subsidies 

It is sometimes argued that other tax subsidies also 

affect the price of virgin materials relative to recyclables. 

Two frequently mentioned provisions alleged to lower the 

supply price of virgin minerals are the foreign tax credit 

and Domestic International Sales Corporations (DISC). Under 

the foreign tax credit, domestic taxpayers may credit foreign 

income taxes against domestic tax liability of foreign income, up to the U.S. corporate rate. Foreign tax credits 

assure capital export neutrality; the tax rate on foreign 

profits does not exceed the tax rate on domestic profits, . unless foreign countries impose higher tax rates than the 

U.S. The foreign tax credit cannot properly be considered a 

subsidy to mining, because it does not reduce the combined 

rate of tax on mining income abroad below the rate of tax on 

mining income in the u.s. 

u.s. corporations that derive 95 percent of gross income 

from exporting goods to foreign countries are allowed to form 

a Domestic International Sales Corporation (DISC) . Income 

earned through a DISC is taxed at a lower effective rate than 

income earned through other domestic corporations. However, 

DISC is not cons ide red a subsidy to virgin minerals which 

compete with recyclables in the U.S. market, because DISC is 

1 im i ted to firms that are primarily exporters. Further, if 

international markets determine the price of the virgin 

mineral and if U.S. mining supply curves are upward sloping, 

DISC may increase U.S. exports and the worldwide market share 

accounted for by domestic mines, but this would not significantly depress the world price, unless the U.S. accounts for 

a major share of world output. 
-31-

Tax subsidies to municipal disposal are sometimes viewed 

as artificial impediments to recycling. These subsidies take 

two forms: l) tax exemption of interest on state and local 

bonds, which reduces the cost to localities of capital 

investments in solid waste disposal, and 2) deductibility 

under the Federal income tax of state and local sales, 

income, and property taxes by individuals who itemize personal deduct ions. These special provisions subsidize all 

types of public programs by state and local governments, 

including resource recovery activities that complement as 

well as compete with recycling. Because these provisions are 

not specific to the materials sector, their potential impact 

on recycling is not i ncluded in the quantitative analyses in 

Chapters 2 and 3. However, Chapter 4 discusses their likely 

direction and magnitude. 

Tax Subsidies to Timber Growing 31 

1. Capital Gains Treatment 

Almost all income from investments in timber is eligible 

for capital gains treatment. Thus, the revenue from the sale 

of timber--revenue which would otherwise be taxed as ordinary 

income received by the manufacturer of a product--is taxed at 

the lower rates normally applied only to exchanges of appreciated capital assets. 

The special capital gains rate has a major impact on the 

supply cost of timber. For corporations, for example, income 

from timber is taxed at only 28 percent rather than 46 

percent (ignoring the impact of the minimum tax) • 4/ Moreover, 

timber growing is a very capital-intensive industry; its most 

important input is waiting time. Most of the value added in 

timber can be defined as a form of capital input, since the 

opportunity cost is interest foregone on assets other than 
-32-

forests. Therefore, reducing the tax rate on capital income 

from the sale of timber has a major impact on the supply 

price. It is estimated below that the capital gains preference alone reduces the supply price of timber by about 20 

percent. 

2. Mismatching of Income and Expense 

An equally significant component of the timber tax 

subsidy is the mismatching of income and expense. This 

occurs because the expenses of growing and carrying timber 

are deducted currently, while the income is recognized only 

when the timber is sold. Deferral of the recognition of 

income is not regarded here as a preference, for reasons 

discussed below. To be consistent with general tax practice, 

however, deferral of income requires a corresponding deferral 

of expenses incurred to produce that income. 

Of course, it is not always easy to determine when an 

expenditure should be expensed and when it should be capitalized for tax purposes. In general, cur rent deduct ions are 

not permitted for expenses that produce income over a long 

period of time. For example, investment in plant and equipment is generally depreciated according to defined rules over 

the productive life of the assets. Because income from 

timber growing is only recognized when the timber is actually 

sold, consistency with general tax practice requires that 

annual expenses of maintaining a forest be capitalized and be 

deductible only as sales occur. This should be accomplished 

by adding such capitalized expenditures to the basis to which 

cost depletion is applied when a portion of the timber is 

cut. 

The tax treatment of interest incurred during construction reflects this principle. Such interest is capitalized 

rather than deducted, because it is regarded as a contr i-
-33-

bution to an asset from which income will be realized in the 

future. Then, as the asset is depreciated, the interest 

costs are properly reflected in the determination of net 

income. Analogously, timber should also be regarded as a 

"self-constructed" asset, with annual expenses deducted only 

when resultant income is realized. 

Sunley cites several examples where expenses of timber 

growing that should be capitalized may be deducted immed iately by taxpayers: S/ 

1. Timber stand improvements such as brush control, 

thinning, pruning and shaping of trees are considered by timber owners as customary annual expenses. 

The Internal Revenue Service has held that such 

expenses should be capitalized since they add to the 

value of the trees. The Courts have held that such 

expenses do not increase the value of the trees and 

thus may be deducted. 

2. Costs incurred in control! ing outbreaks of forest 

insects or disease may have a useful 1 i fe of more 

than one year. Should the useful life be determined 

by the time period after which trees so protected 

will be merchantable or by the time period after 

which the forest protection costs must again be 

incurred? 

3. Property taxes and interest paid on a mortgage may 

be considered as costs necessary to carry timber to 

merchantibility, and thus they should be capitalized 

and added to the cost basis of the stand of timber. 

The tax law, however, holds that these costs may be 

said to be used up in the current period. That is, 

property taxes discharge an annual obligation to the 

State or local government, and the annual interest 
-34-

cost is a cost for the use of the borrowed funds for 

one year. These costs are thus written off currently. 

In the calculations below, the tax subsidy from this 

source is computed as the difference between the present 

value of all deductions allowed for a timber stand under 

current law and the present value of deductions that would be 

allowed under an appropriate timing pat tern. An "appropriate" timing pattern is one in which all expenses except 

sales expenses attributable to commercial thinning are 

capitalized and written off at the time of the final harvest. 

Sales expenses attributable to commercial thinning are immediately deductible in the years in which they occur. Because 

thinning the forest is regarded as an investment in producing 

the final harvest, only sales expenses directly attributable 

to commercial thinning merit a deduct ion at the time of the 

thinning. 

It can be argued that even this method of accounting for 

expenses and sales is too generous to the timber industry. 

Under a full comprehensive income tax, an asset such as 

standing timber, which grows every year, would be taxed 

annually on its appreciation in value. (Some expenses could 

then be deducted immediately, because income would be realized every year.) According to this view, taxing the net 

revenue from timber at the time of sale rather than as 

accrued represents a tax preference. While taxation of 

annual accrual is consistent with a comprehensive income 

base, the Federal Income Tax Code in general taxes income 

when realized, rather than when accrued. Thus, the deferral 

of tax 1 iabil i ty on timber until the time of sale is not 

regarded in the calculations below as a special preference to 

timber growing. 
-35-

The calculations in the next section indicate that the 

mismatching of income and expense provides as large a subsidy 

to timber growing as does the preferential capital gains 

rate. The long time period between planting and harvest 

(15-30 years in the profile used) makes current deductibility 

of expenses properly attributable to the final harvest very 

valuable. 

3. Deduction of Expenses Against Other Ordinary Income 

Normally, it is appropriate to deduct current operating 

costs against revenue in determining taxable income. As 

noted, some deduct ions allowed immediately as current operating costs for timber should be capitalized and written off 

only when the timber is sold. These deduct ions provide an 

additional subsidy because they can be written off against 

ordinary income from other ope rat ions, even though the revenue resulting from these deductible expenditures is taxed 

as capital gains. This means that the tax 1 iabi 1 i ty from 

growing timber, over the entire 1 i fe of the asset, can be 

negative even if total revenue exceeds total costs. 

Suppose, for example, that a corporation is engaged both 

in timber growing and in logging or manufacturing. An ex- . pense of $100 in the timber growing operation can be deducted 

against revenue from logging or manufacturing in computing 

net taxable income. If the $100 expense eventually produces 

$100 revenue from the sale of timber, the corporation's taxable capital gain increases by $100. Because corporate income is taxed at a 46 percent marginal rate, while corporate 

capital gain is taxed at a 28 per cent rate (or slightly 

higher, if the minimum tax applies), the expense, which produced a net income of zero, has created a tax savings of $18. 

In effect, the deduction converts ·ordinary income in logging 

or manufacturing to capital gain in timber growing. 
-36-

It is estimated that this last tax preference reduces 

the supply price of timber by about 9 percent, with the other 

two tax preferences in effect. 

III. Derivation of Supply Shift for Minerals 

Methodology 

To estimate the supply shift from the mineral industry 

tax preferences described above, we use investment profiles 

for "typical" mines supplied to the Treasury Department by 

the U.S. Bureau of Mines. These profiles identify the amount 

and timing of different categories of expenses, and the 

amount and time pattern of revenue. The data on expense and 

on the timing of revenue flows are combined with information 

about how the tax rules would apply to revenue and to different categories of expenses to compute the present value of 

revenue required to yield a normal return on investment. The 

computations are made for two cases: 1) applying the tax 

rules under present law, and 2) applying the tax rules that 

would prevail in the absence of the special tax preferences 

affecting mineral industries. In both cases, required present value of revenue is defined as the present value of 

revenue that yields an after-tax return of 10 percent on 

capital for marginal investments of a corporation paying a 

marginal tax rate of 46 percent. 

The required present value of revenue is computed by 

calculating the sum of the present value of all costs from 

the investment profiles supplied by the U.S. Bureau of Mines. 

These costs include current outlays, investment expenditures, 

royalty payments, severance taxes, and corporate income 

taxes. Because taxes paid depend on the amount of revenue, 

algebraic manipulation is needed to express required revenue 

as a function of the pattern of costs and the applicable tax 
-37-

rules. The Appendix to this chapter shows the derivation of 

the formulas used to compute required revenue, both under 

current law, and in the absence of special tax preferences. 

Under current law, percentage depletion, unless constrained by the net income limitation, reduces the present 

value of taxable income by the product of the percentage 

depletion rate and the present value of gross revenue received by the owner of the mine. However, that port ion of 

income received by landowners as royalty payments is not 

eligible for percentage depletion if taxed as capital gain. 

The present values of current outlays, expensed investments, 

depreciation, and severance taxes are deducted to compute the 

present value of the corporate tax base. The present value 

of recapture of expensed investments is added to the tax 

base, and is smaller than the present value of the expensed 

investments subject to recapture, because of deferral. The 

investment tax credit is treated as a direct reduction in tax 

liability. 

Limits on the investment tax credit and percentage 

depletion can make computing the required revenues under 

current tax law very complex for a firm with one investment, 

because net income and taxes, and thus the allowable depletion deduct ion and investment credit, vary from year to 

year. However, most firms in the mining business are likely 

to be operating a number of similar mines of different vintage. Excess credits or deductions from one mine can be used 

to offset current taxable income from another one. In the 

calculations below, we adjust for excess credits or deduct ions only when the present value of the entire stream of 

otherwise allowabl e credits or deductions exceeds the present 

value of their limit. 
-38-

For four of the mining profiles studied, the present 

value of statutory percentage depletion exceeds one-half the 

present value of otherwise taxable income . In those four 

cases, the percentage depletion allowance enables the firm to 

deduct one half of taxable income as percentage depletion, 

thereby reducing the marginal tax rate on corporate taxable 

income from 46 percent to 23 percent. 

Under the formula used to calculate required revenue in 

the absence of special preferences, the mining firm would not 

be permitted to use percentage depletion or to expense investment in exploration and development. Cost depletion is deducted instead of percentage depletion for investments in 

exploration and development . Royalty payments enter the 

formula in the same way as in the current law case . However, 

the royalty payments reported in the profile are grosseg-up 

so that landowners receive the same after-tax income under 

ordinary income tax at ion as they receive at the favorable 

capital gains rate prevailing under current law . 

Because severance taxes are not imposed by the Federal 

Government, they are not counted among the special tax provisions affecting mining. 

The investment tax credit for purchases of machinery and 

equipment is retained in the formula, and we use the same 

assumed formulas for depreciation in the no preference case 

as under current law. While the investment tax credit, and 

possibly current depreciation allowances represent tax subsidies under current law, they are not specific to mining, 

and would also apply to investment in machinery and equipment 

necessary to collect and transport recyclable materials. 
-39-

The percentage downward shift in the cost of mineral 

production is determined after computing the required revenue 

under current law and absent special provisions affecting 

mineral industries. 

Quantitative Findings 

Table 2.1 summarizes calculations from rn1n1ng profiles. 

The profiles themselves are described in the Appendix to this 

chapter. 

The data in Table 2.1 suggest that preferences to mining 

industries reduce the supply curve by around 10 percent for 

the typical mine. The estimates for the three coal mines 

vary from 8. 4 percent for Eastern coal to 12.3 percent for 

Western coal {Powder River Basin). The supply curve for copper is estimated to shift downward by 10.0 per-cent and the 

supply curve for iron ore {taconite) by 8.3 percent. 

IV. Derivation of Supply Shift for Timber 

Methodology 

The methodology used to compute the shift in the supply 

curve for timber is similar to the one used for mining. Profiles identifying the time pattern of expenses and receipts 

for model Southern Loblolly Pine stands were supplied to the 

Treasury by the U.S. Forest Service. From these profiles, 

gross revenues required to realize a 10 percent after-tax 

rate of return on investment were computed for two cases: 

(1) current law, and (2) current law absent special tax preferences for timber growing. 
-40-

Table 2.1 

Summary Calculations: Mining Profiles 

:Present value of:Present value of: 

gross revenue 

current law 

gross revenue 

neutral tax 

Percentage 

shift in 

:(thousands of$): (thousands of $):supply curve 

Eastern Underground 

Mine and Coal 

Preparation Plant 113,338 123,769 8.4% 

Surface Mine in 

Illinois Basin and 

Coal Preparation 

Plant 136 , 582 155,452 12.1 

Surface Mine, Powder 

River Basin (Coal) 172,763 196 , 897 12.3 

Copper Mine and 

Concentrator 885,737 984,074 10.0 

Taconite Mine and 

Processing Plant 844,549 921,242 8.3 

discount rate = 10 percent 
-41-

The economics of growing timber to produce paper are 

somewhat more complicated than the economics of mineral production. Virgin pulp used in paper production comes from two 

sources: (1) from trees grown specifically for pulp, and (2) 

as a by-product of trees grown for saw timber. In the latter 

case, pulp comes from both pre-commercial thinning of timber 

stands and from wood by-products, such as chips and sawdust. 

Because saw timber and pulp are a joint product, there 

is some ambiguity in identifying the effect of a subsidy to 

growing timber on the supply curve for pulp. The rotation 

period is generally longer for timber stands that mainly 

produce saw timber than for those that mainly produce pulp, 

while the pulp from pre-commercial thinning is obtained 

earlier in the cycle than the saw timber ultimately produced. 

Because mismatching of income and expense is a significant 

part of the tax subsidy to timber growing, the effective rate 

of subsidy increases with the length of the rotation period 

of the timber stand. Thus, the tax subsidy for growing trees 

for saw timber is typically larger than the subsidy for 

growing trees for pulp only. 

This computation measures the marginal incentive provided by the tax system to suppliers of virgin pulp. Because 

much of pulp is obtained as a by-product of growing saw timber, at a relatively small extra marginal cost, it is reasonable to assume that timber stands grown solely for pulp product ion represent the marginal supply. Thus, incentives to 

produce more virgin pulp would, to the extent that they increase output, largely encourage growers to increase the 

amount of timber grown only for pulp production. For this 

reason, the profiles used here provide data on the pattern of 

costs for timber stands used only to produce pulpwood. 
-42-

The profiles supplied by the U.S. Forest Service indicate that the rotation period for 

Loblolly pine stands may vary from 15 

the model Southern 

to 30 years. The 

calculations below show the increase in gross revenue required to yield a 10 percent after-tax rate of return for 

each of four possible rotation periods. If there were rising 

unit costs in increasing timber output, causing the after-tax 

return from timber growing to be reduced by removing tax preferences, the optimal rot at ion period would be shorter. The 

effect of such a change on timber output and prices is discussed briefly in Chapter 3, where behavioral responses are 

considered. 

The Southern profiles are used because the South is the 

major region in the United States for growing trees for pulp 

production. 

In timber growing, some expenditures can be capitalized, 

others expensed. In the timber profile supplied, clearing of 

site, site preparation, and planting, which occur in the 

first year of the rotation, and spraying (in the second year) 

are all capitalized. Annual costs for overhead, land rental, 

and property taxes, and periodic costs of prescribed burning 

for fire protection are expensed. All revenue to timber 

growers is obtained in the last year of the rotation period, 

when the right to cut the timber is sold. (This sale may be 

an internal transfer for an integrated company, which must 

estimate the value of the uncut timber to provide a measure 

of the capital gain.) 

The present value of revenue realized at the time of 

sale must cover the present value of all costs and taxes. 

For a large, integrated paper company, the tax rate is 28 

percent on capital gains (ignoring the minimum tax); however, 

a dollar of deductible expense reduces tax liability by 46 
-43-

cents, because it can be written off against income from logging and manufacturing. All costs that have been capitalized 

rather than expensed enter the depletable basis and are subtracted from revenue to compute capital gain when the right 

to cut is sold. 

To compute the present value of revenue when the special 

tax provisions are removed, all expenses are treated as if 

they were capitalized. They enter the depletable bas is, 

which is then deducted from revenue realized when the timber 

is sold. This taxable income is assumed to bear a 46 percent 

tax rate. The after-tax proceeds are then discounted to the 

beginning of the holding period. 

The Appendix to this chapter shows the formulas used to . compute the present value of required revenue under current 

law and absent tax preferences to timber growing. 

Quantitative Findings 

Table 2.2 shows the effect of the tax subsidies to timber growing on the costs for a representative Southern Loblolly Pine Stand used for growing pulp, for different rotation periods. Column 2 of the table shows the present value 

of revenue per acre necessary to yield a 10 percent return on 

investment under current law, while Column 3 shows the comparable figure absent special tax provisions. The last column reports that the percentage shift in the supply curve 

ranges from 35.7 percent for a 15-year rotation to 43.4 percent for a 30-year rotation. 

If the timber company has a sufficiently high capital 

gain in any year, it could be subject to the minimum tax on 

its capital gains. The minimum tax can raise the tax rate on 

marginal capital gains on the sale of timber by corporations 

to 29.8 percent at most. Under this rate, the percentage 
-44-

reduction in supply is only slightly less than under the 30 

percent rate: 34.3 percent for a 15- year rotation, 37.9 

percent for a 20-year rotation, 40.3 percent for a 25-year 

rotation, and 42 . 0 percent for a 30-year rotation. 

Rotation 

Period 

15 years 

20 years 

25 years 

30 years 

Table 2 . 2 

Summary Calculations: Profiles for Southern 

Loblolly Pine Stand Used for Pulp Production 

Present Value of Present Value of Percentage 

Gross Revenue: Gross Revenue: Shift in 

Current Law Neutral Tax Supply 

(dollars per acre) (dollars per acre) Curve 

$330.81 $514.53 35.7 

$354.24 $583.83 39 . 3 

$368.77 $633.03 41.8 

$377.80 $667.44 43.4 

Table 2. 3 summarizes the effect of tax preferences on 

the supply curve for Southern Loblolly Pine , for a tw_enty 

year rotation . The last row of the table shows that all the 

preferences combined reduce the gross revenue required for a 

10 percent after-tax rate of return on investment by 39.3 

percent. The first and second rows show the effects of two 

of the preferences, capital gains and mismatching of income 

and expense, taken by themselves. It can be seen that the 

two preferences are of almost equal magnitude. For longer 

rotation periods, mismatching of income and expense is a relatively greater preference; for shorter rotation periods the 
-45-

capital gains preference is greater. Moving from the third 

to the fourth row shows the marginal effect of the third tax 

preference for timber , the deduction of expenses against 

other ordinary income. 

Table 2.3 

Effects of Individual Preference Items: 

Timber Profile With 20 Year Rotation 

Capital Gains 

Preference Only 

Mismatching of 

Income and 

Expense Only 

Capital Gains 

and Mismatching 

of Income and 

Expense 

All Preferences 

Present Value 

of Gross 

Revenue; With 

Preferences(s) 

($/acre) 

462.78 

464.34 

408.23 

354.24 

Present Value 

of Gross Percentage 

Revenue; Neu- Shift in 

tral Tax Supply 

($/ acre) Curve 

583.83 20.7 

583 . 83 20.5 

583.83 30.1 

583.83 39.3 

The sum of the supply curve shifts from the first two 

preferences taken individually is greater than the total 

supply curve shift from the two combined, because each preference has a smaller marginal effect in the presence of the 
-46-

other one. For example, taxing income only at the capital 

gains rate decreases the tax saving from reducing the present 

value of the tax base through early write-off of investments. 

The final preference, deduction of expenses against 

other ordinary income, is magnified by the other two. It 

would not be a preference without the capital gains preference, and it is magnified by the mismatching of income and 

expense. Allowing deduction of expenses against other ordinary income, rather than treating expenses as negative capital 

gains, reduces the supply price of timber by about 9 percent. 

V. Conclusions 

A number of Federal tax subsidies reduce the costs of 

mining virgin materials and growing timber. These subsidies 

include percentage depletion; expensing of exploration and 

development costs; and capital gains treatment for royalty 

income for mining; and capital gains treatment of the sale of 

timber; mismatching of income and expense; and conversion of 

ordinary income into capital gain for timber growing. The 

combined effect of the subsidies is to shift the supply curve 

for virgin coal, copper, and iron ore down by 8 to 12 percent, and to shift the supply curve for timber down by 35 to 

43 percent. Unless supply is highly elastic or demand highly 

inelastic, the effect of the tax subsidies on market price is 

likely to be considerably smaller. 

The following chapter examines the likely effect of 

these subsidies on the amount of recycling of scrap steel, 

scrap copper, and wastepaper. 
-47-

Footnotes to Chapter 2 

1/ For a fuller discussion of the comparison between these 

rules and what might be normal accounting procedure, see 

Gerard M. Brannon, Tax Provisions for Non- Energy Minerals and 

Timber, unpublished paper prepared for Resource Conservation 

Committee, 1977. 

2/ This analysis assumes that, at the margin, the rental 

price of land in mineral product ion is determined by its 

value in alternative uses. Eliminating capital gains treatment of royalty payments means that pre-tax royalties would 

have to rise to induce the landowner to continue to supply 

mineral rights to the mining company. If, however , the landowner is earning economic rent, then he might absorb the 

higher cost that would accompany an end of "capital gains " 

treatment of royalty income and merely receive a somewhat 

lower economic rent. In this event, required gross payments 

by the mining company would not rise. This analysis provides 

an estimate of the maximum effect of capital gains treatment 

of royalty payments on the supply price of minerals, because 

it assumes that pre-tax royalities would have to increase . 

3/ For a fuller discussion of these issues, see Emil M. 

Sunley, "The Federal Tax Subsidy of the Timber Industry , " in 

Joint Economic Committee, The Economics of Federal Subsidy 

Programs, July 15, 1972. This discussion borrows from 

Sunley's analysis. 

4/ The minimum tax can raise the total tax rate on corporate 

income from the sale of timber to 29 . 8 percent at most . 

5/ Taken directly from Emil M. Sunley, ££ · cit., p . 320 . 
Chapter 3 

Impact of Federal Tax Subsidies to Virgin Materials 

on the Amount of Recycling 

I. Introduction 

This chapter combines the data in Chapter 2 with estimates of production relationships and demand and supply 

equations to compute the impact of Federal tax subsidies to 

virgin materials on recycling of scrap steel, scrap copper, 

and wastepaper. In all cases, removing the Federal tax 

subsidy would increase recycling by no more than 5 percent 

under the most extreme assumptions and by only one percent or 

less using more plausible estimates. 

The effect of the supply curve shifts on recycling is 

calculated in several steps, each corresponding to a different market where material inputs are exchanged. Available 

statistical estimates of demand and supply elasticities 

applied in each step were derived from data generated while 

the tax subsidies were in effect. All computations are based 

on changes compared to current levels: thus, the numbers at 

each step, when combined, show the i~~reas~ in recycling that 

would result from remo~in9 existing subsidies. These estimates are then transposed to determine the !~_9ucti_2_!!_in 

recycling caused by the existing tax subsidies. 

The next section of this chapter outlines the framework 

of analysis used to estimate changes in recycling that would 

result from a shift in the supply curve for virgin materials. 

This general framework is then used to estimate potential 

increases in recycling of scrap steel, copper, and wastepaper 

resulting from removal of the tax subsidies. 
-50-

II. Framework of Analysis 

Overview 

Subsidies to virgin materials affect recycling to the 

extent that they lower the price of virgin materials. Lower 

materials prices weaken incentives for recycling, part icularly at the post-consumer stage, by making disposal an 

economically more attractive alternative to firms and households. 

The tax subsidies affect only one stage of material 

production (i.e., growth of timber stands used in wood 

products, and mining of coal, iron ore, and limestone used to 

produce pig iron.) Consequently, the percentage shift in the 

supply price of the virgin material used in primary production is considerably smaller than the percentage shift in the 

supply curves reported in Chapter 2. (Hereafter, the terms 

"subsidized resource" and "virgin material" will distinguish 

that portion of the virgin input receiving the tax subsidy 

measured in Chapter 2 -- the subsidized resource -- from the 

total virgin input used in primary production -- the virgin 

material.) 

Measuring the impact on recycling of a given shift in 

the supply curve for each subsidized resource requires: 

• Estimating the impact of the shift in the supply curve 

for each subsidized resource on the price of that 

subsidized resource. 

• Estimating the impact of the change in the price of 

the subsidized resource (s) on the price of the virgin 

input. 
-51-

• Estimating the impact of the change in the price of 

the virgin input on the amount of recycling of secondary materials. 

The general considerations that affect the sizes of each 

of these three impacts are discussed below. 

Effects of Tax Subsidies on Price of Subsidized Resources 

The tax subsidy to each of the subsidized resources 

lowers the private costs of production at any level of output 

by the percentage reported in Chapter 2. The resulting 

decline in the resource price depends on the elasticities of 

supply and demand for the resource. At one extreme, if 

supply of the resource is totally elastic and if U.S. producers can significantly affect the world supply, or if trade 

barriers insulate the u.s. market (either of which means U.S. 

producers would face a downward sloping demand curve) , the 

percentage change in price would equal the percentage reduction in production cost from Chapter 2. 

At the other extreme, if supply is totally inelastic or 

if price is determined on the world market and is unaffected 

by changes in u.s. output (i.e., U.S. producers face a 

totally elastic demand at the world price) , the tax subsidy 

will not affect the resource price. When supply is totally 

inelastic, the subsidy increases the value of land where the 

resource is found without affecting output or price. Where 

the price is unaffected by changes in U.S. output, the 

subsidy only increases that share of world output produced in 

the United States. 
-52-

The Appendix to this chapter illustrates the effect of 

the tax subsidies on the price of the subsidized resources 

for different supply and demand elasticities. It also 

presents an algebraic derivation of the price change as a 

function of the shift in the supply curve and the elasticities of supply and demand for the resource. 

International trade is an especially important factor 

that 1 im its changes in the prices of minerals that would 

otherwise result from percentage depletion, expensing of 

exploration and development costs, and treatment of royalty 

income as capital gain. 

In an open economy where subsidized virgin materials are 

traded internationally, tax preferences will primarily affect 

domestic output, rather than price because the prices for 

traded goods are determined by worldwide rather than domestic 

supply and demand conditions. U.S. tax preferences will 

affect prices only to the extent they significantly change 

either world supply or world demand. 

This output effect is itself a manifestation of resource 

waste caused by the tax subsidies. By encouraging U.S. 

companies to export minerals that cost more to produce than 

the price received or, alternatively, to encourage buyers to 

substitute domestic minerals for less expensive imports, the 

tax subsidies lower U.S. living standards. However, as 

explained below, the efficiency loss caused by the subsidy is 

not manifested in reduced recycling. 

Suppose, for example, that the U.S. subsidizes a commodity which it normally exports, such as coal. Coal is exported because its world price is higher than its domestic market 

price would be in the absence of trade. The subsidy would 

encourage domestic coal product ion and thus increase U.S. 
-53-

coal exports. But the price of coal would not fall unless 

the u.s. were a large supplier of coal on the world market, 

so that the increased exports could be sold only at a reduced 

world price. If the U.S. were a small supplier of coal on 

the world market, the increased exports could probably be 

sold at an unchanged world price. 

Increased coal exports would tend to increase the 

foreign exchange value of the dollar. Since other currencies 

would be worth less in terms of the dollar, the world price 

of coal, measured i n dollars, would fall. Any price decrease 

would be small, however, because any exchange rate adjustment 

would be spread over all U.S. exports and all U.S. imports. 

Therefore, the tax subsidy would have 1 i ttle impact on 

coal prices if increased U.S. coal exports: 

(1} can be sold at the going world price, and 

(2} have a minor effect on the foreign exchange value 

of the dollar. 

Under these conditions, the tax subsidy would increase 

output but would not lower relative prices of virgin materials. The main effect of the subsidy would be to increase 

U.S. coal exports. 

The analysis is symmetrical for an imported product, 

such as bauxite, which is imported because its world price is 

below the price that would prevail in the U.S. market in the 

absence of trade. A bauxite subsidy would encourage domestic 

production and thus reduce bauxite imports. The world price 

of bauxite would not fall unless the U.S., as a large importer of bauxite, we re an important factor in the world 

market. The appreciation in the exchange rate due to the 

reduced imports would, for reasons explained, be small. 
-54-

Therefore, the subsidy would have little impact on 

bauxite prices if reduced U.S. bauxite imports: 

(1) have little, if any effect on world prices, and 

(2) have a minor effect on the foreign exchange value 

of the dollar 

Under these conditions, the tax subsidy again would 

increase domestic output but would not lower relative prices 

of virgin materials. The main effect of the subsidy would be 

to reduce U.s. bauxite imports. These arguments are developed graphically in the Appendix to this chapter. 

As shown in Table 3.1 below, the U.S. is a relatively 

1 arge producer of al urn inurn, coal, copper, iron ore, 1 imestone, newsprint, steel, and woodpulp. Through their impact 

on output, tax subsidies for these commodities may lower 

world prices slightly. However, the demand curve facing 

domestic producers is much more elastic than it would be in 

the absence of international trade. Thus, international 

trade causes increased U.S. output to depress the price much 

less than it would in a closed economy, reducing the impact 

of the tax subsidy on the price of virgin materials. 

None of the commodities in Table 3.1, except for steel, 

accounts for more than 2.0 percent of the total value of U.S. 

trade; therefore, the impact of any of the subsidies on the 

foreign exchange rate can be ignored. 
-55-

Table 3.1 

U.S. Production as a Percent of World Production 

Selected Commodities 

Commodity or Product 

Steel 

Coal 

Iron Ore 

Limestone 

Copper Ore 

Aluminum 

Bauxite 

Newsprint 

Wood pulp 

Percent of World Production l/ 

20.0 

25.0 

11.0 

27.0 

22.0 

34 .0 

3.4 

14.0 

37.6 

.!/ All figures except limestone are for 1973 and are from 

United Nations, Department of Economic and Social Affairs, 

Statistical Yearbook, 1974 New York, 1975. Limestone figures 

are for 1975 and are from unpublished U.S. Commerce 

Department data. 
-56-

~!!~.£!-2!_Ch~e in Subsidized Resource Price on Price of 

Virgin Material Input to Primary Product Production 

The tax subsidies to mineral products are all at the 

mining stage; for timber, at the growing stage. Virgin 

material inputs to primary production require transportation 

and processing. These activities do not receive depletion 

allowances or special capital gains treatment. The price 

effect of the tax subsidy is diluted because the subsidized 

activities represent only one stage in the production of the 

virgin material that competes with recyclables. 

For pig iron, which competes with scrap steel as an 

input in steel furnaces, one must consider tax subsidies to 

coal, iron ore, and limestone. The three together account 

for only a fraction of the value of pig iron used in blast 

furnaces. Similarly, timber accounts for only a small 

fraction of the value of virgin inputs which compete with 

wastepaper in production of paper products. 

It is possible to approximate the price change of a 

virgin rna ter ial product resulting from the price change of 

each of its subsidized resources by multiplying the percentage change in the price of the subsidized resource by its 

share in the total cost of the virgin material. For pig 

iron, with several subsidized mineral inputs, the percentage 

change in price can be computed as a weighted average of the 

effects of tax subsidies on the prices of coal, iron ore, and 

limestone. This method assumes fixed coefficients in production, meaning that the physical mix of inputs used will not 

change when relative input prices change. 

The assumption of fixed coefficients understates the 

effect of a tax subsidy on price by disregarding the possibility that producers may use a greater fraction of the 
-57-

subsidized resources. Conversely, the 

over states the effect of removing a tax 

same assumption 

subsidy by disregarding the possibility that manufacturers may use a smaller 

fraction of the more costly resources. 

Effect of Virgin Material Price Change on Amount of Recycling 

As noted in Chapter 1, it is technically possible to 

decontaminate materials recovered from the solid waste stream 

so that they are perfectly substitutable for virgin materials 

in production of primary products. The relative prices of 

virgin and recyclable materials will determine which is used 

as additional input to increase output of primary products. 

The supply curve of recyclables from Chapter 1 shows how 

lower materials prices reduce the amount of recycling. In 

general, the more elastic the supply of recyclable materials, 

the greater the effect on recycling of the tax subsidies to 

virgin material production. 

Some recyclable materials, such as copper, are comparable in quality to virgin materials in quality and thus are 

interchangeable with them in production. However, scrap 

steel and wastepaper usually are not processed to the point 

where they are equivalent to virgin materials, because the 

costs of increasing quality to a higher grade normally exceed 

the increase in the value of the product. It is therefore 

difficult to estimate supply curves for those recyclable 

materials that are not perfect substitutes for virgin materials. 

Because natural resources and the solid waste stream 

both supply various grades and types of materials for different uses, a full statistical analysis of all virgin and 

recyclable materials exchanged is too unwieldy to be practical. Available econometric studies usually use typical 
-58-

recyclable and virgin materials purchased by primary producers as observations, abstracting from the full complexity of 

all relevant markets. If the average recycled material 

differs from the average virgin material used in production, 

then they would not be perfect substitutes. For this reason, 

econometric studies of steel and paper treat virgin and 

recyclable materials as distinct goods, each with a separate 

demand curve. The supply of recyclable materials depends on 

their price and other variables, while the demand for recyclable materials depends on both their price and the price of 

virgin materials. 

To compute the effect of changes in the price of virgin 

materials on recycling, it is necessary to know: 1) the 

elasticity of supply of recyclable materials, 2) the elasticity of demand for recyclable materials, and 3) the crosselasticity of demand for recyclable materials with respect to 

virgin materials prices. (The cross-elasticity of dema nd is 

equal to the percentage change in desired consumpt i on of 

recyclable materials per unit percentage change in the price 

of virgin materials and thus measur es the degree of substitutability in use between virgin a nd recyclable materials.) 

These elasticities are estimated in the literature surveyed 

in this chapter. 

1) If the elasticity of supply of recyclables is small, 

a reduction in the demand for recyclables would not reduce 

the amount recycled significantly. (Similarly, an increase 

in demand would not increase the amount of recycling significantly.) This could happen if most horne and prompt scrap 

were already recycled, and post-consumer scrap were so 

expensive to collect that scrap prices would have to increase 

sharply to generate any supply. In general, the smaller the 

elasticity of supply of recyclables, the smaller the reduction in recycling from a decrease in the price of the substitute virgin material. 
-59-

2} If the elasticity of demand for recyclable materials 

is great, a downward shift in the demand curve will have 

little effect on the amount of recycling, all other things 

the same. This might happen if goods other than virgin 

materials were readily substitutable for the recyclable 

rna ter ial. Then, a reduct ion in the virgin materials price 

might cause a shift away from other inputs, but not a major 

decrease in recycling of the same input. 

3} If virgin and recyclable materials are poor substitutes in most uses, the cross-elasticity of demand for 

recyclables will be small. In that case, the reduction in 

recycling will be small relative to any price reduction of 

virgin materials. In general, the smaller the crosselasticity of demand for the recyclable input, the smaller 

the reduction in recycling that corresponds to any reduction 

in the price of virgin materials. 

In the following three sections, this framework of 

analysis is used to estimate the effects of tax subsidies to 

virgin material production on recycling of scrap steel, scrap 

copper, and wastepaper. In making these computations, we 

rely on econometric results from previous independent 

studies. The available data are sketchy, and cannot be 

viewed as precise measures of the important behavioral 

responses. None the less, all available evidence supper ts the 

same conclusion--that existing tax subsidies do not signifiE~~!!Y_£~£~E~_!Q~-~~~~~! ~i_£~Eycling, nor would their 

absence markedly increase that amount. l/ 
-60-

III. Scrap Steel Recycling 

The Price of Pig Iron 

Pig iron competes with scrap steel as an input in the 

basic oxygen furnace that makes finished steel. Pig iron is 

made from three virgin materials: iron ore, coal, and 

limestone. The estimated increase in the price of pig iron 

from removing the tax subsidies depends on: 1) the price 

increases of coal, iron ore, and limestone, 2) the percentage 

of the cost of producing a ton of pig iron accounted for by 

coal, iron ore, and limestone, and 3) the potential of 

substituting other inputs in pig iron production as the 

prices of coal, iron ore, and limestone change. 

1. The Price of Coal 

In Chapter 2, we estimated that the supply curve for 

coal was lowered by from 8. 4 to 12. 3 percent by the tax 

preferences. Thus, removal of the preferences would shift 

the domestic supply curve upward by from 9.2 to 14.0 percent.21 

If the supply curve for coal were horizontal, the price 

of coal would increase by from 9.2 percent to 14.0 percent. 

However, the supply curve for coal is 1 ikely to be upward 

sloping, even in the long run, because additional annual 

outputs require developing new mines with higher extraction 

costs and mining existing properties more intensively, 

thereby increasing cost per unit of output. If the supply 

curve were not perfectly elastic, the price change would 

depend on the elasticities of supply and demand for coal. 

{For the exact formula, see the Appendix to this chapter.) 
-61-

Suppose elasticities of supply and demand for coal are 

+5 and -1, respectively. 31 Applying the formula shown in 

the Appendix to this chapter, a 1 percent shift in the supply 

curve would then reduce u.s. output by 4.2 percent and 

increase the world price by 0.8 percent, if the u.s. accounted for the entire world supply. Because the U.S. supplies 

only about 25 percent of world coal output, the percentage 

reduction in the world output would be considerably less than 

the percentage reduction in u.s. output, and the world price 

decline would be correspondingly smaller. The Appendix of 

this chapter provides estimates of the effects of international markets on the price change due to a shift i n the 

domestic supply. These data and assumptions imply that 

removing the tax subsidy might increase the world price by 

about five ninths of the shift in the U.S. supply curve, or 

5.1 to 7.8 percent. 

In the calculations that follow, we use the midpoint of 

these estimates, 6.5 percent. 

2. The Price of Iron Ore (Taconite) 

The estimate from Chapter 2 imp! ies that the supply 

curve of taconite would shift by up to 9.1 percent if the tax 

subsidy were removed. Again, the price change would equal 

the supply curve shift only if the supply curve were hor izontal. 

The depletion of some of the best u.S. iron ore reserves, and the consequent exploitation of higher cost 

sources suggests that the supply elasticity of iron ore may 

be lower than that of coal. 

estimate is available. 

Again, however, no econometric 
-62-

If supply and demand elasticities were +1 and -1, and 

world markets determined the U.S. iron ore price, the increase in price would be much smaller than if supply were 

perfectly elastic. The U.S. accounts for about 11 percent of 

the world's iron ore production. Under the same method used 

for coal, the estimated price increase for iron ore is about 

one-tenth of the supply shift, or about 0.9 percent. 

3. The Price of Limestone 

We were not able to obtain an investment profile with 

which to estimate the impact of Federal tax subsidies on the 

supply of limestone. However, limestone also receives 

percentage depletion likely to be constrained by the net 

income limitation. It is therefore reasonable to assume that 

the shift in the limestone supply curve is comparable to the 

shift in the coal and iron ore supply curves. The estimated 

price change for limestone need not be precise, because 

limestone accounts for only a small fraction of the cost of 

producing pig iron. 

If the limestone supply shift were within the range of 

the coal and iron ore supply shifts and the supply curve were 

perfectly elastic, removing the tax subsidies would increase 

the price of limestone from 8 to 12 percent. Alternatively, 

using supply and demand elasticities of +1 and -1, and noting 

that U.S. produced limestone accounts for 27 percent of world 

output, the central range of estimates for the 1 imestone 

price increase is between 1.7 percent and 2.6 percent. 

4. Determination of Pig Iron Price from Mineral Input 

Prices 

Proportions of mineral inputs used in the produc t ion of 

pig iron are reported in two studies of the effects of the 

tax system on recycling--one by Booz-Allen and Hamilton 
, 

-63-

{hereafter BAH), and the other by the Environmental Law 

Institute (hereafter ELI). 41 ELI reports that manufacture 

of a ton of pig iron requires 1.5 tons of iron ore, .77 tons 

of coal, and .2 tons of limestone; BAH reports inputs of 1.20 

tons of iron, . 60 tons of coal, and .18 tons of 1 imestone. 

ELI reports input prices of $11 per ton, $30 per ton, and $2 

per ton for iron ore, coal, and limestone, respectively; BAH 

reports corresponding prices of $11.30 per ton, $13.76 per 

ton and $1.70 per ton. 51 

Table 3. 2 summarizes the production cost data from the 

ELI and BAH studies. The last column of the Table shows the 

cost per ton of pig iron for each mineral input, as determined by multiplying mineral input per ton of pig iron by 

price per ton of mineral input. 

The effect of the mineral industry tax subsidies on the 

price of pig iron is shown in Table 3.3. The first column of 

Table 3. 3 reports the contribution of each mineral to the 

cost of one ton of pig iron. Columns 2 and 3 report central 

and high estimates of the additional cost of each mineral 

used to produce a ton of pig iron under neutral taxation of 

mineral industries. Columns 2 and 3 estimate the tax subsidy 

by multiplying the percentage price increase from removing 

the tax subsidy by the cost per ton under present law. The 

central estimates use both the central estimate of the supply 

shift and the central estimate of the effect of the supply 

shift on price. The high estimates assume that the percentage price increase equals the high estimate of the supply 

shift. 

Table 3.3 reveals that removing the tax subsidies would 

increase the price of pig iron a maximum of 6.2 percent using 

the ELI weights, and 3.3 percent using the BAH weights. The 

central estimates are 2.2 percent using the ELI weights, and 

0.9 percent using the BAH weights. 
-64-

Table 3.2 

Virgin Mineral Inputs in Production of Pig Iron Input 

Mineral 

Iron ore 

ELI 

BAH 

Coal 

ELI 

BAH 

Limestone 

ELI 

BAH 

Input per 

ton of 

pig iron 

1. 50 

1. 20 

.77 

.60 

.20 

.18 

Price 

ELI: 

BAH: 

of Pig 

$77.00 

$74.07 

Price 

per 

ton 

$11.00 

s 11. 30 

$30.00 

$13.76 

s 2.00 

$ 1. 70 

Iron: 

Cost per 

ton of 

pig iron 

$16.50 

$13.56 

$23.10 

$ 8.26 

$ 0.40 

$ 0.31 
-65-

Table 3.3 

Effect of Mineral Industry Subsidies on Price of Pig Iron 

-----------------------------------------------------------

Mineral 

Iron ore 

ELI 

BAH 

Coal 

ELI 

BAH 

Limestone 

ELI 

BAH 

Sum 

ELI 

BAH 

Cost per ton 

of pig iron 

Present law 

$16.50 

$13.56 

$23.10 

$ 8.26 

$ 0.40 

$ 0.31 

Sum as percentage 

of pig iron price 

ELI 

BAH 

Tax subsidy per ton of pig iron 

Central High 

estimates estimates 

$0.15 $1.50 

$0.12 $1.23 

$1.50 $3.23 

$0.54 $1.16 

$0.01 $0.05 

$0.01 $0.04 

$1.66 $4.78 

$0.67 $2.43 

2.2% 6.2% 

0.9% 3. 3% 
-66-

The method used here overstates the increase in the pig 

iron price, because it assumes 

minerals and other inputs used 

that physical ratios of 

to produce pig iron are 

insensitive to price changes. If these ratios respond to 

price changes, producers will shift to relatively lower cost 

inputs if the tax subsidies to minerals are ended. Thus, 

prices will rise by less than the weighted sum of the change 

in minerals prices using current law input proportions. 

Effect of Pig Iron Price on Steel Recycling 

The impact of pig iron price changes on the amount of 

recycling of scrap steel can be estimated using Equation 

(3.6) derived in the Appendix to this chapter. The effect on 

scrap recycling of a pig iron price change is larger for 

higher values of the elasticity of supply of scrap and the 

cross-elasticity of demand for scrap, and for lower absolute 

values of the elasticity of demand for scrap. 

ELI has estimated econometric models of supply and 

demand for scrap. 61 The cross-elasticity of scrap demand was 

estimated to be 0.28. The supply elasticity was estimated to 

be 1.12. However, this estimate includes the supply of scrap 

from all sources. 'I·he supply of home and prompt scrap is 

very inelastic at the margin, because its low collection 

costs allow it to be recycled at almost any positive scrap 

price. Increases in recycling of post-consumer scrap account 

for most of the supply response to the price change. When 

considering the percentage change in post-consumer scrap 

alone, the elasticity is higher--2. 3 2, in ELI's estimate. 

Finally, ELI estimates the demand elasticity for scrap steel 

to be -0.63. 

Research Triangle Institute (RTI) has estimated supply 

elasticities for scrap steel ranging from 0.3 to 1.0 by a 

method called "process analysis," which uses engineering 

data. ?/ 
-67-

For our upper bound estimate of the amount of recycling, 

we use values of 2.32, 1.0, and -0.63 for the supply 

elasticity, cross-elasticity of demand, and own-price elasticity of demand, respectively. For the central estimate, we 

use ELI's estimates for all scrap: 1.12, 0.28, and -0.63. 

ELI's supply elasticity estimate is close to the upper bound 

value reported by RTI. With these elasticities, we estimate 

a percentage increase in recycling of from 17.9 percent to 

78.6 percent of the percentage increase in the pig iron 

price. 

Combined Effect of Mineral Subsidies on Scrap Steel Recycling 

We combine the upper bound and central estimates of the 

pig iron price change with the upper bound and central 

estimates of the effects of that price change on recycling, 

to estimate the effect of all virgin mineral tax subsidies on 

scrap steel recycling. The upper bound estimate is that 

scrap post-consumer steel recycling would increase by 4.9 

percent if the tax subsidies were removed (the tax subsidies 

reduce post-consumer scrap steel recycling by 4. 7 percent.) 

If the supply elasticity for all scrap steel is used (1.12 

instead of 2. 32) , the upper bound estimate is 2. 3 percent. 

The central estimate is less than 0.5 percent. 

It is important to note that the upper bound estimates, 

while not large, are probably greatly exaggerated. The large 

difference between the upper bound and central estimates 

reflects considerable uncertainty about the elasticity 

parameters. For this reason, the central estimate cannot be 

considered precise. However, the upper bound estimate is 

based on the most extreme assumptions that might yield an 

estimate of a large effect. 
-68-

In computing the upper bound estimate, it was assumed 

that: 1) supply curves for the relevant minerals are totally 

elastic, 2) the shift in the supply curves is at the upper 

range of our estimates, 3) there is no substitutability among 

input minerals used to produce pig iron, 4) the higher of the 

ELI and BAH estimates of the effect of mineral prices on the 

pig iron price is the correct one, and 5) the responsiveness 

of scrap demand to pig iron prices is about four times the 

elasticity estimated by ELI. Modifying any one of these 

assumptions would reduce the estimated impact considerably. 

For this reason, it is extremely unlikely that the tax 

subsidies could reduce the amount of recycling of scrap steel 

by more than one percent. 

IV. Scrap Copper Recycling 

The output of a copper concentrator, including the 

stages of production of mining and concentration is eligible 

for percentage depletion. Scrap copper is a very close 

substitute for virgin blister copper. ELI estimates that 

blister copper is about 20 percent more expensive than copper 

concentrates: thus, percentage depletion applies to about 

5/ 6 of the value of the virgin copper product that competes 

with recyclable copper. It is reasonable to assume that the 

virgin and scrap products are perfect substitutes. 

The Price of Copper 

The tax preferences to mining of virgin copper provided 

by percentage depletion and expensing of exploration and 

development costs lower the supply curve of copper by about 

10 percent. Thus, removing the tax subsidies would raise the 

supply curve for copper concentrates by about 11.1 percent. 
-69-

Because copper concentrates represent about 5/ 6 of the 

value of blister copper, removing the subsidies would raise 

the supply curve for blister copper by 9.3 percent. 

Supply and demand elasticities are available from an 

econometric study by Fisher, Cootner and Baily of the world 

copper industry. 81 The study estimates long-run elast icities of 1. 6 7 for supply of primary copper, -0. 8 67 for 

demand for copper, and 0.32 for supply of scrap copper. 

Using equation (3.3) from the Appendix to this chapter, 

and using the Fisher, Cootner, and Baily elasticity estimates, a 9. 3 percent upward shift in the supply curve for 

blister copper implies a 6.1 percent increase in the price. 

This estimate is biased upwards, however, because the domestically produced virgin copper affected by the subsidies 

accounts for only a fraction of total supply; the U.S. 

accounts for about only 22 percent of world copper output. 

Scrap production also affects the price of copper, but it is 

not curtailed by removing the subsidy to virgin materials. 

Taken together, these factors imply that the price increase 

could be significantly less than the upper bound estimate of 

6.1 percent. Application of the methodology in the Appendix 

to adjust only for the effect of international trade on the 

price change reduces the estimated increase in copper price 

to 2.8 percent. 

Recycling of Scrap Copper 

The increased recycling of scrap copper resulting from 

an increase in price is computed by multiplying the estimated 

percentage price change by the estimated supply elasticity of 

scrap (0.32). This formula yields an upper bound estimate of 

increased recycling of 2.0 percent and a central estimate of 

0.9 percent. 
-70-

Thus, the current Federal tax subsidies to copper mining 

appear to have little deterrent effect on the amount of 

recycling of scrap copper. 

V. Wastepaper Recycling 

Wastepaper competes with virgin wood pulp as an input to 

a wide variety of paper industry products. By lowering the 

cost of wood pulp, the tax subsidies to the timber industry 

create a bias against the use of recycled paper: however, 

their effect on recycling is small. 

Compared to tax subsidies to the minerals industry, the 

tax subsidies to the timber industry are very large. However, the subsidies are not a major impediment to recycling 

for two reasons: 1) the small share of timber in the cost of 

supplying woodpulp to primary product production, and 2) the 

relative insensitivity of wastepaper recycling to changes in 

relative prices. 

Effect on the Price of Woodpulp 

Chapter 2 showed that the tax preferences lower the cost 

of growing timber by between 35.7 and 43.4 percent. Removing 

these subsidies would shift the supply curve for timber 

upward by from 55.5 percent to 76.7 percent. 

The increase in the price of timber, however, may be 

considerably smaller than the supply curve shift from removing the subsidies. Timber land is generally inferior 

land, not suitable for most agricultural uses. Were the tax 

subsidies removed, growing timber might still be the best use 

for this land. In that event, removing the tax subsidies 

would lower the value of timber land, without affecting 

timber output and price. At the margin, there are undoubt-
-71-

edly some areas where timber growing does substitute for 

other uses, and where patterns of land use would change if 

the tax subsidies were removed. Therefore, in the long run, 

timber prices would increase to some degree if tax policy 

changes caused the private costs of growing timber to increase. 

91 However, it has not been possible to quantify the 

extent to which the tax changes would alter prices and 

output, and the extent to which they would only affect the 

value of timber land. 

As noted in Chapter 2, reducing the tax preference to 

capital income from timber growing would shorten the optimal 

rotation period for timber stands. The immediate effect of 

this change could be an acceleration of timber cutting and an 

increase in the available supply of virgin woodpulp. However, the earlier harvest would mean a reduction in future 

supplies and a further reduction would occur if land were 

converted from timber growing to other uses. 

The extremely long production period for timber products 

makes it very d iff icul t to a infer long term relationship 

between changes in timber prices and changes in output from 

historical data. Absent available statistical studies that 

can be cited with even a minor degree of confidence, it is 

assumed that the reduction in the Federal subsidy to timber 

growing from removing the tax subsidies increases the price 

of standing timber by the full amount of the supply curve 

shift. This assumption provides a maximum estimate of the 

disincentives to recycling from timber tax subsidies. The 

reader should note that removing the tax subsidies may lower 

the price of virgin woodpulp in the short run, and may 

increase price in the long run by much less than is shown 

below. 
-72-

Under this upper bound assumption, ending the tax 

subsidies would increase the price of timber by at most 76.7 

percent. According to estimates supplied by ELI, timber 

accounts for between 6 and 12 percent of the price of virgin 

wood pulp. Thus, removing the tax subsidies could increase 

the price of wood pulp by as much as 9. 2 percent, if there 

were no substitutability in production. Even if the price of 

timber rises by the full amount of the increase in growing 

cost, the increase in the price of woodpulp could still be as 

little as 3.3 percent (6 percent of a 55.5 percent increase 

in the timber price). 

Effect on Recycling 

It is possible to process wastepaper so that it is 

equivalent to paper made from virgin woodpulp. It is usually 

more expensive to manufacture paper of any quality from 

recyclable sources; therefore, wastepaper is sold to users 

who do not require an exact duplication of the characteristics of paper made from virgin woodpulp . For this reason, 

existing econometric studies of the marke t for recyc l ed paper 

have treated wastepaper and virgin paper as distinct, though 

related goods. 

ELI has estimated the demand and supply for wastepaper. 

Their estimated elasticities are: 0. 40 for elasticity of 

supply of wastepaper, 0.17 for cross-elasticity of demand for 

wastepaper (with respect to woodpulp price) , and -0 .16 for 

elasticity of demand for wastepaper (with respect to wastepaper price). RTI estimates the elasticity of supply to be 

between 0.4 and 1.7, using process analysis. Equation (3.6) 

in the Appendix and the ELI elasticities imply that recycling 

would increase by 12 percent of the increase in the price of 

woodpulp. Because, as noted, removing the tax subsidies 

would increase the price of woodpulp by at most 9.2 percent, 
-73-

this would yield an increase in recycling of at most 1. 2 

percent. If RTI's highest supply elasticity is combined with 

all the other upper bound estimates, removing the tax subsidies could increase recycling by 1.4 percent. 

ELI's econometric equations show low elasticities of 

demand and supply for wastepaper. While these estimates are 

consistent with the casual observation of low substi tutability between wastepaper and virgin pulp, they may be biased 

downwards because of poor data in the estimating equations. 

In particular, the price data, based on list price, might not 

adequately capture changes in real transactions prices. 

However, even elasticity values substantially higher than 

those estimated by ELI do not lead to a conclusion that 

removing the tax subsidies would dramatically increase 

recycling. For example, if the relevant parameters were 

assumed to be 0.8 for the cross-elasticity of demand, 0.5 for 

the supply elasticity, and -0.5 for the demand elasticity, 

the percentage increase in recycling might be 31 percent of 

the increase in the woodpulp price, or a maximum of 3 percent 

above current law levels. 

VI. Conclusions 

The quantitative impact of tax subsidies to virgin 

materials on the amount of recycling is uncertain, because 

the probable responsiveness of suppliers and users to changes 

in prices of virgin and scrap materials has not been quantified precisely. Nonetheless, illustrative calculations using 

the best available evidence show that current Federal tax 

subsidies to virgin materials do not have a major negative 

effect on recycling of scrap steel, scrap copper, and wastepaper under the most extreme assumptions, and most probably 

have very little effect. Similar conclusions have been 
-74-

reported in research performed by independent contractors for 

EPA, some of whose methodology and data have been used in 

this chapter. lO/ 

However, these conclusions do not mean that tax subsidies to virgin materials production are insignificant. The 

tax preferences reviewed in Chapter 2 entail important equity 

concerns, and may also have a considerable impact on domestic 

output of some virgin materials. These effects, however 

important, are not a concern of this report. 

Footnotes to Chapter 3 

l / A similar type of computation has been made by the Environmental Law Institute (hereafter referred to as ELI) in a 

study performed under contract to the U.S. Environmental 

Protection Agency. ELI • s estimates of the impact of tax 

subsidies on the supply price differ from those developed in 

Chapter 2. This chapter combines the supply price effects 

from Chapter 2 with ELI •s and alte rnative e conometric estimates of supply and demand elasticities. See Robert C. 

Anderson and Richard D. Spiegelman, The Impact of The Federal 

Tax Code on Resource Recovery, report prepared at Environmental Law Institute for Office of Research and Development, 

u.s. Environmental Protection Agency, 1976. 

21 If the price of an input is lowered by 11 x" percent by a 

tax subsidy, then it has become (1-x) times the initial 

price. Removing the subsidy would then raise the price by 

"x/ (1-x)" percent of the post-subsidy price. 

3

1 A demand elasticity of -1 implies that the total value of 

coal consumption would be unchanged for small changes in the 

price because the percentage increase in the price per unit 

would be matched by an equal percentage reduction in the 
-75-

quantity consumed. Absent available econometric estimates of 

the long run demand for coal, this assumption is reasonable; 

it falls within the range of demand elasticities estimated 

for other minerals. 

A much higher value is used for the supply elasticity 

because accessible coal reserves are abundant and, in the 

long run, more coal could probably be mined without a substantial increase in unit costs. However, no long run supply 

elasticities for coal are available in the literature surveyed. A recent study by Charles River Associates (CRA} 

provides estimates of short run elasticities ranging from 

0.33 to 2.36. The value used here is twice the maximum short 

run elasticity estimated by CRA. See Charles River As sociates, Coal Price Formation, final report prepared for 

Electric Power Research Institute, December 1977. 

If the supply elasticity is lower than the value used in 

these calculations, then the tax subsidies have a smaller 

effect on the price of coal and, hence, a smaller negative 

impact on recycling of scrap steel. 

4/ Booz-Allen and Hamilton, An Evaluation of the Impact of 

Discriminatory Taxation on the Use of Primary and Seconda~ 

Raw Material, final report submitted to Environmental Protection Agency, Washington, D.C., June 28, 1974, and Robert C. 

Anderson and Richard D. Spiegelman, op. cit. 

51 The two studies use price data from different years, and 

production estimates from different sources. 

6

1 See Robert C. Anderson and Richard D. Spiegelman, op. cit. 

See also Robert C. Anderson and Richard D. Spiegelman, "Tax 

Policy and Secondary Material Use," Journal of Environmental 

Economics, volume 4, Number 1, March 1977. 
-76-

7/ A.K. Miedema, An Empirical Evaluation of the Market and 

Net Welfare Effects of A Product Disposal Charge, Research 

Triangle Institute {RTI), December 1977. For a review of the 

RTI work and other studies estimating supply elasticities for 

recyclable inputs, see ICF Incorporated, Estimates of Substitu!l~E-2E~~Ely_§l~~!i£i!i~~-!~E-~~~!=~~E~~~eE_~~~!~ 

~at~l~!~, draft report submitted to u.s. Environmental 

Protection Agency, August 11, 1978. 

81 F. Fisher, P. Cootner, and N. Baily, "An Econometric Model 

of the World Copper Industry," Bell Journal of Economics and 

Management Science, August 1972. 

9/ In technical terms, if the supply curve were totally 

inelastic {i.e., timber output were unchanged if timber 

prices changed) , removing the tax subsidies would simply 

lower the value of timber land. If, on the other hand, the 

supply curve were totally elastic, the price would increase 

by the full amount of the estimated cost increase. 

lO/ See Environmental Law Institute, £E · cit and Booz-Allen, 

Hamilton, 2£· cit. 
Chapter 4 

Recycling Subsidy Options 

I. Justifications commonly cited for subsidizing recycling 

activities. 

Solid waste management involves two distinctive activities. First, collecting the debris of production and consumption; second, physically disposing of it by landfill or 

inc iner at ion, or subjecting it to some form of resource recovery process and then disposing of the residual solid 

waste. Both sets of solid waste management activities are 

subject to competitive conditions. The technologies for collection and for processing solid waste are widely known, and 

entry into these activities is not barred by patents. The resources required, labor and capital, have no limiting specialized characteristics. While there may be economies of 

scale in both sets of waste management activities, in neither 

does the condition of natural monopoly prevail. l/ 

If the activities of waste collection and processing 

fulfill the conditions of competitive markets, there is no a 

priori just if icat ion for public subsidies to any of these 

activities. However, proponents of resource recovery, including recycling, cite one or more of the following four 

just if icat ions for subsidizing resource recovery from solid 

waste: it relieves communities of some solid waste management costs; it reduces environmental degradation; it offsets 

price-distorting effects of tax subsidies to virgin materials 

production; and it conserves finite resources and energy. We 

turn now to a critical review of these rationales for subsidizing resource recovery from solid waste. 
- 78 -

A. Reduction in the burden of solid waste management 

borne by local governments. 

In its Fourth Report to Congress: Resource Recovery and 

Waste Reduction, the Environmental Protection Agency has estimated that 134.8 million tons of municipal solid waste was 

disposed of in the United States in 1974 at an estimated 

total cost of nearly $4 billion. A major but unquantified 

fraction of this cost is financed by municipally operated 

collection and disposal systems; and a significant fraction, 

again unestimated, of the municipally controlled waste management is financed by g eneral taxes. 21 Disposing of the 

waste in an environmentally acceptable manner would have cost 

an estimated $1.6 billion more. The volume of municipal 

solid waste has been growing at an estimated annual rate of 

1.9 percent, and will reach 166 million tons by 1985. 

Although these facts indicate that solid waste disposal 

absorbs large amounts of resources, by themselves, they 

provide no basis for subsidizing recycling activities: 

--Some local governments, with the consent of their 

voters, undertake solid waste management tasks and 

finance them by local taxes; others undertake the 

tasks and finance them with fees; still others contract with private firms and finance the work by appropriations from the general fund, or by fee assessments. In all these cases, communities dec ide how 

they wish to have solid waste management services performed and financed. Federal government subsidies 

which would reduce the costs of solid waste management 

merely transfer that burden from those who generate 

the waste to Federal taxpayers. If communities elect 

to have their governments perform services on their 
-79-

behalf and to finance them by taxes and fees, the resultant burdensome tax at ion is not a valid claim to 

Federal subsidy that would relieve these burdens. 31 

--The evidence does not support a conclusion that municipal solid waste management is any more a financing 

problem for local governments than other categories of 

expenditure. Even if the estimated $4 billion cost of 

solid waste management in 1974 were borne entirely by 

local gove rnments, which was not the case, and we add 

to this the estimated $1.6 billion of unmet environmental protect ion costs, the total would be only 4 

percent of all local governmental expenditures that 

year. Moreover, while local government expenditures 

have increased at an annual rate of 11 percent during 

the last decade, the inflat ion-adjusted rate of increase in municipal solid waste costs is but 3.5 percent. 

B. Reduction i n environmental degradation. 

The Environmental Protection Administration has 

estimated that 92 percent of municipal solid waste in the 

United States is disposed of by landfill and more than 

two-thirds of land disposal site s do not meet environmental 

standards. These estimates imply that, under present conditions, waste disposal imposes a sizable social cost in 

degradation of the environment. As noted, it would have cost 

annually $1.6 billi on (in 1974 dollars) to conform disposal 

systems to environmental standards. If the volume of waste 

requiring disposal could be reduced to zero by resource recovery, not only would the $1.6 billion of unmet environmental losses suffered by socie ty be saved, but also the 

actual disposal costs incurred that year, estimated to be 
-80-

$500 million. 4/ While subsidies to recycling cannot reduce 

disposal to zero, they can contribute to some reduction, and 

hence to a reduction in environmental damage. 

The evasion of environmental laws in the disposal of 

solid waste by communities is deplorable, but does not 

warrant assumption by Federal taxpayers of the burden of 

rna inta in ing local environmental quality through the funding 

of subsidies to recycling. Not only does a recycling subsidy 

violate the "polluter pays" principle, it does so in a costly 

manner. If the polluter pays principle is to be breached, 

the least costly way for the Federal government to assume 

some or all of the cost of environmental maintenance is 

directly, through grants or similar payments to local governments, per ton of waste collected; this payment might then 

be used by those governments either for disposal of solid 

waste in an environmentally acceptable manner, or for 

building and operating resource recovery facilities. To 

subsidize resource recovery generally, or recyclable 

materials only, is to bias unnecessarily the choice among 

disposal opt ions. When environmentally acceptable disposal 

is cheaper, as it is in most places in the United States, to 

encourage resource recovery is a waste of scarce labor and 

capital resources. 

Moreover, for reasons detailed in Chapters 1 and 3, the 

incremental cost per ton removed from the solid waste stream 

by a subsidy to recycling only is extremely high and rises 

rapidly as the volume to be removed from the waste stream 

increases. In 1974, the average disposal cost of municipal 

solid waste was estimated to be less than $4 per ton, and if 

all disposal had conformed with environmental standards, that 

cost might have increased by an aver age of $1.19. In contrast, the estimated subsidy cost of removing an additional 
-81-

ton of paper from the municipal solid waste stream is $395; a 

ton of ferrous scrap, $120 to $185; and a ton of copper 

scrap, $4,720. 5/ These estimates pertain only to removal of 

additional tonnages in the range of one or two percent of the 

quantities currently recycled and, hence, to even smaller 

fractions of municipal solid waste. Removing more would 

rapidly escalate these costs per ton. 

In sum, avoidance of environmental degradation costs affords no basis for Federal subsidy to recycling. 

Nonetheless, if a Federal subsidy to local communities is to 

be provided to help them meet their obligations to maintain 

environmental quality while disposing of their solid waste in 

violation of the polluter pays principle, it should be 

provided at the point where collected municipal solid waste 

is available for disposal, whether by landfill, incineration, 

or resource recovery processing. Such a direct subsidy to 

local communities conditional on their avoidance of 

environmental damage in the disposal of solid waste will cost 

less than 0 .1 to 1. 0 percent of a subsidy to recycling for 

the same purpose. 

c. Offset to price-distorting effects of tax subsidies. 

Chapter 2 reviewed the Internal Revenue Code provisions 

that create a preference, or subsidy, for the production of 

virgin materials. Although many observers conclude that 

these subsidies justify compensatory subsidies to recyclable 

materials, Chapter 3 notes that the claim for compensatory 

subsidy assume s that subsidies to the domestic production of 

virgin materials results in lower prices of those materials 

and, thus, reduces demand for recyclable materials. But the 

degree to which domestic prices of virgin materials are reduced by production subsidies depends upon the character of 
-82-

world markets for these materials and the relative importance 

of U.S. consumption and product ion in those markets. Moreover, the induced reduction in demand for recyclable materials associated with any depression of virgin materials 

prices attributable to U.s. subsidies is greatly attenuated 

by the far less than per feet degree of substitutability of 

recyclable for virgin materials in product ion of the full 

spectrum of primary products derivable from these materials. 

In sum, leaving aside the question, not dealt with in 

this report, whether subsidies for the domestic production of 

virgin materials is a justifiable governmental intervention 

in the allocation of scarce labor and capital resources, the 

evidence available does not support an inference that these 

subsidies, by their effect on domestic virgin material 

prices, deter resource recovery from solid waste to a degree 

that warrants a countervailing subsidy. For the three significant recyclable materials examined--ferrous scrap, copper 

and paper--the probable deterrence to recycling attributable 

to virgin material subsidies is in the range of 0. 5 to 1. 0 

percent of the volume recycled. This is not a magnitude sufficient to warrant installing a countervailing subsidy 

program which is likely to have serious administrative 

problems, as discussed below. (See Section II, A, below). 

D. Conservation of "finite" resources and energy. 

1. Finite resource conservation. 

It is a truism that the earth 1 s resources are finite, and it follows from this that if present generations 

"use-up" high-grade ores and other nonrenewable resources 

constituting the earth 1 s crust, succeeding generations will 
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have less. This being so, the argument continues, we should 

recover resources from solid waste for the benefit of future 

generations. Since much of the solid waste stream is presently disposed of, not processed as a source of material and 

energy, a strong case is therefore alleged to exist for subsidizing resource recovery. The extra resources invested in 

recycling by the present generation is to preserve for future 

generations their claim to the earth's resources. 

There are three weak links in this chain of reasoning to justify a subsidy to resource recovery activities. 

First, although the earth's crust is "finite" it is vast. So 

1 i ttle of it has been thoroughly surveyed geologically, no 

one can with reasonable confidence estimate its useful 

resource content. Unmeasured "finiteness" is not a sat isfactory reason to constrain current rates of economic utilization of the natural endowment. 

Second, living standards are determined by the stock 

of human and physical capital that embody the store of knowledge, as well as by the natural endowment. Growth in the 

stock of physical capital, and in its productivity, as well 

as accretion of knowledge--enhanced productivity of human 

capital--together substitute for depleting natural resources. 

The available evidence suggests that not only has the real 

cost of extracting minerals in the United States declined, 

but that the decline in cost of extraction is greater than 

the decline in real costs of other production. G/ All this 

has occur red over the last century notwithstanding the fact 

that the grades of most ores exploited have declined. ?/ 

Finally, it is not correct to assert that claims of 

future generations are unaccounted for in decisions made today. Individuals consume and save today according to their 
-84-

judgment of future needs. Each generation comprises per sons 

of all ages; thus, each "generation" makes dec is ions that 

span an average of two or more decades, linking generations 

to each other in infinite sequence. Moreover, enterprises 

that make production decisions for a full spectrum of economic activities ranging from mining and forestry to retailing of consumer goods organize as corporations in order that 

they may operate with extremely long planning horizons. Well 

organized mark e ts exist through which households and 

enterprises may execute their decisions spanning decades; 

these are called "capital markets" in which present claims 

are exchanged for future claims. 

If, say, copper-trading enterprises believed that 

the world were in danger of running out of low cost ores, 

they would restrict current sales, preferring to hold 

inventories in the ground and in warehouses rather than to 

sell at cur rent prices. If the cost of acquiring funds in 

capital markets is 10 percent, anyone who supposes the future 

growth in price of materials will be greater than 10 percent, 

compounded, will withhold current available supplies, raising 

current prices of the materials to "reflect the claims" of 

future consumers. Additionally, enterprises in the copper 

business will invest (acquire pr e s ent claims to resources in 

capital markets in e xchange for promises to make future 

payments) in finding new ore deposits and in reducing the 

cost of extracting and processing ores from existing 

deposits. While some contend that the market rate of 

discount which functionally links present and future 

generations is too high, i.e., 

much, this does not mean 

generations are disregarded. 

discounts 

that the 

future claims too 

claims of future 
-85-

In sum, the apparent finiteness of natural resources 

provides no compelling argument for expending society's 

scarce resources in a subsidized level of resource recovery. 

We don't know the magnitude of resources in the earth's 

crust; we continue to increase the rate at which we learn to 

extract useful minerals from rock; and we already have a 

reasonably useful mechanism for adapting current use of 

natural resources to likely future demands. 

2. Energy conservation. 

The energy conservation rationale for subsidizing 

resource recovery is based on the observation that the number 

of Btu's, or barrels of oil-equivalent energy, required to 

produce a unit of primary product--metal, paper, glass--from 

virgin materials exceeds the energy required to produce the 

same unit from recyclable materials. If we subsidize resource recovery, we save Btu's of energy. 

There is some validity in this argument, but it 

rests on an inference that the effect of our oil, gas, and 

electric energy price controls is to cause the market prices 

of energy to be understated. If that inference is correct, 

then reducing usage of energy by one Btu saves more resources 

than is implied by the "saving" measured at the present 

market prices of energy. That is, the relative attractiveness 

of using recyclable materials, which embody less energy, is 

understated by the underpricing of energy. 

On the other hand, there are reasons to believe that 

the inefficiencies of price regulation make energy prices 

higher than they would be in the absence of regulation: 

"rate of return" regulation of uti 1 i ty prices induces too 
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capital intensive modes of electric energy generation and 

distribution; oil and gas price regulation has increased the 

costs of finding, processing, and d istr ibut ing this form of 

energy so that what has been gained by suppressing prices at 

the well-head may be largely offset by increased costs elsewhere in the system. It is doubtful that mispr icing of 

energy mea sur ably biases choices against resource recovery; 

therefore, saving a Btu of energy through recycling does not 

result in a resource saving not already accounted for in the 

choice to recycle, rather than dispose of solid waste. 

Energy is not some special resource external to the 

economic system, but simply an embodiment of capital, labor 

and the natural endowment in a particularly useful form. 

Economic pol icy should aim to minimize the total cost of 

production to improve our standard of living. We gain 

nothing by substituting an extra dollar's worth of resources 

in recycling material in order to save less than a dollar's 

worth of costs, whether those costs are for society's labor 

and capital in the form of energy, or other inputs. If it 

pays to recycle, one of the reasons it pays is that, among 

other things, recycling uses less energy. If, despite its 

lesser energy use, recycling does not pay, the energy saving 

due to recycling is irrelevant. 

Summary. 

If a subsidy corrects a failure of markets to allocate 

resources effie iently, it yields society a net gain. That 

is, should social valuation of the output of the economic 

system fail to be reflected in market prices, or should the 

costs of resources consumed in production fail to be accounted for by enterprises engaged in production, or should 
-87-

there be a barrier to utilization of least costly technology, 

government intervention to correct these failures results in 

a net benefit--increased standard of living. In such instances, the apparent cost of a subsidy financed by taxes is 

offset, in part or in whole, by a larger value of goods and 

services. 

There are no glaring market failures which might be offset effectively by subsidies to recycling, or resource 

recovery. 

--Solid waste management, recycling, and resource recovery are activities not characterized as natural 

monopolies. Technologies are widely known, and there 

are no market economies of scale or institutional barriers that 1 im it entry. Recycling and resource recovery will take place whenever value of product justifies incurring production costs. 

--Although municipalities frequently fail to price solid 

waste collection services to equate costs and benefits 

at the points where solid waste collection occurs, 

this is an exercise of constitutional rights reserved 

to states, not a manifestation of market failure. 

--Although there are numerous instances in which solid 

wastes are disposed of in an environmentally unacceptable manner, these are failures to comply with Federal, state, and local environmental standards, not 

market failures. 

--Although there are tax subsidies to virgin material 

production which reduce imports of certain materials 
-88-

and increase exports of others, recycling and resource 

recovery are not appreciably deterred. Additional 

subsidy to recycling therefore would not avoid resource wastage due to existing tax subsidies. 

--There is no persuasive argument that markets for 

natural resources, including those convertible into 

energy, do not account for present and expected future 

scare i ty·. 

In sum, subsidies to recycling and resource recovery do 

not ensure a more efficient allocation of resources. Instead 

they are likely to reduce total social welfare by devoting 

too many resources to recycling compared with the benefits 

received and too few resources to more economical means of 

waste disposal. 

II. Considerations in the formulation of a subsidy to 

recycling. 

Notwithstanding the absence of a justification for subsidizing recycling on the ground of improved overall allocation of society's resources of labor and capital, noneconomic 

considerations compel many to support institution of a system 

of recycling subsidies. Personal belief in a "conservation 

ethic" is a sufficient reason for some to urge public support 

for more recycling of solid waste than is justified on pure 

cost-benefit grounds. Others, engaged in the recycling 

process, have a pardonable pride in their activities, and 

they seek public recognition and support to expand their 

sphere of interest. 
-89-

The remainder of this chapter reviews the issue s in 

formulating a subsidy program to increase the recycling of 

solid waste: definition of the activity to be subsidized; 

the form of the subsidy; and how resolution of the se questions inter acts wi th the structure of activities eng aged in 

recycling to determine the ultimate cost of achieving the 

declared objective. 

A. Definition of recycling activities. 

"Recycling" de scribes a process in which material things 

which have become worthless and therefore disposable are converted into materials usable in the production of things 

which do have value. Recycling is often thought to be restoration of the contents of trashbins and garbage pails to 

flows of raw materials, and this is the view taken in this 

report. But, for the purpose of evaluating a subsidy program, this is an over-simplified view of .the way raw materials that have been fashioned into products move through the 

economic system . 

Consider the variety of cho i ce-paths that exist at each 

stage of the economic process. At the primary product ion 

stage referred to i n Chapter 1, defective batches may be come 

home scrap and repr ocessed, or they may be salable, at lower 

pr i ces, for use i n less demanding product fabrication. At 

the fabrication stage, the same choice prevails for defective 

products: they may be salable as "seconds," they may be reworked, or they may be thrown in the trash pile. Similarly, 

when the first purchaser of a product finishes with his principal use of it, he may put it to secondary use--relegate his 

older car to utility use, add books and periodicals he has 

completed reading to his 1 ibr ary shelves--or he may sell it 

to a dealer, or he may throw it into a trash heap, paying 

someone to collect it. Second-hand dealers may recondition 

articles for resale, discarding more or less of the original 
-90-

material i:n the process, or they may hold them in inventory 

for future resale. Finally, once the collectors of trashbins 

and garbage pails have acquired the contents, the choices 

available include processing the solid waste into recyclable 

materials, useful energy, and, possibly, other products, or 

disposing of the original volume. Even the resource recovery 

activity will generate solid waste, and this may be held in a 

kind of slag heap awaiting further processing, or it may be 

disposed of. 

This diversity of paths traced by ultimately recyclable 

materials through the economic system raises two issues. 

First, in addition to the direct costs of a subsidy to increase recycling, a considerable additional indirect cost 

will be incurred that is in conflict with the conservation 

ethic; and second, the pragmatic difficulty of identifying 

both the agents to whom the subsidy will be paid, and the 

base on which the amount of subsidy will be computed. 

1. Additional indirect costs of a recycling subsidy. 

If, at all stages from primary product ion through consumption, there are choices between some continued use of a 

semi-finished product or finished good, or discarding it, 

subsidization of recycling will discourage continued use. 

When "seconds" and reconditioned products are made more 

valuable as grist for the recycling process, they will more 

readily be entered into solid waste streams. The "useful 

life" of products will be shortened by the introduction of a 

recycling subsidy. Thus given, a standard of living, one of 

the results of a recycling subsidy will be a tendency to 

increase the volume of solid waste genera ted. Part of the 

recycling subsidy therefore will be absorbed in more primary 

product production to sustain a given standard of living than 
-91-

would occur without the subsidy. The increased primary 

product production will induce an increase in virgin material 

usage that will offset some of the conservation achieved by 

recycling. Subsidizing recycling per se also discourages 

general resource recovery, including conversion of waste into 

useful energy. Thus, a subsidy policy narrowly aimed toward 

encouraging recycling of materials to replace virgin 

materials causes an induced waste of resources. The wasted 

resources include natural resources as well as capital and 

labor. 

2. Identifying the agents and base for a recycling 

subsidy. 

But, more importantly, the large numbers of transactors 

involved in the process affected by a recycling subsidy, and 

the variety of interrelated decisions that would be affected, 

implies a severity of operational administrative problems 

seldom given attention by recycling subsidy proponents. 

Given the objective of a recycling subsidy, the least ambiguous set of activities engaged in the process, and also one 

comprising the fewest economic units, is that in which recyclable material is incorporated into a primary product. To 

simply recount the numbers of trash collectors, dealers and 

brokers in "scrap," and reconditioners and salvagers of articles, and to consider the numbers of transactions which may 

be consummated between the discard of solid waste and its 

ultimate conversion into reusable material should be sufficient to disqualify any of these preliminary stages of the recycling process from consideration as feasible points at 

which to interject a subsidy. 
-92-

For example, suppose the subsidy is $5 per ton of paper. 

If the subsidy is paid to the collector, how may it be ascertained that the collect ion is only from the waste discarder, and not a second collection of the same paper already 

bearing a $5 subsidy? The initial collector might sell the 

paper to a dealer who, after sorting and bailing it, has the 

paper collected a second time for delivery to a paper mill. 

Absent a subsidy, the functional identification of transactors i s unnecessary: each party to a transaction is free to 

exchange. In the presence of a subsidy, a pre-identification 

procedure--some 1 icens ing scheme--becomes necessary; and to 

administer the subsidy, an elaborate licensee monitoring system is also necessary. Moreover, if the subsidy is injected 

at any point prior to actual use of the recyclable material 

in primary product production, there can be no assurance that 

the subsidy will go entirely to furthering of recycling 

rather than other disposal of the materials. 

Although there are fewer primary product producers than 

there are entities that handl e solid waste, thereby fac il itating formal identification of points to which the subsidy 

will flow, the basis for awarding the subsidy remains difficult to define. Suppose that identification of a primary 

product producer is made. Ideally, the base for the subsidy 

would be the recyclable material content of his final product, for this is the only quantity of homogeneous material 

qualifying for the subsidy. Unfortunately, there is no way 

to determine from the physical and chemical characteristics 

of metals, paper, and glass which, if any, of the product's 

molecules were derived from virgin, and which from recycled 

materials. 
-93-

The alternative is to measure inputs of recyclable materials to the primary production process. But this requires 

classifying of materials the physical identities of which are 

destroyed in the production process. Invoices and evidences 

of payment, which are sufficient to audit purchases and inventories of materials and supplies entering "cost of goods 

sold" in an income statement, or tax return, would not be 

adequate to d ist ingu ish between recyclable materials, which 

qualify for subsidy, and virgin materials, which do not. 

Physical identification of materials is possible only when 

they arrive on the premises of a qualified primary product 

producer; thus, administration of a recycling subsidy will 

require some mechanism, such as on-site inspectors, to 

examine materials, validate invoices, and ensure that a 

shipment of materials qualifying for subsidy is not resold or 

otherwise made eligible for resubsidization. 

Now suppose that an appropriate mechanism for administering the subsidy is installed at the primary product producer level, the only practical point for injecting it. The 

next question is how to frame the subsidy. The subsidy might 

be some specific dollar amount per unit of recyclable material purchased, or it might be some percentage of the purchase 

price of the material. Recognizing that the purchase price 

of recyclable material depends on its degree of contamination 

and the distance it has been shipped, either of these two 

ways of providing the subsidy will have unintended d istort ionary consequences. If the subsidy is a fixed amount per 

unit, it will favor low-priced materials, those which are 

less pure and transported over shorter distances. If the 

subsidy is ad valorem, it will not affect the relative attractiveness of different grades of materials but it will 

encourage 

producers' 

decontamination 

premises. In 

at sites other than the primary 

either case, the subsidy causes 
-94-

changes in the location of activity that only increase the 

size and cost of the subsidy without increasing the amount of 

recycling. 

In sum, specification of a subsidy program for recycling 

presents formidable problems. Injecting the subsidy at 

points where recyclable materials are converted into primary 

products minimizes these problems, but does not eliminate the 

need for some licensing procedure and the possible use of 

inspectors to monitor and to validate claims. However the 

subsidy is stated, whether as a specific or ad valorem 

bounty, it will induce a relocation of activity. 

B. Subsidy mechanisms. 

A subsidy is simply a payment by government which causes 

the price paid by the purchasers of a subsidized good or service to be less than the seller's net proceeds from the sale. 

As noted in Chapter 1, whether the subsidy payment goes to 

the seller or to the buyer, the result is the same. If the 

subsidy payment is to the buyer, his net outlay is less than 

the payment he makes to the seller. If he wishes to buy more 

of the now cheaper (to him) goods, he can afford to bid more 

to elicit additional supplies, if that is necessary, and 

still pay a (subsidized) price lower than he had previously. 

If the subsidy payment is to the seller, his profit per unit 

sold increases. To sell more of the now more profitable subsidized goods, he will have to exert more effort, incur some 

costs, or lower selling price. If a particular seller does 

not respond to the more profitable conditions created by the 

subsidy, his competitors will. Thus, whether the subsidy is 

handed over to the buyer or the seller, the result is an increased usage with the amount of the subsidy a 11 wedge" between the payment of the buyer and the net realization of the 

seller. 
-95-

As noted in Chapter 3, the degree to which a subsidy increases usage depends upon the responsiveness of demand for, 

and supply of, the subsidized goods. The more responsive, or 

price elastic, are demand and supply, the greater the change 

in usage due to the subsidy. The under lying conditions in 

recyclables markets make these elasticities small. Most of 

any recycling subsidy therefore will be absorbed in higher 

selling cost: reduction of selling price, net of subsidy, to 

penetrate markets, and/or higher costs to gather and decontaminate recyclables for reuse. These conditions of demand 

and supply of recyclables explain why the costs noted above 

of recycling an additional ton of paper, or ferrous and nonferrous material, are so high. We now turn to a critical 

examination of proposed ways to pay recycling subsidies. 

1. The two ways to effect subsidy payments. 

Governments may make subsidy payments in either of 

two ways which are equivalent, 

may make the payment in cash: 

in principle. A government 

for each ton of recyclable 

material, the government offers to pay a transactor X dollars 

on submission of evidence that an exchange has occurred. Alternatively, since virtually all possible transactors are 

taxpayers, the government may offer to reduce a transactor's 

tax liabilities otherwise due by X dollars per ton of recyclable material, again on submission of evidence that an exchange has occurred. In either case, the subsidized transactor and subsidizing government end up in the same position: 

the transactor has X dollars more in pocket per ton (he has 

either received a Treasury check for X dollars, or he has reduced his tax payment by X dollars); the government has increased its deficit by X dollars (it has expended X dollars, 

or it has reduced Treasury receipts by X dollars) • 
-96-

It is important to note that, whether the subsidy is 

paid in cash or is cleared through a qualified transactor's 

tax account, the economic consequences are also the same. In 

effect, the government, through the agency of the qualified 

transactor, has "purchased" X dollars of the resources embodied in a ton of the subsidized recyclable material and 

given them to private persons for private use. For each ton 

of subsidized recyclable materials ultimately used to produce 

goods and services, private parties are relieved of X dollars 

in resource costs, which are paid for by taxpayers without 

regard to their consumption. The deficit of X dollars per 

ton subsidized will either be made-up in reduced government 

expenditures for other purposes, or by additional tax imposed 

to cover the deficit. If the subsidy is not compensated for, 

the net deficit will be a source of inflation, if it is monetized, or a reduction in the savings available to finance 

private capital formation if it is not monetized. There is 

no free lunch. 8/ 

2. Differences between tax and appropriated 

subsidies. 

Given a definition of the activity to be subsidized 

and a formula for determining the amount of the subsidy, the 

economics of the subsidy are the same. Its effect on the 

volume of subsidized activity and its using-up of productive 

resources, will be the same whether the subsidy is fin anced 

by appropriated funds or by reductions in tax otherwise due. 

But there are political and adm in istr at ive differences between the two methods of payment which must be considered 

when framing a subsidy program. 

Couching the subsidy as an expenditure program 

involves those Congressional committees that authorize and 

appropriate funds for the substantive program purpose of the 
-62-

If supply and demand elasticities were +1 and -1, and 

world markets determined the U.S. iron ore price, the increase in price would be much smaller than if supply were 

perfectly elastic. The U.S. accounts for about 11 percent of 

the world's iron ore production. Under the same method used 

for coal, the estimated price increase for iron ore is about 

one-tenth of the supply shift, or about 0.9 percent. 

3. The Price of Limestone 

We were not able to obtain an investment profile with 

which to estimate the impact of Federal tax subsidies on the 

supply of limestone. However, limestone also receives 

percentage depletion likely to be constrained by the net 

income limitation. It is therefore reasonable to assume that 

the shift in the limestone supply curve is comparable to the 

shift in the coal and iron ore supply curves. The estimated 

price change for limestone need not be precise, because 

limestone accounts for only a small fraction of the cost of 

producing pig iron. 

If the limestone supply shift were within the range of 

the coal and iron ore supply shifts and the supply curve were 

perfectly elastic, removing the tax subsidies would increase 

the price of limestone from 8 to 12 percent. Alternatively, 

using supply and demand elasticities of +1 and -1, and noting 

that U.S. produced limestone accounts for 27 percent of world 

output, the central range of estimates for the 1 imestone 

price increase is between 1.7 percent and 2.6 percent. 

4. Determination of Pig Iron Price from Mineral Input 

Prices 

Proportions of mineral inputs used in the produc t ion of 

pig iron are reported in two studies of the effects of the 

tax system on recycling--one by Booz-Allen and Hamilton 
, 

-63-

{hereafter BAH), and the other by the Environmental Law 

Institute (hereafter ELI). 41 ELI reports that manufacture 

of a ton of pig iron requires 1.5 tons of iron ore, .77 tons 

of coal, and .2 tons of limestone; BAH reports inputs of 1.20 

tons of iron, . 60 tons of coal, and .18 tons of 1 imestone. 

ELI reports input prices of $11 per ton, $30 per ton, and $2 

per ton for iron ore, coal, and limestone, respectively; BAH 

reports corresponding prices of $11.30 per ton, $13.76 per 

ton and $1.70 per ton. 51 

Table 3. 2 summarizes the production cost data from the 

ELI and BAH studies. The last column of the Table shows the 

cost per ton of pig iron for each mineral input, as determined by multiplying mineral input per ton of pig iron by 

price per ton of mineral input. 

The effect of the mineral industry tax subsidies on the 

price of pig iron is shown in Table 3.3. The first column of 

Table 3. 3 reports the contribution of each mineral to the 

cost of one ton of pig iron. Columns 2 and 3 report central 

and high estimates of the additional cost of each mineral 

used to produce a ton of pig iron under neutral taxation of 

mineral industries. Columns 2 and 3 estimate the tax subsidy 

by multiplying the percentage price increase from removing 

the tax subsidy by the cost per ton under present law. The 

central estimates use both the central estimate of the supply 

shift and the central estimate of the effect of the supply 

shift on price. The high estimates assume that the percentage price increase equals the high estimate of the supply 

shift. 

Table 3.3 reveals that removing the tax subsidies would 

increase the price of pig iron a maximum of 6.2 percent using 

the ELI weights, and 3.3 percent using the BAH weights. The 

central estimates are 2.2 percent using the ELI weights, and 

0.9 percent using the BAH weights. 
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Table 3.2 

Virgin Mineral Inputs in Production of Pig Iron Input 

Mineral 

Iron ore 

ELI 

BAH 

Coal 

ELI 

BAH 

Limestone 

ELI 

BAH 

Input per 

ton of 

pig iron 

1. 50 

1. 20 

.77 

.60 

.20 

.18 

Price 

ELI: 

BAH: 

of Pig 

$77.00 

$74.07 

Price 

per 

ton 

$11.00 

s 11. 30 

$30.00 

$13.76 

s 2.00 

$ 1. 70 

Iron: 

Cost per 

ton of 

pig iron 

$16.50 

$13.56 

$23.10 

$ 8.26 

$ 0.40 

$ 0.31 
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Table 3.3 

Effect of Mineral Industry Subsidies on Price of Pig Iron 

-----------------------------------------------------------

Mineral 

Iron ore 

ELI 

BAH 

Coal 

ELI 

BAH 

Limestone 

ELI 

BAH 

Sum 

ELI 

BAH 

Cost per ton 

of pig iron 

Present law 

$16.50 

$13.56 

$23.10 

$ 8.26 

$ 0.40 

$ 0.31 

Sum as percentage 

of pig iron price 

ELI 

BAH 

Tax subsidy per ton of pig iron 

Central High 

estimates estimates 

$0.15 $1.50 

$0.12 $1.23 

$1.50 $3.23 

$0.54 $1.16 

$0.01 $0.05 

$0.01 $0.04 

$1.66 $4.78 

$0.67 $2.43 

2.2% 6.2% 

0.9% 3. 3% 
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The method used here overstates the increase in the pig 

iron price, because it assumes 

minerals and other inputs used 

that physical ratios of 

to produce pig iron are 

insensitive to price changes. If these ratios respond to 

price changes, producers will shift to relatively lower cost 

inputs if the tax subsidies to minerals are ended. Thus, 

prices will rise by less than the weighted sum of the change 

in minerals prices using current law input proportions. 

Effect of Pig Iron Price on Steel Recycling 

The impact of pig iron price changes on the amount of 

recycling of scrap steel can be estimated using Equation 

(3.6) derived in the Appendix to this chapter. The effect on 

scrap recycling of a pig iron price change is larger for 

higher values of the elasticity of supply of scrap and the 

cross-elasticity of demand for scrap, and for lower absolute 

values of the elasticity of demand for scrap. 

ELI has estimated econometric models of supply and 

demand for scrap. 61 The cross-elasticity of scrap demand was 

estimated to be 0.28. The supply elasticity was estimated to 

be 1.12. However, this estimate includes the supply of scrap 

from all sources. 'I·he supply of home and prompt scrap is 

very inelastic at the margin, because its low collection 

costs allow it to be recycled at almost any positive scrap 

price. Increases in recycling of post-consumer scrap account 

for most of the supply response to the price change. When 

considering the percentage change in post-consumer scrap 

alone, the elasticity is higher--2. 3 2, in ELI's estimate. 

Finally, ELI estimates the demand elasticity for scrap steel 

to be -0.63. 

Research Triangle Institute (RTI) has estimated supply 

elasticities for scrap steel ranging from 0.3 to 1.0 by a 

method called "process analysis," which uses engineering 

data. ?/ 
-67-

For our upper bound estimate of the amount of recycling, 

we use values of 2.32, 1.0, and -0.63 for the supply 

elasticity, cross-elasticity of demand, and own-price elasticity of demand, respectively. For the central estimate, we 

use ELI's estimates for all scrap: 1.12, 0.28, and -0.63. 

ELI's supply elasticity estimate is close to the upper bound 

value reported by RTI. With these elasticities, we estimate 

a percentage increase in recycling of from 17.9 percent to 

78.6 percent of the percentage increase in the pig iron 

price. 

Combined Effect of Mineral Subsidies on Scrap Steel Recycling 

We combine the upper bound and central estimates of the 

pig iron price change with the upper bound and central 

estimates of the effects of that price change on recycling, 

to estimate the effect of all virgin mineral tax subsidies on 

scrap steel recycling. The upper bound estimate is that 

scrap post-consumer steel recycling would increase by 4.9 

percent if the tax subsidies were removed (the tax subsidies 

reduce post-consumer scrap steel recycling by 4. 7 percent.) 

If the supply elasticity for all scrap steel is used (1.12 

instead of 2. 32) , the upper bound estimate is 2. 3 percent. 

The central estimate is less than 0.5 percent. 

It is important to note that the upper bound estimates, 

while not large, are probably greatly exaggerated. The large 

difference between the upper bound and central estimates 

reflects considerable uncertainty about the elasticity 

parameters. For this reason, the central estimate cannot be 

considered precise. However, the upper bound estimate is 

based on the most extreme assumptions that might yield an 

estimate of a large effect. 
-68-

In computing the upper bound estimate, it was assumed 

that: 1) supply curves for the relevant minerals are totally 

elastic, 2) the shift in the supply curves is at the upper 

range of our estimates, 3) there is no substitutability among 

input minerals used to produce pig iron, 4) the higher of the 

ELI and BAH estimates of the effect of mineral prices on the 

pig iron price is the correct one, and 5) the responsiveness 

of scrap demand to pig iron prices is about four times the 

elasticity estimated by ELI. Modifying any one of these 

assumptions would reduce the estimated impact considerably. 

For this reason, it is extremely unlikely that the tax 

subsidies could reduce the amount of recycling of scrap steel 

by more than one percent. 

IV. Scrap Copper Recycling 

The output of a copper concentrator, including the 

stages of production of mining and concentration is eligible 

for percentage depletion. Scrap copper is a very close 

substitute for virgin blister copper. ELI estimates that 

blister copper is about 20 percent more expensive than copper 

concentrates: thus, percentage depletion applies to about 

5/ 6 of the value of the virgin copper product that competes 

with recyclable copper. It is reasonable to assume that the 

virgin and scrap products are perfect substitutes. 

The Price of Copper 

The tax preferences to mining of virgin copper provided 

by percentage depletion and expensing of exploration and 

development costs lower the supply curve of copper by about 

10 percent. Thus, removing the tax subsidies would raise the 

supply curve for copper concentrates by about 11.1 percent. 
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Because copper concentrates represent about 5/ 6 of the 

value of blister copper, removing the subsidies would raise 

the supply curve for blister copper by 9.3 percent. 

Supply and demand elasticities are available from an 

econometric study by Fisher, Cootner and Baily of the world 

copper industry. 81 The study estimates long-run elast icities of 1. 6 7 for supply of primary copper, -0. 8 67 for 

demand for copper, and 0.32 for supply of scrap copper. 

Using equation (3.3) from the Appendix to this chapter, 

and using the Fisher, Cootner, and Baily elasticity estimates, a 9. 3 percent upward shift in the supply curve for 

blister copper implies a 6.1 percent increase in the price. 

This estimate is biased upwards, however, because the domestically produced virgin copper affected by the subsidies 

accounts for only a fraction of total supply; the U.S. 

accounts for about only 22 percent of world copper output. 

Scrap production also affects the price of copper, but it is 

not curtailed by removing the subsidy to virgin materials. 

Taken together, these factors imply that the price increase 

could be significantly less than the upper bound estimate of 

6.1 percent. Application of the methodology in the Appendix 

to adjust only for the effect of international trade on the 

price change reduces the estimated increase in copper price 

to 2.8 percent. 

Recycling of Scrap Copper 

The increased recycling of scrap copper resulting from 

an increase in price is computed by multiplying the estimated 

percentage price change by the estimated supply elasticity of 

scrap (0.32). This formula yields an upper bound estimate of 

increased recycling of 2.0 percent and a central estimate of 

0.9 percent. 
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Thus, the current Federal tax subsidies to copper mining 

appear to have little deterrent effect on the amount of 

recycling of scrap copper. 

V. Wastepaper Recycling 

Wastepaper competes with virgin wood pulp as an input to 

a wide variety of paper industry products. By lowering the 

cost of wood pulp, the tax subsidies to the timber industry 

create a bias against the use of recycled paper: however, 

their effect on recycling is small. 

Compared to tax subsidies to the minerals industry, the 

tax subsidies to the timber industry are very large. However, the subsidies are not a major impediment to recycling 

for two reasons: 1) the small share of timber in the cost of 

supplying woodpulp to primary product production, and 2) the 

relative insensitivity of wastepaper recycling to changes in 

relative prices. 

Effect on the Price of Woodpulp 

Chapter 2 showed that the tax preferences lower the cost 

of growing timber by between 35.7 and 43.4 percent. Removing 

these subsidies would shift the supply curve for timber 

upward by from 55.5 percent to 76.7 percent. 

The increase in the price of timber, however, may be 

considerably smaller than the supply curve shift from removing the subsidies. Timber land is generally inferior 

land, not suitable for most agricultural uses. Were the tax 

subsidies removed, growing timber might still be the best use 

for this land. In that event, removing the tax subsidies 

would lower the value of timber land, without affecting 

timber output and price. At the margin, there are undoubt-
-71-

edly some areas where timber growing does substitute for 

other uses, and where patterns of land use would change if 

the tax subsidies were removed. Therefore, in the long run, 

timber prices would increase to some degree if tax policy 

changes caused the private costs of growing timber to increase. 

91 However, it has not been possible to quantify the 

extent to which the tax changes would alter prices and 

output, and the extent to which they would only affect the 

value of timber land. 

As noted in Chapter 2, reducing the tax preference to 

capital income from timber growing would shorten the optimal 

rotation period for timber stands. The immediate effect of 

this change could be an acceleration of timber cutting and an 

increase in the available supply of virgin woodpulp. However, the earlier harvest would mean a reduction in future 

supplies and a further reduction would occur if land were 

converted from timber growing to other uses. 

The extremely long production period for timber products 

makes it very d iff icul t to a infer long term relationship 

between changes in timber prices and changes in output from 

historical data. Absent available statistical studies that 

can be cited with even a minor degree of confidence, it is 

assumed that the reduction in the Federal subsidy to timber 

growing from removing the tax subsidies increases the price 

of standing timber by the full amount of the supply curve 

shift. This assumption provides a maximum estimate of the 

disincentives to recycling from timber tax subsidies. The 

reader should note that removing the tax subsidies may lower 

the price of virgin woodpulp in the short run, and may 

increase price in the long run by much less than is shown 

below. 
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Under this upper bound assumption, ending the tax 

subsidies would increase the price of timber by at most 76.7 

percent. According to estimates supplied by ELI, timber 

accounts for between 6 and 12 percent of the price of virgin 

wood pulp. Thus, removing the tax subsidies could increase 

the price of wood pulp by as much as 9. 2 percent, if there 

were no substitutability in production. Even if the price of 

timber rises by the full amount of the increase in growing 

cost, the increase in the price of woodpulp could still be as 

little as 3.3 percent (6 percent of a 55.5 percent increase 

in the timber price). 

Effect on Recycling 

It is possible to process wastepaper so that it is 

equivalent to paper made from virgin woodpulp. It is usually 

more expensive to manufacture paper of any quality from 

recyclable sources; therefore, wastepaper is sold to users 

who do not require an exact duplication of the characteristics of paper made from virgin woodpulp . For this reason, 

existing econometric studies of the marke t for recyc l ed paper 

have treated wastepaper and virgin paper as distinct, though 

related goods. 

ELI has estimated the demand and supply for wastepaper. 

Their estimated elasticities are: 0. 40 for elasticity of 

supply of wastepaper, 0.17 for cross-elasticity of demand for 

wastepaper (with respect to woodpulp price) , and -0 .16 for 

elasticity of demand for wastepaper (with respect to wastepaper price). RTI estimates the elasticity of supply to be 

between 0.4 and 1.7, using process analysis. Equation (3.6) 

in the Appendix and the ELI elasticities imply that recycling 

would increase by 12 percent of the increase in the price of 

woodpulp. Because, as noted, removing the tax subsidies 

would increase the price of woodpulp by at most 9.2 percent, 
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this would yield an increase in recycling of at most 1. 2 

percent. If RTI's highest supply elasticity is combined with 

all the other upper bound estimates, removing the tax subsidies could increase recycling by 1.4 percent. 

ELI's econometric equations show low elasticities of 

demand and supply for wastepaper. While these estimates are 

consistent with the casual observation of low substi tutability between wastepaper and virgin pulp, they may be biased 

downwards because of poor data in the estimating equations. 

In particular, the price data, based on list price, might not 

adequately capture changes in real transactions prices. 

However, even elasticity values substantially higher than 

those estimated by ELI do not lead to a conclusion that 

removing the tax subsidies would dramatically increase 

recycling. For example, if the relevant parameters were 

assumed to be 0.8 for the cross-elasticity of demand, 0.5 for 

the supply elasticity, and -0.5 for the demand elasticity, 

the percentage increase in recycling might be 31 percent of 

the increase in the woodpulp price, or a maximum of 3 percent 

above current law levels. 

VI. Conclusions 

The quantitative impact of tax subsidies to virgin 

materials on the amount of recycling is uncertain, because 

the probable responsiveness of suppliers and users to changes 

in prices of virgin and scrap materials has not been quantified precisely. Nonetheless, illustrative calculations using 

the best available evidence show that current Federal tax 

subsidies to virgin materials do not have a major negative 

effect on recycling of scrap steel, scrap copper, and wastepaper under the most extreme assumptions, and most probably 

have very little effect. Similar conclusions have been 
-74-

reported in research performed by independent contractors for 

EPA, some of whose methodology and data have been used in 

this chapter. lO/ 

However, these conclusions do not mean that tax subsidies to virgin materials production are insignificant. The 

tax preferences reviewed in Chapter 2 entail important equity 

concerns, and may also have a considerable impact on domestic 

output of some virgin materials. These effects, however 

important, are not a concern of this report. 

Footnotes to Chapter 3 

l / A similar type of computation has been made by the Environmental Law Institute (hereafter referred to as ELI) in a 

study performed under contract to the U.S. Environmental 

Protection Agency. ELI • s estimates of the impact of tax 

subsidies on the supply price differ from those developed in 

Chapter 2. This chapter combines the supply price effects 

from Chapter 2 with ELI •s and alte rnative e conometric estimates of supply and demand elasticities. See Robert C. 

Anderson and Richard D. Spiegelman, The Impact of The Federal 

Tax Code on Resource Recovery, report prepared at Environmental Law Institute for Office of Research and Development, 

u.s. Environmental Protection Agency, 1976. 

21 If the price of an input is lowered by 11 x" percent by a 

tax subsidy, then it has become (1-x) times the initial 

price. Removing the subsidy would then raise the price by 

"x/ (1-x)" percent of the post-subsidy price. 

3

1 A demand elasticity of -1 implies that the total value of 

coal consumption would be unchanged for small changes in the 

price because the percentage increase in the price per unit 

would be matched by an equal percentage reduction in the 
-75-

quantity consumed. Absent available econometric estimates of 

the long run demand for coal, this assumption is reasonable; 

it falls within the range of demand elasticities estimated 

for other minerals. 

A much higher value is used for the supply elasticity 

because accessible coal reserves are abundant and, in the 

long run, more coal could probably be mined without a substantial increase in unit costs. However, no long run supply 

elasticities for coal are available in the literature surveyed. A recent study by Charles River Associates (CRA} 

provides estimates of short run elasticities ranging from 

0.33 to 2.36. The value used here is twice the maximum short 

run elasticity estimated by CRA. See Charles River As sociates, Coal Price Formation, final report prepared for 

Electric Power Research Institute, December 1977. 

If the supply elasticity is lower than the value used in 

these calculations, then the tax subsidies have a smaller 

effect on the price of coal and, hence, a smaller negative 

impact on recycling of scrap steel. 

4/ Booz-Allen and Hamilton, An Evaluation of the Impact of 

Discriminatory Taxation on the Use of Primary and Seconda~ 

Raw Material, final report submitted to Environmental Protection Agency, Washington, D.C., June 28, 1974, and Robert C. 

Anderson and Richard D. Spiegelman, op. cit. 

51 The two studies use price data from different years, and 

production estimates from different sources. 

6

1 See Robert C. Anderson and Richard D. Spiegelman, op. cit. 

See also Robert C. Anderson and Richard D. Spiegelman, "Tax 

Policy and Secondary Material Use," Journal of Environmental 

Economics, volume 4, Number 1, March 1977. 
-76-

7/ A.K. Miedema, An Empirical Evaluation of the Market and 

Net Welfare Effects of A Product Disposal Charge, Research 

Triangle Institute {RTI), December 1977. For a review of the 

RTI work and other studies estimating supply elasticities for 

recyclable inputs, see ICF Incorporated, Estimates of Substitu!l~E-2E~~Ely_§l~~!i£i!i~~-!~E-~~~!=~~E~~~eE_~~~!~ 

~at~l~!~, draft report submitted to u.s. Environmental 

Protection Agency, August 11, 1978. 

81 F. Fisher, P. Cootner, and N. Baily, "An Econometric Model 

of the World Copper Industry," Bell Journal of Economics and 

Management Science, August 1972. 

9/ In technical terms, if the supply curve were totally 

inelastic {i.e., timber output were unchanged if timber 

prices changed) , removing the tax subsidies would simply 

lower the value of timber land. If, on the other hand, the 

supply curve were totally elastic, the price would increase 

by the full amount of the estimated cost increase. 

lO/ See Environmental Law Institute, £E · cit and Booz-Allen, 

Hamilton, 2£· cit. 
Chapter 4 

Recycling Subsidy Options 

I. Justifications commonly cited for subsidizing recycling 

activities. 

Solid waste management involves two distinctive activities. First, collecting the debris of production and consumption; second, physically disposing of it by landfill or 

inc iner at ion, or subjecting it to some form of resource recovery process and then disposing of the residual solid 

waste. Both sets of solid waste management activities are 

subject to competitive conditions. The technologies for collection and for processing solid waste are widely known, and 

entry into these activities is not barred by patents. The resources required, labor and capital, have no limiting specialized characteristics. While there may be economies of 

scale in both sets of waste management activities, in neither 

does the condition of natural monopoly prevail. l/ 

If the activities of waste collection and processing 

fulfill the conditions of competitive markets, there is no a 

priori just if icat ion for public subsidies to any of these 

activities. However, proponents of resource recovery, including recycling, cite one or more of the following four 

just if icat ions for subsidizing resource recovery from solid 

waste: it relieves communities of some solid waste management costs; it reduces environmental degradation; it offsets 

price-distorting effects of tax subsidies to virgin materials 

production; and it conserves finite resources and energy. We 

turn now to a critical review of these rationales for subsidizing resource recovery from solid waste. 
- 78 -

A. Reduction in the burden of solid waste management 

borne by local governments. 

In its Fourth Report to Congress: Resource Recovery and 

Waste Reduction, the Environmental Protection Agency has estimated that 134.8 million tons of municipal solid waste was 

disposed of in the United States in 1974 at an estimated 

total cost of nearly $4 billion. A major but unquantified 

fraction of this cost is financed by municipally operated 

collection and disposal systems; and a significant fraction, 

again unestimated, of the municipally controlled waste management is financed by g eneral taxes. 21 Disposing of the 

waste in an environmentally acceptable manner would have cost 

an estimated $1.6 billion more. The volume of municipal 

solid waste has been growing at an estimated annual rate of 

1.9 percent, and will reach 166 million tons by 1985. 

Although these facts indicate that solid waste disposal 

absorbs large amounts of resources, by themselves, they 

provide no basis for subsidizing recycling activities: 

--Some local governments, with the consent of their 

voters, undertake solid waste management tasks and 

finance them by local taxes; others undertake the 

tasks and finance them with fees; still others contract with private firms and finance the work by appropriations from the general fund, or by fee assessments. In all these cases, communities dec ide how 

they wish to have solid waste management services performed and financed. Federal government subsidies 

which would reduce the costs of solid waste management 

merely transfer that burden from those who generate 

the waste to Federal taxpayers. If communities elect 

to have their governments perform services on their 
-79-

behalf and to finance them by taxes and fees, the resultant burdensome tax at ion is not a valid claim to 

Federal subsidy that would relieve these burdens. 31 

--The evidence does not support a conclusion that municipal solid waste management is any more a financing 

problem for local governments than other categories of 

expenditure. Even if the estimated $4 billion cost of 

solid waste management in 1974 were borne entirely by 

local gove rnments, which was not the case, and we add 

to this the estimated $1.6 billion of unmet environmental protect ion costs, the total would be only 4 

percent of all local governmental expenditures that 

year. Moreover, while local government expenditures 

have increased at an annual rate of 11 percent during 

the last decade, the inflat ion-adjusted rate of increase in municipal solid waste costs is but 3.5 percent. 

B. Reduction i n environmental degradation. 

The Environmental Protection Administration has 

estimated that 92 percent of municipal solid waste in the 

United States is disposed of by landfill and more than 

two-thirds of land disposal site s do not meet environmental 

standards. These estimates imply that, under present conditions, waste disposal imposes a sizable social cost in 

degradation of the environment. As noted, it would have cost 

annually $1.6 billi on (in 1974 dollars) to conform disposal 

systems to environmental standards. If the volume of waste 

requiring disposal could be reduced to zero by resource recovery, not only would the $1.6 billion of unmet environmental losses suffered by socie ty be saved, but also the 

actual disposal costs incurred that year, estimated to be 
-80-

$500 million. 4/ While subsidies to recycling cannot reduce 

disposal to zero, they can contribute to some reduction, and 

hence to a reduction in environmental damage. 

The evasion of environmental laws in the disposal of 

solid waste by communities is deplorable, but does not 

warrant assumption by Federal taxpayers of the burden of 

rna inta in ing local environmental quality through the funding 

of subsidies to recycling. Not only does a recycling subsidy 

violate the "polluter pays" principle, it does so in a costly 

manner. If the polluter pays principle is to be breached, 

the least costly way for the Federal government to assume 

some or all of the cost of environmental maintenance is 

directly, through grants or similar payments to local governments, per ton of waste collected; this payment might then 

be used by those governments either for disposal of solid 

waste in an environmentally acceptable manner, or for 

building and operating resource recovery facilities. To 

subsidize resource recovery generally, or recyclable 

materials only, is to bias unnecessarily the choice among 

disposal opt ions. When environmentally acceptable disposal 

is cheaper, as it is in most places in the United States, to 

encourage resource recovery is a waste of scarce labor and 

capital resources. 

Moreover, for reasons detailed in Chapters 1 and 3, the 

incremental cost per ton removed from the solid waste stream 

by a subsidy to recycling only is extremely high and rises 

rapidly as the volume to be removed from the waste stream 

increases. In 1974, the average disposal cost of municipal 

solid waste was estimated to be less than $4 per ton, and if 

all disposal had conformed with environmental standards, that 

cost might have increased by an aver age of $1.19. In contrast, the estimated subsidy cost of removing an additional 
-81-

ton of paper from the municipal solid waste stream is $395; a 

ton of ferrous scrap, $120 to $185; and a ton of copper 

scrap, $4,720. 5/ These estimates pertain only to removal of 

additional tonnages in the range of one or two percent of the 

quantities currently recycled and, hence, to even smaller 

fractions of municipal solid waste. Removing more would 

rapidly escalate these costs per ton. 

In sum, avoidance of environmental degradation costs affords no basis for Federal subsidy to recycling. 

Nonetheless, if a Federal subsidy to local communities is to 

be provided to help them meet their obligations to maintain 

environmental quality while disposing of their solid waste in 

violation of the polluter pays principle, it should be 

provided at the point where collected municipal solid waste 

is available for disposal, whether by landfill, incineration, 

or resource recovery processing. Such a direct subsidy to 

local communities conditional on their avoidance of 

environmental damage in the disposal of solid waste will cost 

less than 0 .1 to 1. 0 percent of a subsidy to recycling for 

the same purpose. 

c. Offset to price-distorting effects of tax subsidies. 

Chapter 2 reviewed the Internal Revenue Code provisions 

that create a preference, or subsidy, for the production of 

virgin materials. Although many observers conclude that 

these subsidies justify compensatory subsidies to recyclable 

materials, Chapter 3 notes that the claim for compensatory 

subsidy assume s that subsidies to the domestic production of 

virgin materials results in lower prices of those materials 

and, thus, reduces demand for recyclable materials. But the 

degree to which domestic prices of virgin materials are reduced by production subsidies depends upon the character of 
-82-

world markets for these materials and the relative importance 

of U.S. consumption and product ion in those markets. Moreover, the induced reduction in demand for recyclable materials associated with any depression of virgin materials 

prices attributable to U.s. subsidies is greatly attenuated 

by the far less than per feet degree of substitutability of 

recyclable for virgin materials in product ion of the full 

spectrum of primary products derivable from these materials. 

In sum, leaving aside the question, not dealt with in 

this report, whether subsidies for the domestic production of 

virgin materials is a justifiable governmental intervention 

in the allocation of scarce labor and capital resources, the 

evidence available does not support an inference that these 

subsidies, by their effect on domestic virgin material 

prices, deter resource recovery from solid waste to a degree 

that warrants a countervailing subsidy. For the three significant recyclable materials examined--ferrous scrap, copper 

and paper--the probable deterrence to recycling attributable 

to virgin material subsidies is in the range of 0. 5 to 1. 0 

percent of the volume recycled. This is not a magnitude sufficient to warrant installing a countervailing subsidy 

program which is likely to have serious administrative 

problems, as discussed below. (See Section II, A, below). 

D. Conservation of "finite" resources and energy. 

1. Finite resource conservation. 

It is a truism that the earth 1 s resources are finite, and it follows from this that if present generations 

"use-up" high-grade ores and other nonrenewable resources 

constituting the earth 1 s crust, succeeding generations will 
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have less. This being so, the argument continues, we should 

recover resources from solid waste for the benefit of future 

generations. Since much of the solid waste stream is presently disposed of, not processed as a source of material and 

energy, a strong case is therefore alleged to exist for subsidizing resource recovery. The extra resources invested in 

recycling by the present generation is to preserve for future 

generations their claim to the earth's resources. 

There are three weak links in this chain of reasoning to justify a subsidy to resource recovery activities. 

First, although the earth's crust is "finite" it is vast. So 

1 i ttle of it has been thoroughly surveyed geologically, no 

one can with reasonable confidence estimate its useful 

resource content. Unmeasured "finiteness" is not a sat isfactory reason to constrain current rates of economic utilization of the natural endowment. 

Second, living standards are determined by the stock 

of human and physical capital that embody the store of knowledge, as well as by the natural endowment. Growth in the 

stock of physical capital, and in its productivity, as well 

as accretion of knowledge--enhanced productivity of human 

capital--together substitute for depleting natural resources. 

The available evidence suggests that not only has the real 

cost of extracting minerals in the United States declined, 

but that the decline in cost of extraction is greater than 

the decline in real costs of other production. G/ All this 

has occur red over the last century notwithstanding the fact 

that the grades of most ores exploited have declined. ?/ 

Finally, it is not correct to assert that claims of 

future generations are unaccounted for in decisions made today. Individuals consume and save today according to their 
-84-

judgment of future needs. Each generation comprises per sons 

of all ages; thus, each "generation" makes dec is ions that 

span an average of two or more decades, linking generations 

to each other in infinite sequence. Moreover, enterprises 

that make production decisions for a full spectrum of economic activities ranging from mining and forestry to retailing of consumer goods organize as corporations in order that 

they may operate with extremely long planning horizons. Well 

organized mark e ts exist through which households and 

enterprises may execute their decisions spanning decades; 

these are called "capital markets" in which present claims 

are exchanged for future claims. 

If, say, copper-trading enterprises believed that 

the world were in danger of running out of low cost ores, 

they would restrict current sales, preferring to hold 

inventories in the ground and in warehouses rather than to 

sell at cur rent prices. If the cost of acquiring funds in 

capital markets is 10 percent, anyone who supposes the future 

growth in price of materials will be greater than 10 percent, 

compounded, will withhold current available supplies, raising 

current prices of the materials to "reflect the claims" of 

future consumers. Additionally, enterprises in the copper 

business will invest (acquire pr e s ent claims to resources in 

capital markets in e xchange for promises to make future 

payments) in finding new ore deposits and in reducing the 

cost of extracting and processing ores from existing 

deposits. While some contend that the market rate of 

discount which functionally links present and future 

generations is too high, i.e., 

much, this does not mean 

generations are disregarded. 

discounts 

that the 

future claims too 

claims of future 
-85-

In sum, the apparent finiteness of natural resources 

provides no compelling argument for expending society's 

scarce resources in a subsidized level of resource recovery. 

We don't know the magnitude of resources in the earth's 

crust; we continue to increase the rate at which we learn to 

extract useful minerals from rock; and we already have a 

reasonably useful mechanism for adapting current use of 

natural resources to likely future demands. 

2. Energy conservation. 

The energy conservation rationale for subsidizing 

resource recovery is based on the observation that the number 

of Btu's, or barrels of oil-equivalent energy, required to 

produce a unit of primary product--metal, paper, glass--from 

virgin materials exceeds the energy required to produce the 

same unit from recyclable materials. If we subsidize resource recovery, we save Btu's of energy. 

There is some validity in this argument, but it 

rests on an inference that the effect of our oil, gas, and 

electric energy price controls is to cause the market prices 

of energy to be understated. If that inference is correct, 

then reducing usage of energy by one Btu saves more resources 

than is implied by the "saving" measured at the present 

market prices of energy. That is, the relative attractiveness 

of using recyclable materials, which embody less energy, is 

understated by the underpricing of energy. 

On the other hand, there are reasons to believe that 

the inefficiencies of price regulation make energy prices 

higher than they would be in the absence of regulation: 

"rate of return" regulation of uti 1 i ty prices induces too 
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capital intensive modes of electric energy generation and 

distribution; oil and gas price regulation has increased the 

costs of finding, processing, and d istr ibut ing this form of 

energy so that what has been gained by suppressing prices at 

the well-head may be largely offset by increased costs elsewhere in the system. It is doubtful that mispr icing of 

energy mea sur ably biases choices against resource recovery; 

therefore, saving a Btu of energy through recycling does not 

result in a resource saving not already accounted for in the 

choice to recycle, rather than dispose of solid waste. 

Energy is not some special resource external to the 

economic system, but simply an embodiment of capital, labor 

and the natural endowment in a particularly useful form. 

Economic pol icy should aim to minimize the total cost of 

production to improve our standard of living. We gain 

nothing by substituting an extra dollar's worth of resources 

in recycling material in order to save less than a dollar's 

worth of costs, whether those costs are for society's labor 

and capital in the form of energy, or other inputs. If it 

pays to recycle, one of the reasons it pays is that, among 

other things, recycling uses less energy. If, despite its 

lesser energy use, recycling does not pay, the energy saving 

due to recycling is irrelevant. 

Summary. 

If a subsidy corrects a failure of markets to allocate 

resources effie iently, it yields society a net gain. That 

is, should social valuation of the output of the economic 

system fail to be reflected in market prices, or should the 

costs of resources consumed in production fail to be accounted for by enterprises engaged in production, or should 
-87-

there be a barrier to utilization of least costly technology, 

government intervention to correct these failures results in 

a net benefit--increased standard of living. In such instances, the apparent cost of a subsidy financed by taxes is 

offset, in part or in whole, by a larger value of goods and 

services. 

There are no glaring market failures which might be offset effectively by subsidies to recycling, or resource 

recovery. 

--Solid waste management, recycling, and resource recovery are activities not characterized as natural 

monopolies. Technologies are widely known, and there 

are no market economies of scale or institutional barriers that 1 im it entry. Recycling and resource recovery will take place whenever value of product justifies incurring production costs. 

--Although municipalities frequently fail to price solid 

waste collection services to equate costs and benefits 

at the points where solid waste collection occurs, 

this is an exercise of constitutional rights reserved 

to states, not a manifestation of market failure. 

--Although there are numerous instances in which solid 

wastes are disposed of in an environmentally unacceptable manner, these are failures to comply with Federal, state, and local environmental standards, not 

market failures. 

--Although there are tax subsidies to virgin material 

production which reduce imports of certain materials 
-88-

and increase exports of others, recycling and resource 

recovery are not appreciably deterred. Additional 

subsidy to recycling therefore would not avoid resource wastage due to existing tax subsidies. 

--There is no persuasive argument that markets for 

natural resources, including those convertible into 

energy, do not account for present and expected future 

scare i ty·. 

In sum, subsidies to recycling and resource recovery do 

not ensure a more efficient allocation of resources. Instead 

they are likely to reduce total social welfare by devoting 

too many resources to recycling compared with the benefits 

received and too few resources to more economical means of 

waste disposal. 

II. Considerations in the formulation of a subsidy to 

recycling. 

Notwithstanding the absence of a justification for subsidizing recycling on the ground of improved overall allocation of society's resources of labor and capital, noneconomic 

considerations compel many to support institution of a system 

of recycling subsidies. Personal belief in a "conservation 

ethic" is a sufficient reason for some to urge public support 

for more recycling of solid waste than is justified on pure 

cost-benefit grounds. Others, engaged in the recycling 

process, have a pardonable pride in their activities, and 

they seek public recognition and support to expand their 

sphere of interest. 
-89-

The remainder of this chapter reviews the issue s in 

formulating a subsidy program to increase the recycling of 

solid waste: definition of the activity to be subsidized; 

the form of the subsidy; and how resolution of the se questions inter acts wi th the structure of activities eng aged in 

recycling to determine the ultimate cost of achieving the 

declared objective. 

A. Definition of recycling activities. 

"Recycling" de scribes a process in which material things 

which have become worthless and therefore disposable are converted into materials usable in the production of things 

which do have value. Recycling is often thought to be restoration of the contents of trashbins and garbage pails to 

flows of raw materials, and this is the view taken in this 

report. But, for the purpose of evaluating a subsidy program, this is an over-simplified view of .the way raw materials that have been fashioned into products move through the 

economic system . 

Consider the variety of cho i ce-paths that exist at each 

stage of the economic process. At the primary product ion 

stage referred to i n Chapter 1, defective batches may be come 

home scrap and repr ocessed, or they may be salable, at lower 

pr i ces, for use i n less demanding product fabrication. At 

the fabrication stage, the same choice prevails for defective 

products: they may be salable as "seconds," they may be reworked, or they may be thrown in the trash pile. Similarly, 

when the first purchaser of a product finishes with his principal use of it, he may put it to secondary use--relegate his 

older car to utility use, add books and periodicals he has 

completed reading to his 1 ibr ary shelves--or he may sell it 

to a dealer, or he may throw it into a trash heap, paying 

someone to collect it. Second-hand dealers may recondition 

articles for resale, discarding more or less of the original 
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material i:n the process, or they may hold them in inventory 

for future resale. Finally, once the collectors of trashbins 

and garbage pails have acquired the contents, the choices 

available include processing the solid waste into recyclable 

materials, useful energy, and, possibly, other products, or 

disposing of the original volume. Even the resource recovery 

activity will generate solid waste, and this may be held in a 

kind of slag heap awaiting further processing, or it may be 

disposed of. 

This diversity of paths traced by ultimately recyclable 

materials through the economic system raises two issues. 

First, in addition to the direct costs of a subsidy to increase recycling, a considerable additional indirect cost 

will be incurred that is in conflict with the conservation 

ethic; and second, the pragmatic difficulty of identifying 

both the agents to whom the subsidy will be paid, and the 

base on which the amount of subsidy will be computed. 

1. Additional indirect costs of a recycling subsidy. 

If, at all stages from primary product ion through consumption, there are choices between some continued use of a 

semi-finished product or finished good, or discarding it, 

subsidization of recycling will discourage continued use. 

When "seconds" and reconditioned products are made more 

valuable as grist for the recycling process, they will more 

readily be entered into solid waste streams. The "useful 

life" of products will be shortened by the introduction of a 

recycling subsidy. Thus given, a standard of living, one of 

the results of a recycling subsidy will be a tendency to 

increase the volume of solid waste genera ted. Part of the 

recycling subsidy therefore will be absorbed in more primary 

product production to sustain a given standard of living than 
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would occur without the subsidy. The increased primary 

product production will induce an increase in virgin material 

usage that will offset some of the conservation achieved by 

recycling. Subsidizing recycling per se also discourages 

general resource recovery, including conversion of waste into 

useful energy. Thus, a subsidy policy narrowly aimed toward 

encouraging recycling of materials to replace virgin 

materials causes an induced waste of resources. The wasted 

resources include natural resources as well as capital and 

labor. 

2. Identifying the agents and base for a recycling 

subsidy. 

But, more importantly, the large numbers of transactors 

involved in the process affected by a recycling subsidy, and 

the variety of interrelated decisions that would be affected, 

implies a severity of operational administrative problems 

seldom given attention by recycling subsidy proponents. 

Given the objective of a recycling subsidy, the least ambiguous set of activities engaged in the process, and also one 

comprising the fewest economic units, is that in which recyclable material is incorporated into a primary product. To 

simply recount the numbers of trash collectors, dealers and 

brokers in "scrap," and reconditioners and salvagers of articles, and to consider the numbers of transactions which may 

be consummated between the discard of solid waste and its 

ultimate conversion into reusable material should be sufficient to disqualify any of these preliminary stages of the recycling process from consideration as feasible points at 

which to interject a subsidy. 
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For example, suppose the subsidy is $5 per ton of paper. 

If the subsidy is paid to the collector, how may it be ascertained that the collect ion is only from the waste discarder, and not a second collection of the same paper already 

bearing a $5 subsidy? The initial collector might sell the 

paper to a dealer who, after sorting and bailing it, has the 

paper collected a second time for delivery to a paper mill. 

Absent a subsidy, the functional identification of transactors i s unnecessary: each party to a transaction is free to 

exchange. In the presence of a subsidy, a pre-identification 

procedure--some 1 icens ing scheme--becomes necessary; and to 

administer the subsidy, an elaborate licensee monitoring system is also necessary. Moreover, if the subsidy is injected 

at any point prior to actual use of the recyclable material 

in primary product production, there can be no assurance that 

the subsidy will go entirely to furthering of recycling 

rather than other disposal of the materials. 

Although there are fewer primary product producers than 

there are entities that handl e solid waste, thereby fac il itating formal identification of points to which the subsidy 

will flow, the basis for awarding the subsidy remains difficult to define. Suppose that identification of a primary 

product producer is made. Ideally, the base for the subsidy 

would be the recyclable material content of his final product, for this is the only quantity of homogeneous material 

qualifying for the subsidy. Unfortunately, there is no way 

to determine from the physical and chemical characteristics 

of metals, paper, and glass which, if any, of the product's 

molecules were derived from virgin, and which from recycled 

materials. 
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The alternative is to measure inputs of recyclable materials to the primary production process. But this requires 

classifying of materials the physical identities of which are 

destroyed in the production process. Invoices and evidences 

of payment, which are sufficient to audit purchases and inventories of materials and supplies entering "cost of goods 

sold" in an income statement, or tax return, would not be 

adequate to d ist ingu ish between recyclable materials, which 

qualify for subsidy, and virgin materials, which do not. 

Physical identification of materials is possible only when 

they arrive on the premises of a qualified primary product 

producer; thus, administration of a recycling subsidy will 

require some mechanism, such as on-site inspectors, to 

examine materials, validate invoices, and ensure that a 

shipment of materials qualifying for subsidy is not resold or 

otherwise made eligible for resubsidization. 

Now suppose that an appropriate mechanism for administering the subsidy is installed at the primary product producer level, the only practical point for injecting it. The 

next question is how to frame the subsidy. The subsidy might 

be some specific dollar amount per unit of recyclable material purchased, or it might be some percentage of the purchase 

price of the material. Recognizing that the purchase price 

of recyclable material depends on its degree of contamination 

and the distance it has been shipped, either of these two 

ways of providing the subsidy will have unintended d istort ionary consequences. If the subsidy is a fixed amount per 

unit, it will favor low-priced materials, those which are 

less pure and transported over shorter distances. If the 

subsidy is ad valorem, it will not affect the relative attractiveness of different grades of materials but it will 

encourage 

producers' 

decontamination 

premises. In 

at sites other than the primary 

either case, the subsidy causes 
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changes in the location of activity that only increase the 

size and cost of the subsidy without increasing the amount of 

recycling. 

In sum, specification of a subsidy program for recycling 

presents formidable problems. Injecting the subsidy at 

points where recyclable materials are converted into primary 

products minimizes these problems, but does not eliminate the 

need for some licensing procedure and the possible use of 

inspectors to monitor and to validate claims. However the 

subsidy is stated, whether as a specific or ad valorem 

bounty, it will induce a relocation of activity. 

B. Subsidy mechanisms. 

A subsidy is simply a payment by government which causes 

the price paid by the purchasers of a subsidized good or service to be less than the seller's net proceeds from the sale. 

As noted in Chapter 1, whether the subsidy payment goes to 

the seller or to the buyer, the result is the same. If the 

subsidy payment is to the buyer, his net outlay is less than 

the payment he makes to the seller. If he wishes to buy more 

of the now cheaper (to him) goods, he can afford to bid more 

to elicit additional supplies, if that is necessary, and 

still pay a (subsidized) price lower than he had previously. 

If the subsidy payment is to the seller, his profit per unit 

sold increases. To sell more of the now more profitable subsidized goods, he will have to exert more effort, incur some 

costs, or lower selling price. If a particular seller does 

not respond to the more profitable conditions created by the 

subsidy, his competitors will. Thus, whether the subsidy is 

handed over to the buyer or the seller, the result is an increased usage with the amount of the subsidy a 11 wedge" between the payment of the buyer and the net realization of the 

seller. 
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As noted in Chapter 3, the degree to which a subsidy increases usage depends upon the responsiveness of demand for, 

and supply of, the subsidized goods. The more responsive, or 

price elastic, are demand and supply, the greater the change 

in usage due to the subsidy. The under lying conditions in 

recyclables markets make these elasticities small. Most of 

any recycling subsidy therefore will be absorbed in higher 

selling cost: reduction of selling price, net of subsidy, to 

penetrate markets, and/or higher costs to gather and decontaminate recyclables for reuse. These conditions of demand 

and supply of recyclables explain why the costs noted above 

of recycling an additional ton of paper, or ferrous and nonferrous material, are so high. We now turn to a critical 

examination of proposed ways to pay recycling subsidies. 

1. The two ways to effect subsidy payments. 

Governments may make subsidy payments in either of 

two ways which are equivalent, 

may make the payment in cash: 

in principle. A government 

for each ton of recyclable 

material, the government offers to pay a transactor X dollars 

on submission of evidence that an exchange has occurred. Alternatively, since virtually all possible transactors are 

taxpayers, the government may offer to reduce a transactor's 

tax liabilities otherwise due by X dollars per ton of recyclable material, again on submission of evidence that an exchange has occurred. In either case, the subsidized transactor and subsidizing government end up in the same position: 

the transactor has X dollars more in pocket per ton (he has 

either received a Treasury check for X dollars, or he has reduced his tax payment by X dollars); the government has increased its deficit by X dollars (it has expended X dollars, 

or it has reduced Treasury receipts by X dollars) • 
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It is important to note that, whether the subsidy is 

paid in cash or is cleared through a qualified transactor's 

tax account, the economic consequences are also the same. In 

effect, the government, through the agency of the qualified 

transactor, has "purchased" X dollars of the resources embodied in a ton of the subsidized recyclable material and 

given them to private persons for private use. For each ton 

of subsidized recyclable materials ultimately used to produce 

goods and services, private parties are relieved of X dollars 

in resource costs, which are paid for by taxpayers without 

regard to their consumption. The deficit of X dollars per 

ton subsidized will either be made-up in reduced government 

expenditures for other purposes, or by additional tax imposed 

to cover the deficit. If the subsidy is not compensated for, 

the net deficit will be a source of inflation, if it is monetized, or a reduction in the savings available to finance 

private capital formation if it is not monetized. There is 

no free lunch. 8/ 

2. Differences between tax and appropriated 

subsidies. 

Given a definition of the activity to be subsidized 

and a formula for determining the amount of the subsidy, the 

economics of the subsidy are the same. Its effect on the 

volume of subsidized activity and its using-up of productive 

resources, will be the same whether the subsidy is fin anced 

by appropriated funds or by reductions in tax otherwise due. 

But there are political and adm in istr at ive differences between the two methods of payment which must be considered 

when framing a subsidy program. 

Couching the subsidy as an expenditure program 

involves those Congressional committees that authorize and 

appropriate funds for the substantive program purpose of the 
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subsidy, and the executive agency to administer the program 

will be one with assigned responsibility in the area. For 

appropriated recycling subsidies, Congressional committees 

with jurisdiction might be any of a number of committees and 

subcommittees concerned with commerce, resources and energy, 

or public works, and the likely administering agencies might 

be the Department of Commerce or the Environmental Protection 

Admin istr at ion. In contrast, clearing the subsidy through 

tax accounts involves the House Ways and Means and Senate 

Finance Committees: and the administering agency is the 

Internal Revenue Service. 

Although these differences should have no impact on 

the effectiveness of the subsidy program, or on the 

administrative mechanism by which it is implemented, as a 

practical matter there are significant differences between 

tax and expenditure subsidy programs. The weight of these 

differences are that subsidies financed with appropriated 

funds are superior to tax subsidies. 

a. The cost of administering appropriated 

subsidies is lower. 

If the costs of administering a subsidy program 

are to be compared, the quality of admin istr at ion must be 

held constant. In order to achieve some level of fraud 

control, the purely technical tasks of defining and certifying recycling activities qualifying for the subsidy and 

monitoring quantities eligible for the subsidy will require 

specialized administrators. There is no existing tax 

administrative function within the Internal Revenue Service 

which requires any specialized knowledge of solid waste 

management, scrap materials handling, or recycling processes. 

If called upon, the Internal Revenue Service might hire and 

train such personnel. 

t ive scale" suggests 

However, the "economy of administrathat the cost of building-up and 
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supervising such an organization would be lower if this task 

were undertaken by an agency already administering programs 

related to recycling. 

In order t.o maintain a given quality of administration, Executive and Congressional oversight is required. 

If the subsidy is appropriated, it becomes a program responsibility of an agency and has an explicit provision for 

administration and for systematic program evaluation, by both 

the agency and by Congressional committee staffs. If the 

program is funded as a tax subsidy, there is no corresponding 

provision in the IRS appropriation to assure the availability 

of manpower and facilities for adrninistr at ion and program 

evaluation. The IRS will naturally seek resources, but no 

sympathetic hearing from its appropriation commit tee can be 

expected. It is difficult to extract additional funds to 

administer the tax system when, as a result of the add i t"ional 

tax subsidies, 

if the subsidy 

the IRS is collecting less in tax. Moreover, 

is appropriated, the normal annual budget 

review provides an opportunity for Congressional scrutiny of 

the program, with the aid of congressional and executive 

agency staffs thoroughly familiar with the subject matter. 

If the subsidy is financed through the tax system, any review 

of its effectiveness will be in the extraordinarily complex 

context of tax legislative deliberations, with only perfunctory aid from Treasury and Joint Comrni ttee on Taxation 

staffs possessing minimal knowledge of the technical aspects 

of recycling. 

These consider at ions lead to a conclusion that, 

for a given quality of administrative effectiveness -

adherence to program goals and fraud tolerance - a recycling 

subsidy paid with appropriated funds is superior to one paid 

through the tax system. 
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b. Costs of appropriated subsidies are more 

controllable. 

Tax subsidies are open-ended; any amount is payable according to the volume of subsidized activity for as 

long as the tax provision remains in effect. Some appropriated fund programs are also open-ended, but the requirement 

that Congress annually appropriate funds provides a ready 

means of regulating resources devoted to such programs. Most 

expenditure programs are funded in fixed amounts. Authorizations are for stipulated numbers of years, appropriations 

of obligational authority for specified time periods, usually 

one year. 

c. Tax subsidies are generally formulated so 

that, for a given amount of subsidized 

activity, the budgetary cost is greater. 

The tax subsidies to virgin materials production 

reviewed in Chapter 2 have one characteristic in common with 

all other tax subsidies, save one: they convey the payment 

to the subsidized entity in tax-exempt form. 91 Percentage 

depletion, favorable treatment of exploration and development 

and reforestation expenditures, and capital gains treatment 

of timber all subsidize mining and forestry activities by reducing taxable income to provide the ente rprise with more 

after-tax income. If these producers received subsidy payments in the market to cover their costs of production, those 

payments would enter taxable incomes. Instead, they are compensated by remissions of tax; in effect, they are remunerated in after-tax, or nontaxable dollars. This has two 

highly undesirabl e consequences: 
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i. Understatement of resource cost. 

As previously noted, in our economic system, 

resource costs are always measured in market prices, and they 

become incomes to individuals who have supplied labor, capital, and other resources. In an economic system that features an income tax, nontaxable payments are literally worth 

more to the recipient than ordinary market payments for services. For example, suppose there is a uniform tax rate of 

40 percent. If an individual were willing to provide a service for $1, after-tax because this measures the value of 

goods and services he in fact will be able to command as a 

result of his expenditure of effort--he would demand a market 

price of $1.67 to leave himself $1 after paying 40 percent, 

or $"0. 6 7, in tax. His services, measured in market prices, 

are worth $1.67. 

Now, suppose the Federal government allows him 

a special 50 cent de duction in computing his taxable income 

provided he devotes his service to recycling. Given his tax 

rate of 40 percent, this deduction is equivalent to a 20 

cent nontaxable subsidy. But, with this nontaxable subsidy 

he would be willing to sell his recycling service for $1.33 

in the market, for , with the 50 cent recycling subsidy deduction, he will only pay 33 cents in tax after earning $1.33 

in pre-tax income and have left his necessary $1 after-tax 

return. 

In effect, conveying the subsidy of 20 cents 

in tax-exempt form accomplishes a 34 cent reduction (subsidy) 

in the market price of the service. If the subsidy were 

appropriated, the amount appropriated would have to be 34 

cents to perm it the seller to make available $1.6 7 in recycling services to purchasers at $1.33. Purchasers would 

pay $1. 33, the government 34 cents; the subsidized seller 
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would report $1.67 of taxable income, pay 67 cents in tax, 

and have left the necessary $1 in after-tax reward. Clearly, 

34 cents is the correct cost measure of government subsidy 

support in this example. It is the market value of the resources which will generate 20 cents of after-tax reward to 

the subsidized seller, just as the $1.33 paid by purchasers 

generates the remaining 80 cents of necessary after-tax reward to the seller. 

Because tax subsidies are commonly evaluated 

as simply the "tax saving," 20 cents in this example, 

provided by artificial deductions, or by other means for 

reducing the taxability of income earned by the subsidized 

activity, the real cost of the subsidy is understated. 

Doubtlessly, "tax incentives" enjoy widespread popul4rity 

among legislators and taxpayers because the cost of the 

government program financed by tax subsidies is under stated 

and therefore appears to cost less; and once the tax subsidy 

program is in effect, its impact on the size of the Budget is 

effectively disguised, for the "revenue loss" is not 

exhibited in the Budget. 

ii. Implicit extra cost due to degradation of 

the tax structure. 

In the example, a subsidy worth 34 cents in resources was shown to be provided by a 50 cent artificial 

deduction allowed the qualified enterprise. Suppose another 

qualified activity is operated by someone whose aggregate income places him in a 50 percent tax bracket. A $1.67 presubsidy market pr i ce of the service nets this person an 

after-tax reward of 83.5 cents; and if he is engaged in the 

activity, this return is presumably sufficient to elicit his 

services. For th i s qualified enterprise, however, the 50 

cent artificial deduction is worth 25 cents after-tax, 
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replacing a market reward of 50 cents. A 50 cent artificial 

deduction is worth, after-tax, 25 percent more to a 50 

percent taxpayer than to a 40 percent taxpayer. In terms of 

market prices, a 50 cent artificial deduction is worth 50 

percent more to the 50 percent taxpayer than to the 40 

percent taxpayer (50 cents compared with 34 cents}. If a 

market price subsidy of 34 cents would accomplish the 

objective of the subsidy, then providing a 50 cent deduction 

to all qualified activities, when the tax rates to which the 

owners of the enterprises are subject progressively rise with 

their aggregate incomes, increases the real social cost of 

the tax subsidy as compared with an equivalent appropriated 

subsidy. More is paid to high-income subsidy agents through 

remission of tax than would be required to be paid as an 

appropriated subsidy. 

This phenomenon is well-known in the case of bond 

yields for state and local government bond issues which are 

exempt from Federal income tax under Sect ion 103 of the Internal Revenue Code. Be cause interest on these bonds is tax 

exempt, their market yields are lower than yields on comparable taxable issues. In fact, the "spread" between taxable 

and nontaxable bonds has ranged from 30 to 35 percent. Since 

yields, 1 ike all prices, are determined at the margin--the 

yield necessary to get the last dollar of tax-exempt bonds 

issued held by someone satisfied with his after-tax yield 

thereon--this spread suggests that the marginal tax rate of 

the marginal holder is somewhere in the neighborhood of 30 to 

35 percent. lO/ Thus, all holders of tax-exempt bonds 

subject to tax rates above this range earn more subsidy than 

is effectively enjoyed by state and local government bond 

issuers, the presumed beneficiaries of the interest tax 

subsidy. Replacing tax-exempt ion of state and local bond 

issues with an appropriated cash subsidy to provide a 30-35 

percent reduction in borrowing costs would reduce the budgetary cost of the financing subsidy now provided state and 
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local governments. Alternatively, an appropriated interest 

subsidy with the same net budgetary cost as results from interest tax exemption would provide a larger net subsidy to 

state and local government borrowers. 

C. Specifying a base for a tax subsidy to recycling. 

As with appropriated subsidies, defining the recycling 

activity to be subsidized through the tax system presents one 

problem; specifying the base for the tax subsidy presents the 

other. The choice is between providing the subsidy to either 

the output, or total cost of production, or for some portion 

of the cost. 

1. Total cost (price) as a base 

In the discussion to this point, a possible recycling subsidy has been described as a bounty per unit of 

output of recyclable material. Such a subsidy might also be 

viewed as one which subsidizes all the input costs, wherever 

incur red, in getting the material out of the solid waste 

stream and into reusable form. Such a bounty, or "negative 

sales tax", on a base of recyclable materials purchased or 

sold is the most efficient--least costly--means of achieving 

the subsidy objective. Given the competitive characteristic 

of the several stages of recycling activities and the diversity in kinds of enterprises and technologies employed, the 

most efficient subsidy is one that does not prejudice choices 

among the numerous ways that the tasks of resource recovery 

may be accomplished. Capital-intensive and labor-intensive 

processes benefit equally from a bounty on total cost of recyclables; at each stage, enterprises have unaltered incentives to adopt the least cost way of carrying out their 

tasks. 
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2. Capital equipment as a base. 

The efficiency of bounties on total cost contrast 

with the biases of .. capital subsidies." In addition to percentage depletion allowances, such specialized subsidies include special investment credits, 11 rapid write-off 11 of 

investments in recycling machinery, and tax-exempt bond 

financing of qualified facilities. Although each of these 

forms of subsidy might be paid with appropriated funds, they 

are typically formulated as tax subsidies. The apparent 

reason for this is that so-called "business taxes" are 

essentially taxes on the income from capital. Thus, if a tax 

subsidy is provided via business income taxes, it invariably 

involves special tax treatment of capital expenditures. ll/ 

Capital subsidies are inferior to bounties to 

achieve narrowly 

recycling. They 

defined objectives, such as to encourage 

induce qualified enterprises to use more 

capital-intensive processes, thereby dissipating some of the 

subsidy in wasted productive resources. Moreover, the 

availability of capital subsidies to an enterprise depends on 

its having otherwise taxable income. A special deduction is 

useless to a taxpayer if he has no taxable income to reduce; 

a credit against tax is equally worthless if no tax is owed. 

12/ 

Nor are capital subsidies for a narrowly defined objective easier to administer than bounties. All the problems 

of identifying qualified enterprises for bounties exist for 

capital subsidies. In place of the problems in determining 

recyclables eligible for the bounty, capital subsidies present the same problems in determining which assets are employed in recycling per se, how much of other assets are 

jointly used in recycling and other processes, and which assets are not eligible whatsoever. In principle, a careful 
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monitoring of inputs and outputs would resolve the bounty 

problems; but no known method of economic analysis or cost 

accounting can resolve the problems of identifying capital 

used in recycling and eligible for subsidy. 

Nevertheless, capital subsidies maintain an undeserved 

popularity among proponents of recycling subsidies. The remainder of this sect ion reviews these incentives, one of 

which has been in effect since 1968, another enacted in 1978. 

In all cases, it is assumed that some arbitrary definition of 

"qualified activity and equipment," or that some certification procedure, has been established. 

a. A percentage depletion allowance for recyclable 

materials. 

As noted in Chapter 2, a percentage depletion allowance is a particular way to reduce the taxability of income from an enterprise. The qualified ente rprise is permitted to deduct in computing taxable income an amount equal 

to some stated percentage of the value of the product being 

recycled. In this respect, a percentage depletion allowance 

resembles an ad valorem bounty and is subject to the same 

weakness: A subsidy proportional to the value of recyclable 

materials will induce a relocation of the several stages of 

recycling activities merely to maximize the subsidy; it will 

encourage prior decontamination, more transportation, etc. 

And because percentage depletion creates a subsidy by 

reducing taxable income, it carries the grave defects of all 

tax-exempt subsidies noted above: It leads to a budgetary 

understatement of the real resource cost of the subsidy 

program, and it wastes resources by over-rewarding those 

owners of subsidized enterprises who happen to have above 

average incomes. 
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Since percentage depletion provides approximately 

the same subsidy as could be provided by an appropriated 

bounty, and with the same administrative cost and difficulty, 

there is no reason to frame a recycling subsidy in this 

form. 131 

b. Tax-exempt bond financing of qualified 

facilities. 

Most economic activities undertaken by state and 

local governments are exempt from Federal income tax. Also, 

interest on bonds issued by state and local governments 

always has been exempt from tax. This treatment of state and 

local governmental activities -- many of which, such as solid 

waste management, the operation of electric, transportation, 

and water utilities, and liquor distribution, are also undertaken by private, taxable enterprises -- may be considered a 

generalized subsidy enjoyed by the customers of these governmentally owned and operated enterprises. To the extent that 

any of these activities is financed by taxes, the subsidized 

publicly-provided services are further subsidized by the allowance of deduct ions for these taxes in computing Federal 

tax liability. 14/ 

One consequence of 

local government operation 

activities is an inducement 

these Federal tax subsidies to 

and tax financing of economic 

to use this institutional arr angement of providing solid waste management services that 

might otherwise be provided privately or publicly at prices, 

or fees, based on cost of service. Not only does this mechanism shift some of the costs from the beneficiaries of the 

service, it may also be used as a device for income redistribution. Households in many j ur isd ict ions may enjoy waste 

collection and disposal services for which they are not directly charged, and the Federally unsubsidized costs are then 
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borne by taxpayers within the community according to the burden d istr ibut ion implied by the community's own tax system, 

not by their use of these services. While regrettable from 

the point of view which holds that individuals should pay for 

the resource costs of the services they enjoy, this result is 

an inherent consequence of the Constitutional reservation of 

rights to the states, and of the long-standing Federal tax 

deductibility of most state and local taxes. 

As noted in Chapter 2, these advantages of municipally undertaken services are not a subsidy to solid waste 

management, or to resource recovery, ~ se. However, 

investments by private firms in solid waste disposal 

facilities are eligible for financing by tax-exempt bonds. 15/ 

Under the arrangements sanctioned in the tax law, a state or 

local government may, at its own discretion, agree to issue 

bonds, the proceeds of which will be used to finance a solid 

waste disposal facility to be operated by a private firm. 

The benefitting firm agrees to pay the governmental 

bond-issuing authority a periodic 11 rental, 11 the proceeds of 

which will cover interest and retirement of the bonds. At 

the end of the lease term, the lessee firm owns the property. 

For all practical purposes, including taxation, the private 

firm "leasing 11 the facility is the owner as well. For tax 

purposes, the firm will be able to depreciate the portion of 

the facility's cost subject to wear-and-tear and 

obsolescence, and any qualified property in the plant will be 

eilgibl e for the investment credit. Because this 

preferential treatment of privately owned property financing 

has been restricted to only a few kinds of investment, 

including solid waste disposal, it is regarded as a tax 

subsidy. 
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The Treasury's administration of this subsidy program, and a similar subsidy to investment in pollution control facilities, illustrates the problems of definition described ear 1 ier. To implement the program, income tax regulations were issued which define solid waste as "property 

which is useless, unused, unwanted or discarded solid material which has no market or other value at the place where it 

is located." They also define a qualifying facility to be 

"any property used for the collection, storage, treatment, 

utilization, processing, or final disposal of solid waste." 

[Reg. sect. 1.103-8 (f) (2)]. In practice, it has proved 

difficult to draw the line between normal, rational 

industrial processing 

is then subject to 

by-products and 

-- in which the residue of one process 

further processing to obtain valuable 

the processing of "waste." When is 

"slag", or other industrial waste, "solid waste," the 

processing of which is a qualified activity, and when is its 

further processing a simple extension of the firm's 

productive activity? The question has proved to be 

unanswerable. lG/ Ten years after enactment of the subsidy, 

efforts to develop clarifying regulations continue so that 

private firms and their bond counsel may have reasonable 

certainty which projects will qualify for the subsidy. 

Resource recovery plants clearly qualify for taxexempt bond financing, so we may use engineering estimates of 

their construction and operation to quantify this subsidy. A 

resource recovery plant is generally one which receives solid 

waste that would otherwise be disposed of, then separates incombustible sol ids, and converts the remainder into useful 

energy. The incombustibles may become recyclable materials, 

or they may be compacted and disposed of. On the basis of 

engineering estimates for such plants, we estimate that taxexempt bond financing of such a privately owned plant provides a subsidy equal to an appropriated subsidy of 5 percent 
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of total cost of operation. 171 Of course , being a capital 

subsidy, this is less efficient than the equal cash grant. 

The same plant run by a governmental authority would 

benefit by an additional 15 percentage point reduction in 

total cost of operation, assuming the same quality of 

management. The additional benefit to municipal plants 

reflects both the Federal income tax exemption and the lower 

borrowing cost of such a plant which enjoys the implicit 

guarantee to lenders provided by the issuer ' s taxing 

h . 18/ aut or1ty. 

c . Subsidies for the acquisition of machinery and 

equipment used in recycling . 

Other subsidies have been proposed to reduoe the 

capital cost portion of recycling costs, and thus the cost of 

recyclable materials. These are commonly thought of as tax 

subsidies because their "payment" has been traditionally 

financed through the tax accounts of qualified enterprises, 

and therefore are available only to taxable entities. Such 

subsidies include investment tax credits additional to the 

credit presently provided for investment in depreciable machinery and equipment, but not for structures, and "rapid 

write-off" of capital expenditures for tax purposes. Each of 

these forms of capital subsidy could be provided as easily in 

the form of cash grants which would measure the resource cost 

of the subsidy correctly and avoid the undesirable tax policy 

effects of a nontaxable subsidy. Providing the subsidy as a 

cash grant would also make possible its extension to nontaxable entities. In the following discuss ion of rapidwrite-off schemes and additional investment credits, we 

therefore take cash-grant, or appropriated subsidy, equ ivalents as the comparative norm. 
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(i) "Rapid write-off" schemes. 

(a) How "rapid write-offs" become a subsidy 

In any economic system in which government 

operations, and subsidy programs, must be financed by taxes, 

only what is left after taxes is fr e ely disposable by individuals--for consumption or investment in privately-owned 

capital. This is obvious in the case of sales or excise 

taxes: Sellers of taxed goods and services have only what is 

left after the sales taxes have been handed over to government to pay employees, suppliers, creditors and equity 

owners. The tax proceeds spent by government, plus the 

after-tax incomes of workers and capital owners, then become 

the wherewithal to purchase the goods and serv i ces sold at 

gross-of-tax prices. 

This is equally true, but less obvious, when 

taxes are levied on incomes. In an income tax regime, goods 

and services exchange at gross-of-tax prices. Sellers 

allocate these revenues from the sales of output into wage 

payments, payments to suppliers, and the remaining share 

accruing to suppliers of the capital. These allocations of 

pre-tax incomes are also the pre-tax incomes of the 

participants in the economic process who are then required to 

pay the taxes to government. Then, government income tax 

collections, plus the after-tax personal incomes, suffices to 

purchase t he output sold at gross of tax prices. This 

description shows the general equivalence of sales and income 

tax systems and also explains why sales taxes are frequently 

called "indirect," and income taxes "direct:" Under a sales 

tax system, individuals receive disposable income directly 

and are unaware how the taking of the government share 

"indirectly" has reduced their disposable incomes. Under an 

income tax system, individuals are first paid the 
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gross-of-tax, market prices of their contribution to the 

economic process, and then are required "directly" to hand 

over to government its share. 

In administering an income tax, particularly the 

tax on income from capital, it is important that the amount 

subject to tax be free of elements representing amounts on 

which income tax already has been paid. For example, when an 

enterprise purchases machinery and equipment, the funds used 

are, by definition, disposable (after-tax) resources of the 

persons supplying the funds. It is well-known that machinery 

and equipment are "used-up" during the period after it has 

been acquired. Physical wear-and-tear plus obsolescence assures that the value of plant and equipment will someday be 

zero. Thus, the sales prices of the products produced with 

the aid of this machinery and equipment must include amounts 

to cover this using-up, or depreciation, of the capital used, 

as well as a payment (taxable income) to the capital suppliers for providing the finance to make possible its initial 

acquisition and maintenance. 

That portion of the sales proceeds of enterprises 

which represents depreciation, also called "recovery of capital," is a return of their previously tax-paid resources to 

the capital owners and, therefore, ought not to be subject to 

tax again. For this reason, in the computation of taxable 

incomes of enterprises, an "allowance" for depreciation is 

permitted as an allocation , or deduction, from gross revenues 

derived from sales, along with wages paid, etc. , to avoid 

taxing again the resources on which tax has already been 

paid. 

How the tax allowance for depreciation, or capital recovery, is determined is critical to investment decisions. If the allowable tax deductions reasonably match the 
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actual disappearance of machinery and equipment value, the 

full burden of income tax will be borne by capital owners: 

they will pay their "fair share" of taxes. If tax allowances 

for depreciation ~ the occurrence of actual capital consumption, i.e., are less during some periods than the experienced loss of capital value, the enterprise will then pay 

tax on some income that includes at least some resources on 

which tax had already been paid. On the other hand, if tax 

allowances precede the occurrence of depreciation, taxable 

income will exclude some amount of pre-tax income. 

Allowances for tax depreciation ultimately equal 

the acquisition cost of capital assets that eventually become 

worthless, or decline in value. The relation between tax depreciation allowances and experienced depreciation thus determines the timing of tax payments. When tax depreciation 

allowances ~' taxes are pre-paid: when tax depreciation allowances precede experienced depreciation, taxes are deferred. Pre-payment of tax is always more burdensome, and "deferred payment" less burdensome, than paying amounts when 

due. Therefore, the characteristics of tax depreciation 

rules, in combination with any set of legislated tax rates, 

determines the effective tax burden imposed on the use of 

capital resources and, hence, the capital costs of producing 

particular goods and services. Art if ically speeding-up the 

allowance for depreciation is thus a capital cost-reducing 

subsidy paid through the tax system. 

(b) The variable subsidy value of five-year 

amortization 

The most commonly prescribed rapid write-off form 

of subsidy is "five-year amortization." Rather than the normal tax depreciation pattern, the investor is permitted to 
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deduct one-fifth the cost of the asset for five years. Obthis scheme depends on the 

The longer the normal patv iously, the subsidy provided by normal tax depreciation pattern: 

tern, the greater the deferral and, hence, subsidy. Table 

4.1 shows the subsidies provided by five-year amortization of 

four categories of depreciable assets involved in recycling 

activities, expressed as equivalent appropriated cash grants, 

or asset price reductions. 19/ 

Table 4.1 

Capital Subsidies Implied by Five-Year Amortization / 

Asset price reduction equivalent of 

Class of recycling subsidy if tax rate of owner is: 

property ________ =---~~! __________ !~! __________ 2Q! 

(Percent) 

Vehicles 0 0 0 

Machinery and equipment used in: 

Pulp and paper 2.60 7.52 15 .18 

Primary nonferrous 

metals manufacturing 2.90 8.35 16.71 

Primary ferrous 

metals manufacturing 4.84 13.45 25.49 

a/ Computations assume a 10% discount rate and allow full 

investment credit. 
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Investment in vehicles used in recycling activities 

would not benefit from five-year amortization. Five years of 

equal deductions, rather than accelerating the pattern of deductions and slowing-down the payment of income tax, decelerates deduct ions and accelerates tax payments, as compared 

with normal tax depreciation allowances for vehicles. In the 

cases of machinery used in paper and pulp, nonferrous and 

ferrous metals recycling, five-year amortization accelerates 

tax deductions and provides some net subsidy. But, for any 

given tax rate of the asset owner, the subsidy value of fiveyear amortization is least in pulp and paper, greatest in 

ferrous metals. 

Five-year amortization not only yields unequal 

subsidies to different activities, but, for any given 

recycling activity, the subsidy value of five-year 

amortization dramatically increases with the tax rate of the 

owner. Small businesses, generally described by 22 percent 

tax rates, gain the least subsidy, investors subject to the 

maximum tax rate of 70 percent gain the greatest subsidy. 

Few business owners are subject to the 70 percent 

rate. To arbitrage differences in subsidy value, equipment 

leasing arrangements will be devised. Under the terms of 

these leases, a group of wealthy passive limited partners 

will assume ownership of those types of recycling equipment 

adaptable to leasing, and recycling enterprises will "rent" 

the equipment for long terms. These arrangements enable the 

tax subsidy to be cleared through the tax accounts of highincome individuals subject to high tax rates. Such arrangements are called "shelters" because the limited partners use 

the artificially accelerated deductions to shelter their 

otherwise taxable incomes. To the extent that leasing 

occurs, the realized subsidy value will be between the 

amounts tabulated in the columns relating to 22 to 48 percent 
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taxpayers and the amounts shown in the 70 percent taxpayer 

column. If the number of persons who would be subject to 70 

percent tax rates were large and their wealth sufficient to 

finance the purchase of all leasable assets, the realized 

subsidies would be those in the 70 percent taxpayer column. 

Since this is not the case, the "marginal" ownership will be 

in a rate-bracket below 70 percent. Nevertheless there will 

be a tax revenue loss equal to the difference between lease 

rentals determined at the margin and the amounts shown in the 

70 percent column representing a transfer of after-tax income 

to limited partners which does not go to reduce the cost of 

using recycling equipment. This is an example of extra tax 

subsidy cost like that described above in connect ion with 

tax-exempt bond interest. 

Tax she! ter format ion makes the budget cost of 

such capital subsidies greater than cash grant subsidies for 

the same purpose . Thus, rapid write-off schemes are the 

least desirable of all tax subsidies for the acquisition of 

capital goods used in recycling: They provide differential 

benefits according to the kind of capital used, the material 

recycled, and the tax status of the investor; and they induce 

the formation of ownership arrangements whose only function 

is to increase the tax benefit realized without a cor responding increase in the subsidy to use of the capital. 

(ii.) Investment credits. 

(a) How an investment credit subsidizes, 

recycling. 

An investment credit, properly structured, 

would be the exact equivalent of a cash-grant subsidy for the 

purchase (sale) of qualified capital goods. The enterprise 
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purchasing the machinery and equipment, or other assets, 

receives a grant of, say, 10 percent of his purchase price; 

then, for each $1 of qualifie d goods be acquires, he pays 

only 90 cents of borrowed or equity resources. The result is 

a 10 percent reduction in the portion of capital costs thus 

subsidized: the enterprise need charge its customers an 

amount for recovery of capital, income taxes, and an 

after-tax rate of return equal to 90 percent of the charges 

otherwise required to justify the purchase and use of $1 

worth of capital. To the extent that capital is used in 

recycling, this subsidy would reduce costs; and to the extent 

that use of recyclable materials is responsive to cost, such 

a subsidy would increase recycling. 

An investment subsidy could achieve its objective 

whether it is paid in funds appropriated by Congress, or by 

permitting the investing enterprise to subtract the appropriate amount from his tax payments otherwise due. But the 

present investment credit, and the additional 10 percent 

credit that has been enacted for equipment used in recycling 

and for certain classes of "alternative" or "energy conserving" property, do not quite match the characteristics of a 

simple cash-grant subsidy. Both the normal and the additional 10 percent investment credit differ from a simple cash 

grant in 3 ways: 

(1) If a cash grant of 10 percent had been made, 

the private firm could recover through depreciation deductions only the 90 percent of cost it had privately financed. 

Because the investment credit is considered a "reduction in 

tax," however, not a government grant, the investing e nterprise is permitted to recover through tax depreciation deductions not only its own 90 c e nts of disposable resources 

expended to acquire the subsidized assets, but also the 10 

. . h d. t 20/ cents f1nanced by the government grant v1a t e tax ere 1 • 
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In the event there is an additional 10 percent credit, the 

investor pays 80 cents and is permitted to recover $1 in 

depreciation deductions. 

(2) A cash grant would be uniform for all qualified recycling equipment, regardless of its expected 1 ife. 

However, partly because the taxpayer is permitted to take 

depreciation deductions for the cost of the asset financed by 

the government, only partial investment credit is allowable 

for assets with expected lives for tax depreciation purposes 

of less than seven years. 211 As will be seen below, this 

introduces a discrimination between processes using different 

forms of capital. 

(3) A cash grant would be paid regardless of the 

income status of the recycler; the amount of investment-credit which can be taken in any year is limited by tax liability 

for the year, although excesses of credit eligibility may be 

carried back three years and forward seven. 221 

A cash-grant capital subsidy has equal value to 

all investors, regardless of their taxable status, but the 

investment credit is like the other tax subsidies reviewed 

above in that it discriminate s in favor of high income investors. This discrimination is due to the first and third 

departures from a cash grant just noted. The privilege of 

taking depreciation deductions for the government's share of 

capital cost provides the investor an additional stream of 

future deductions from taxable income, the value of which is 

directly dependent on the tax rate of the investor taking the 

deductions. Secondly, limiting the amount of subsidy to some 

portion of tax liability for a year also tends to favor the 

better-off. 
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Allowing the investor to depreciate the investment grant also makes the value of the subsidy dependent on 

the tax 1 ife of the qualified property. Tax depreciation 

deductions for short-1 ived assets are obtained quickly; the 

same total tax depreciation deductions accrue over a longer 

period for long-lived assets. Since the amount of bonus depreciation per dollar of subsidized assets is fixed by the 

investment credit rate, the bonus depreciation is worth more 

to owners of short-lived assets. 

{b) Values of additional investment credit, by 

type of asset and taxability of owner. 

The variability of an additional 10 percent investment credit subsidy as compared with an appropriated cash 

grant is illustrated in Table 4. 2. Whereas a simple 10 percent cash subsidy would reduce the cost of using qualified 

capital uniformly by 10 percent, a 10 percent investment 

credit does not. For any given tax rate of the asset owner , 

vehicles are afforded a lesser subsidy because the fractional 

share of the credit they are allowed overcompensates for the 

bonus depreciation allowed; and although the subsidy differences are less marked among the other categories of recycling 

assets than was the case with five-year amortization, they 

remain, though reversed in sign: Longer lived assets gain 

less from the bonus depreciation. Again, tax rate sensitivity occurs, though less marked than in the five-year amortization cases. Because the investment credit has less severe 

inherent biases than depreciation acceleration, it is clearly 

a superior subsidy mechanism; however it remains inferior to 

cash grant subsidies. 
119-

Table 4.2 

Capital SubsidiP~ Tmn iPd hv ~n Annirion~l 

10 Percent Investment Credit ~/ 

Price reduction equivalent of subsidy, 

Class of recycling if tax rate of owner is: 

property 22% 48% 70% 

Vehicles 8.93 12.70 19.73 

Machinery and equipment used in: 

Pulp and paper 

manufacture 13.43 17.84 24.70 

Nonferrous metal 

manufacture 13.39 17.68 24.25 

Ferrous metal 

manufacture 13.12 16.70 21.70 

~I It is assumed the additional credit will be structured in 

the same way as the present 10 percent credit: assets 

with a tax life of 5 but less than 7 years receives 2/3 

credit; there is no basis adjustment, and the bonus 

depreciation is evaluated with a discount rate of 10 

percent. 

D. Summary. 

Despite the evidence that a subsidy to recycling cannot 

be justified on the ground that it will increase the standard 

of 1 i v ing by improving the allocation of resources, if a 

subsidy is to be provided: 

--It should be based on the quantity of recyclable 

materials used in primary production--production of 

paper, metals, glass. This minimizes the difficulty of 

, 
- ------------------------~ 

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identifying a qualified recycler, but it nevertheless 

requires an elaborate administrative mechanism to 

identify recyclable inputs qualified for the subsidy. 

--It should be paid with appropriated funds rather than 

through the tax system. This minimizes administrative 

cost to achieve a given quality of program administration, 

subsidy 

correctly presents the resource cost of the 

in the Budget, and avoids the extra cost 

(payments to above-average taxpayers) inherent in tax 

subsidies paid in after-tax dollars. In the case of 

capital subsidies, appropriated subsidies avoid inequality of subsidy values among assets of different 

durabilities inherent in such tax subsidies as rapid 

write-offs and investment credits. 

Finally, it should be noted that, in addition to the 

budgetary cost of recycling subsidies, these interventions in 

markets induce additional resource waste, a reduction in the 

value of goods and services produced. Subsidizing recycling 

induces a shortening in the useful lives of products that 

might otherwise be put to secondary uses or be reconditioned 

and it disfavors recovery of energy from combustible portions 

of the solid waste stream. 

Footnotes to Chapter 4 

l/ In solid waste collection, the basic operating unit is a 

vehicle and crew. Usually, the volume of waste to be 

collected is far greater than that which would keep a 

basic unit fully employed. Although some management 

economies may derive from operating multiple vehicle 

units, there is no evidence that the optimal size of a 
-121-

waste collecti on enterprise is so large that monopoly is 

a normal expectation. Indeed, private trash collect ion 

firms frequently coexist with governmental monopoly of 

certain kinds of collection activities. That many communities establish a governmental monopoly of solid 

waste collect ion may be regarded as a local preference 

for achieving some income distributional objectives within a political jurisdiction, i.e., by financing the conduct of waste management through a set of taxes based on 

local measures of "ability to pay" rather than charges 

based on quantity of service demanded. 

In resource recovery, particularly when useful energy is 

at least one of the outputs sought, technological economies of scale may limit the number of such plants in a 

market. (See U.S. Congress, Office of Technology Assessment, Materials and Energy from Waste, 197 8.) But since 

a resource recovery enterprise must always compete with 

disposal and with processes utilizing solid waste for the 

derivation of useful (recyclable) materials, the degree 

of monopoly power of a resource recovery enterprise must 

be neg 1 ig ible. 

~./ A survey of 2, 060 cities disclosed that 36 percent of 

them financed solid waste management by local taxes, but 

there is no indication whether this 36 percent accounted 

for 36 percent of the municipal solid waste, for more, or 

less. (p. 19 of "A Review of the Cur rent Status of 

Municipal Solid Waste Management," in the Third Report of 

the Resource Conservation Committee, July, 1978). 

ll Congress has funded categorical grant programs as well as 

general revenue sharing. Grant programs may be justified 

on the ground that they permit cost-sharing in the implementation of Federal programs, and general revenue 
~ - -----------------

-122-

sharing may be justified on the ground that this provides 

a better utilization of the Federal tax base than the 

financing of Federal expenditure programs. Neither of 

these justifications appear to be applicable to municipal 

solid waste management, per se. 

!/ The estimate is that 85 to 88 percent of municipal solid 

waste management costs are consumed in collection activities. Whatever happens to the waste after it is collected, this cost will have to be incurred. Thus, 

avoidance of disposal "saves" only 12 to 15 percent of 

municipal solid waste management costs plus the unrecognized environmental damage costs. See Third Report of 

the Resource Conservation Committee, July, 1978, p. 2 and 

sources cited. 

~/ These estimates are based on the elasticities of supply 

and demand reported in Chapter 3 and the following unsubsidized prices and quantities of recyclable materials: paper, $45/ton, 16 million tons; ferrous, $75/ton, 

40 million tons; copper, $1,100/ton, 400,000 tons. 

i/ Barnett, Harold J., and Morse, Chandler, Scarcity and 

Growth: The Economics of Natural Resource Availability 

(Baltimore: The Johns Hopkins Press, 196 3, Chapters 8 

and 9. Although this study was completed before the 

recent (1972-74) cyclical upswing in raw materials 

prices, and subsequent downswing, there is no reason to 

believe the underlying long-term forces have radically 

changed. 

21 It has also been demonstrated that, on the basis of 

plausible estimates of the quality of exhaustible r esources, with no change in technology, the mere substitution of capital and labor for resources makes 
-123-

pass ible a perpetual level of consumption (standard of 

1 iv ing) in the face of declining resource quality (incr easing cost of extraction) that is 1 ittle less than 

could be attained if resource quality were unchanging 

(extract ion cost constant) • See Solow, Robert M. and 

Wan, Frederic Y. , "Extract ion Costs in the Theory of 

Exhaustible Resources," The Bell Journal of Economics, 

Vol. VII, No. 2 (1976), pp. 359-70. 

~/ These observations hold whether the subsidy is paid 

through expenditure of appropriated funds or as "reductions in tax." Unfortunately, the accounting convent ions governing Federal Budget presentations do not 

fairly present the economic consequences of subsidie s 

financed through tax accounts. For example, if $100 

million is expended on, say, agricultural subsidies, this 

is duly entere d in the expenditure side of the Budget, 

and all observe rs can readily see that $100 million of 

resources are being used by governme nt in support of 

agricultural programs. But, if the $100 million is paid 

out through a cancellation of farmers' tax othe rwise due, 

the subsidy amount simply evaporates. 

Suppose, that without the subsidy, government expend itur e s and r ev e nue s ar e $1 billion and that the subsidy 

will be financ ed by additional taxes. If the $100 million is finance d as an expenditure, the new budget total 

will be $1.1 billion; if the $100 million is financed as 

a "tax subsidy" the ne w budget total, including the additional resources consumed by the subsidy, and also 

financed by $100 million in additional taxes, will still 

be $1 bill ion. Enactment of tax subsidies helps create 

the illusion that government intervention in resource 

allocation is costless. Indeed, this illusion is carried 

over into the Na t ional Income Accounts by the Bureau of 
-124-

Economic Analysis, which also treats tax subsidies as 

"reductions in tax" and not elements of the government 

share of GNP. 

~/ The one except ion to this general rule of tax subsidies 

is the "New Jobs Credit" enacted in 1977, which has been 

replaced by a comparably structured "Targeted Jobs 

Credit" in the Revenue Act of 1978. This subsidy, designed to encourage ex pans ion of employment in smaller 

enterprises, is a credit against income tax based on the 

employer's increase in payroll. However, the employer is 

required to reduce his current year's deduction for wages 

and salaries paid by the amount of the credit . In 

effect, the subsidy is paid out in taxable form, just as 

it would have been had the program been enacted as a 

Labor Department Manpower Program. 

l.Q/ There are significant institutional differences between 

the markets for state and local issues and others that 

suggest that 30-35 percent spread may be an understatement. The institutional differences have to do with term 

d istr ibut ions of outstanding debt and with the ultimate 

incomparability of critical elements of bond indentures, 

such as collateral, or income flows, to which bondhold 

have legal claim. 

11/ This is not essential if the income tax account is merely 

to be used as a device for clearing payments to a taxpayer. In the earlier discussion in this chapter, it was 

noted that a bounty per ton of recyclable material might 

be paid to a qualified enterprise by permitting him to 

offset the amount owed to him by the government against 

the tax he owes the government. The New Jobs Credit, 

described in a prior note is an example of such a noncapital related tax subsidy. 
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~/ Carry-back and -forward privileges mitigate this character is tic of tax subsidies. "Operat,ing losses" due to 

excessive tax deductions may be carried back three years 

and forward five; most tax credits which exceed the taxpayer's current-year capacity to absorb them may be 

carried back t hree years and forward seven. But securing 

a future "refund" of unrequited losses or earned subsidies is less valuable than cash-in-hand. 

_!11 If the disadvantages of locating res pons ibil it ies for a 

recycling subsidy in the tax-writing comitttees and IRS 

are disregarded, the equivalent of a bounty can nevertheless be prov i ded by clearing its payment through tax 

accounts. The amount of the subsidy for which a taxpayer 

qualifies would be computed by rules which are the same 

for a cash bounty or a percentage depletion deduction. 

However, in order to avoid the undesirable consequences 

of a nontaxable subsidy (artificial depletion deduction), 

the qualifying taxpayer could be reimbursed for the 

amount of the subsidy in the following way: the taxpayer 

would reduce his "cost of goods sold" deduction that year 

by the amount of the subsidy, thereby bringing the subsidy into the tax base as if it were a market payment; he 

would compute his tax liability and then reduce this by 

the amount of subsidy credit due him. 

14/ If a municipality charges fees for particular services, 

payments of these fees would not be deductible in computing taxable income for they are not different in kind 

or substance f r om other dispositions of taxpayers' personal disposable income. In all cases, however, payments 

made by an enterprise in connection with its conduct of a 

business would be deductible in computing enterprise taxable income. 
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.!..?_! Prior to 196 8, virtually any private enterprise investment, at the discretion of a state or local government 

authority, might have been financed by issuance of taxexempt bonds. In 1968, Congress amended Section 103 of 

the Internal Revenue Code to strictly limit the issuance 

of such bonds. However, among the exemptions from these 

new restrict ions was the f inane ing of "sewage or solid 

waste disposal facilities." [Section 103(b) (4) (E)] 

Since solid waste disposal facilities are among the few 

private activities eligible for tax-exempt financing, the 

privilege clearly becomes a specialized subsidy. 

16/ A boiler system to recover useful energy from bark 

stripped from timber in a forestry products plant has 

been ruled to be a "solid waste" disposal facility qualifying for tax-exempt bond financing. On the other hand, 

a metal shredding machine installed in a j una yard has 

been ruled not to be qualified. 

!II Because resource recovery plants are likely to be operated by, or in conjunction with, electric utility enterprises, the financial structure of a utility was taken as 

the basis for computing the advantage provided by taxexempt bond-financing. Basic parameters used in the calculation were: 

(1) Debt/equity ratio: 53 percent debt. 

(2) Borrowing rate: 10 percent taxable, 7 percent 

nontaxable. 

(3) After-tax rate of return to equity : 15 percent. 

(4) Composition of capital: 85 percent depreciable. 

(5) Tax variables: Depreciable life: 12.5 years. 

Tax rate: 46 percent. 

10 percent credit for qualified property. 

(6) Economic life of plant (to compute annualized 

capital cost per ton processed): 25 years. 

(7) Non-capital costs per ton processed: $6.36. 
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~/ It was assumed that a municipal plant would operate with 

70 percent debt, 30 percent equity (retained earnings)--

1 ike municipally owned electric plants. It was also 

assumed that the borrowing rate is 6 percent, less than 

the 7 percent effective rate payable by a private beneficiary of "revenue bonds." 

~/ The computations assume a discount rate of 10 percent and 

do not reduce the investment credit allowable. Normally, 

assets with a depreciable life of 5 years may only qualify for 2/3 credit: but unless specific provision is made 

in the Code--as it has been in the case of certain pollution control facilities--5-year amortization property 

qualifies for no credit. Continued allowance of the 

credit for the computations above was assumed in order to 

highlight the dependence of rapid write-off schemes on 

the normal tax life of assets. Had the 5-year amortization option been deprived of investment credit, then only 

primary ferrous metal manufacturing machinery and equipment owned by 70 percent taxpayers would have derived a 

net subsidy: in all other cases loss of the credit would 

have been more costly to the investor than the gain from 

acceleration of tax depreciation deductions. 

20/ When the investment credit was first introduced in 1962, 

taxpayers were required to reduce acquisition price, 

called "basis" in tax accounting terminology, by the 

amount of credit allowable for purposes of computing 

future tax depreciation allowances. However, because 

actual allowance of the credit was limited by the amount 

of tax liability of the taxpayer in the year he acquired 

the asset, in many instances taxpayers had not yet 

achieved the cash benefit of the credit but, nevertheless, "suffered" reduct ions in tax depreciation allowances. This was regarded as unfair as well as being a 
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source of complex recordkeeping and tax recomputation in 

the event the asset was sold. Therefore, Congress 

repealed the requirement of a bas is adjustment in 1964. 

Ironically, had Congress simply required the investment 

credit be treated as a cash grant (with a corresponding 

reduction of "basis"), all complexities would have disappeared. 

l.!l If the asset life is less than 3 years, no credit is 

allowed; if the life is 3 years, but less than 5, l/3 

credit is allowed; if the 1 ife is 5, but less than 7 

years, 2/3 credit is allowed. 

~/ The present annual limitation on investment credit 

allowed is the first $25,000 of tax liability plus 60 

percent of tax 1 iabil i ty in excess of $25, 000. "under 

provisions of the Revenue Act of 1978, the 60 percent 

figure will rise to 90 percent by 1982. 
Appendix to Chapter 2 

Computation of Supply Curve Shifts for Minerals and Timber 

from Tax Preferences 

I. Supply Price Equations for Minerals 

The required present value of gross revenues equals the 

present value of all costs, including operating costs, 

investment and taxes. In the equations below, the variables 

are defined as: 

R = gross revenue 

R* = gross revenue under neutral taxation 

0 = current outlays 

S = royalties 

S* = royalty payments if taxed as ordinary income 

T = severance taxes 

I = investment expenditures 

E = amount of investment deducted as current expense 

G = recapture of expensed investment 

H = capital gains on land and depreciated assets 

K = investment tax credit 

d = depreciation 

D = cost depletion under neutral taxation 

u = statutory corporate income tax rate 

r = statutory corporate tax rate on capital gains 

a = statutory percentage depletion rate 

PV( )= present value operator 

Under current law, for corporations using percentage 

depletion, we can write: 
-130-

PV{R) = PV{O) + PV{I) + PV{T) - PV(K) + PV(S) + 

u [ { PV { R ) - PV { S ) ) { 1-a ) - PV ( 0 ) - PV { E ) + PV ( G ) 

- PV{d) + {r/ u)PV{H) - PV{T)] •.. Equation {2.1) 

Rearranging terms in Equation (2.1) 1 we obtain: 

PV(R) = PV(S) + 1 x [PV(O) (1-u) + PV(I) + PV{T) -

[1-u{l-a)] PV{K) - u{PV{E) - PV{G) + 

PV{d) - (r/u)PV(H) + PV(T))] 

••• Equation (2.2) 

Equation 2.2 is applied directly to compute the present 

value of gross revenue under current law. 

Where the present value of statutory percentage depletion exceeds one-half the present value of otherwise -taxable 

income, percentage depletion reduces the tax rate on taxable 

income 1 defined without taking any depletion 1 by one-half. 

Thus, the formula for computing PV(R) becomes: 

PV{R) = __ 1_ 

{1-u) 

[PV(O) (1-(u/ 2)) + PV(I) + PV(T) 

-PV{K) - (u/ 2) {PV{E) - PV(G) + PV{d) 

-(r/ u)PV{H)+PV{T))] + PV(S) ••.• Equation (2.3) 

Under neutral treatment, required gross revenue from a 

mine can be written: 

PV(R*) = PV(O) + PV(I) + PV(S*) - PV(K) + PV(T) + 

u(PV{R*) - PV(O) - PV(d) - PV{D) - PV(S*) 

- PV ( T ) ) . • . • E qua t i on ( 2 . 4 ) 
-131-

where: 

PV(S*) = (1-r) PV(S) is the before-tax royalty 

(1-u) payments necessary to make 

after-tax royalties received 

the same as under current law 

Rearranging terms, Equation (2.4) can be written as: 

PV(R*) = PV(O) + PV(S*) + PV(T) + 1 

( 1-u) 

u ( PV (d) + PV (D) ) ] 

[PV(I) - PV(K) -

••• Equation ( 2. 5) 

Equation (2.5) is used to compute required revenue under 

neutral taxation of mining investments. 

II. Mineral Investment Profiles 

The mineral industry profiles show different types of 

estimated expenses for every year of the operation of a 

"typical" mine. Expenses are subdivided into 13 categories: 

(1) structures, (2) machinery and equipment, (3) research and 

development, (4) land acquisition cost, (5) working capital, 

(6) maintenance materials, (7) maintenance labor, (8) materials and supplies, ( 9) rents and royal ties ( including severance taxes, where applicable) , (10) utility services, ( 11) 

other services, (12) production labor, and (13) marketing and 

administration. These data were reclassified into current 

expenses, depreciable investments, and non-depreciable 

investments (land and working capital), and estimated 

depreciation schedules were applied to the depreciable 

capital. In addition, qualified investment under the 

investment tax credit (machinery and equipment) was 

identified, and the applicable credit computed, on the basis 

of the life of the investment. This method was used to 
-132-

convert the raw data supplied by the Bureau of Mines into 

annual estimates of current outlays, investment, depreciation, the investment tax credit, and cost depletion. 

Then, present values for all of these i terns were computed 

using a 10 percent discount rate. 

Table 2A-l reports the present value of all terms used 

in the calculations for each of the five mining profiles. In 

all the calculations, the corporate income tax rate used is 

46 percent, the capital gains rate 28 percent. The percentage depletion rate is 10 percent for coal, and 15 percent 

for copper and taconite. 

III. Supply Price Equations for Timber 

The required present value of revenues equals the sum of 

the present value of all current outlays, all investments, 

and all taxes. The variables in the equations below are defined as: 

R = revenue required for 10 percent return on investment 

I = investment 

0 = current outlays 

D = cost depletion 

a = fraction of investment that is expensed under current 

law 

R* = revenue required for 10 percent return on investment 

with timber preferences removed 

D* = allowable cost depletion with timber preferences 

removed 

g = capital gains tax rate for corporations 

u = income tax rate for corporations 

PV( ) = present value operator 
-133-

Table 2A-l 

Data Derived From Mineral Industry Profiles 

Profiles 

Eastern Ill inois Western Copper Taconite 

coal l Coal 2 Coal 3 . 4 Mine 5 Item M1ne 

PV(O) 59,532 59,548 62,834 532,834 557,741 

PV(S) 9,238 30,652 44,035 0 0 

PV(I) 32,051 35,774 41,791 320,645 259,117 

PV (E) 91 155 227 38,532 1,509 

PV(H) 108 0 69 0 0 

PV(K) 1,536 3,079 3,544 12,617 13,620 

PV(d) 11,366 16,984 21,035 126,133 106,562 

PV(D) 1,736 53 75 13,776 409 

PV(T) 6,572 9,002 22,505 0 0 

PV(G) 68 128 188 6,872 876 

PV (S*) 0 12,317 40,869 58,713 0 

All values are in thousands of dollars. The variable 

definitions are: 0 = current outlays, s = royalties, 

I = investment, E = currently expensed investment, H = 

capital gains on final sales of land and depreciated assets, 

K = investment tax credit, d = depreciation, D =cost depletion, T = severance taxes, G = recapture of expensed investment, S* = royalty payments if taxed as ordinary income, and 

PV( ) =present value operator. 
-134-

Under current law, the required present value can be 

expressed as: 

PV ( R) = PV ( 0 ) + PV {I ) + g [ PV ( R) - PV (D) 1 

-u[PV(O) + aPV(I) 1 .... Equation (2.6) 

The first expression in brackets, which represents the present value of taxes paid, is multiplied by "g" instead of 

"u", because revenue from the sale of timber is taxed at the 

capital gains rate. The term aPV(I) represents the amount of 

investment that can be deducted as a cur rent expense. These 

two items account for most of the tax subsidy. The term 

[PV(O) + aPV(I)1 is multiplied by "u", reflecting the fact 

that it is deducted against ordinary income, rather than 

against capital gain in timber growing. 

Rearranging the terms in Equation (2.6), the required 

present value of revenues can be expressed as: 

PV { R) = l [ PV ( 0 ) ( l - u) + PV ( I ) ( 1-au) - g PV (D) ) 

1-g .... Equation (2. 7) 

Equation ( 2. 8) expresses the required present value of 

revenue if the special tax provisions were removed. 

PV ( R *) = PV ( 0 ) + 1 [ PV ( I ) - uPV ( D *) ] 

1-u ..•• Equation (2.8) 

In Equation (2.8), the income from the sale of timber is 

taxed at "u," the rate applied to ordinary income. There is 

no expensed investment. PV(D*), the present value of depletion, is greater than PV{D), because the previously expensed 

investments become part of the depletable basis. However, 

the present value of cost depletion is small, because depletion is only allowed at the time of final harvest. 
-135-

IV. Timber Profiles 

The data used in the timber profiles are shown in 

Table 2A- 2. The categories of expenses are the same for 

pulpwood rotations of 15, 20, and 25 years as for the 30 year 

rotation shown. The only difference is that prescribed 

burning for fire protection only occurs in years 10, 15 and 

20 for the 25-year rotation; in years 10 and 15, for the 

20-year rotation; and in year 10 for the 15-year rotation. 

All costs are categorized as investments in the calculations. Overhead, land rental, property tax, and prescribed 

burning for fire protection are treated as expensed under 

current law, while clearing of site, site preparation, planting, and spraying are treated as capitalized. All costs are 

treated as capitalized under neutral taxation. 

Table 2A-2 

Model Southe rn Loblolly Pine Stand 

(extensive cultivation for 30 year pulpwood rotation) 

Item (tax treatment) Cost/ acre Year incurred 

Overhead (exp) $ 3.00 Annual 

Land rental (e xp) 20.00 Annual 

Property tax (exp) 2.10 Annual 

Cleaning of site (cap) 73.00 1 

Site preparati on (cap) 30.00 . 1 

Planting (cap) 43.00 1 

Spraying (cap) 15.00 2 

Prescribed burning for 

fire protection (exp) 3.65 10,15,20,25 

Timber can be cut at 15, 20, 25 or 30 years. 
-136-

Table 2A-l Footnotes 

l / 1. 06 Mill ion ton per year Eastern Underground Coal Mine, 

72-inch coal, continuous miner and Coal Preparation Plant 

for Eastern Underground Mine. 

2/ 2 Million ton per year Surface Mine in Illinois Basin and 

Coal Preparation Plant for Illinois Basin Mine. 

31 5 Million ton per year Surface Mine, Powder River Basin. 

4/ 245,000 ton per day Open-Pit Copper Mine and 98,000 ton 

per day Copper Concentrator 

5/ Taconite Mine and Taconite Processing Plant. 
Appendix to Chapter 3 

I. Effect of Tax Subsidy on Price of Virgin Materials 

Graphical Illustrations 

The tax subsidies to virgin materials shift their supply 

curves downward, lowering the private cost of production at 

any given level of output. The effect on virgin material 

prices is shown in Figure 3. 1. Supply shifts down from s1 to 

s2, raising domestic output of the virgin material from x1 to 

x2, and lowering price from wl to w2. 

The relative size of the two effects of the supply curve 

shift -- the price effect and the output effect -- depends on 

the elasticity of the demand and supply curves for the virgin 

material. If the price elasticity of supply were infinite, 

i.e., if the annual output of mines and/or timber stands 

could be increased without increasing the unit cost, the 

price would decline by the same percentage as the downward 

shift in the supply curve. On the other hand, if supply were 

upward sloping and demand were perfectly elastic, price would 

remain unchanged. The supply curve shift would increase 

domestic output, but leave price unchanged. If the supply 

curve were vertical (i.e., output totally unresponsive to 

price), the tax subsidy would raise the price received by 

sellers, but would leave output and the price to buyers 

unchanged. 
Price of 

Virgin 

Material 

w 

-138-

x, x~ 

X 1 = output of virgin material in absence of tax subsidy 

X 2 = output of virgin material with tax subsidy 

W 1 = price of virgin material in absence of tax subsidy 

W 2 = price of virgin material with tax subsidy 

Domestic Output 

of Virgin Material 

Figure 3.1 Effect of Tax Subsidies on Virgin Material Prices 
-139-

These three cases are illustrated in Figure 3.2. In 

case 1, the demand curve is totally elastic. Price remains 

unchanged (W1 = w2 ), while output increases from x1 to x2 . 

supply is infinitely elastic, and demand is 

Price declines by the full amount of the 

In case 2, 

downward sloping. 

supply curve shift 

x1 to x2 . 

from w1 to w2 , while output increases from 

In case 3, supply is totally inelastic, and demand is 

downward sloping. Both output and price paid by consumers 

remain unchanged. Eliminating the tax subsidies reduces 

after-tax revenue per unit of output received by producers 

from R1 to R2 • Because producers do not alter their economic 

behavior, they absorb the full cost of the tax increase. (If 

new investors in a competitive capital market required an 

unchanged after-tax return to be induced to purchase mining 

or timber growing land, the cost of the tax increase to 

current owners would take the form of a reduction in land 

values.) 

Algebraic Formulation 

The effect of demand and supply elasticities on the 

price change resulting from a supply curve shift can be 

expressed algebraically. For conceptual simplicity, suppose 

that both supply and demand are constant elasticity functions. Then, the supply and demand curves can be written as: 

(Supply) 

•.•• Equation (3.la) 
Price of 

Virgin 

Material 

-140-

Case 1: Demand 

Infinitely Elastic 

0 X, 

Figure 3.2 

Domestic Output 

of Virgin Material 

Effect of Tax Subsidies on Virgin Material Prices: Alternative Elasticity Assumptions 
Price of 

Virgin 

Material 

Price of 

Virgin 

Material 

Case 2: Supply 

Infinitely Elastic 

0 

Case 3: Supply 

Totally Inelastic 

0 

-141-

Figure 3.2 (Continued) 

Domestic Output of 

Virgin Material 

Domestic Output 

of Virgin Material 
-142-

log(X) = d0 + d1 log(W) + d2log(Z2) 

.... Equation (3.lb) 

(Demand) 

In Equations (3.1), X= output, W =price, c1 = elasticity of supply of the virgin material; d1 = elasticity of 

demand for the virgin material; z1 and z2 represent variables 

(other than price) that affect supply and demand, respectively; and c0 , c 2, d0 , and d2 are constants. Rearranging 

terms, the supply equation can be written: 

log (W) = K + (l/c1) log (X) ...• Equation (3.2) 

The subsidies to virgin materials lower the value of K 

in Equation ( 3. 2), because they lower the supply price for 

any level of output of the virgin material. A 10 percent 

reduction in the supply curve means that K is reduced by 10 

percent. Solving Equations (3.1) for W in terms of all the 

constants, and differentiating with respect to K, we obtain: 

.... Equation (3.3) 

Equation (3.3) states that the percentage change in 

price for a given percentage shift in the supply curve equals 

the elasticity of supply divided by the algebraic difference 

between the elasticities of supply and demand. Because the 

elasticity of supply, c1 , is positive and the elasticity of 

demand, d1 , is negative, (dlogW/ dlogK) is always greater than 

zero and less than one. 

As the elasticity of supply approaches infinity (i.e., a 

flat supply curve), or the elasticity of demand approaches 

zero (i.e., a vertical demand curve) the percentage change in 
-143-

price becomes equal to the percentage shift in the supply 

curve (dlogW/ dlogK = 1). For very high absolute values of 

the elasticity of demand (i.e., a flat demand curve indicating a constant market price for any level of domestic output), or for ver y low values of the elasticity of supply 

(i.e., a vertical supply curve), the percentage change in 

price approaches zero . 

II. Effects of International Markets on Price Change from 

Tax Subsidy 

Tax Subsidy on an Exported Product 

Consider the situation in which the United States 

subsidizes a commodity which it normally exports, for instance, coal. We assume that exchange rates are either free 

to float or are adjusted from time to time , and that prior to 

the subsidy the U.S. balance of payments is in equilibrium. 

The coal market is depicte d in Figur e 3.3. 

The pre-subsidy long-run domestic supply curve for coal 

is represented by S. The demand curve from domestic use r s is 

shown by D. The world demand for coal facing u.s. producers 

is given by W, and is assumed for now to be perfectly elastic. This means that u.s. producers account for such a small 

fraction of world coal output that they cannot affect the 

world price. In the absence of inte rnational trade, the 

U. S. would produce quantity q of coal at price Po . Because 

the world price of coal, P1 , is higher than P0 , the u.s. 

consumes quantity c 0 of coal, produces quantity a

0 , and 

exports quantity c 0a 0 . The U. S . now provides a subsidy on 

coal equal to amount t 0 . The subsidy will increase the 

supply curve or shift it downwards by the amount of the 

subsidy, t

0 , to S* . Exports incr e ase to quantity c 0

a 1 , but 
Price of 

Coal 

(Dollars) 

p 

0 

-144-

Quantity of 

Coal (tons) 

Figure 3.3 Partial equilibrium effect of a subsidy on an exported product 
-145-

the world price, which is determined by world demand and 

supply conditions, remains constant at P1 . In the short run, 

since world price is constant, producers receive the benefit 

of the entire subsidy, t 0 • 

In the long run, the dollar must appreciate to eliminate 

the payments imbalance caused by the subsidy and increased 

exports. However, since the appreciation will restrain a 

variety of exports and stimulate a variety of imports, the 

dollar price of exported coal will not fall by as much as the 

amount of the subsidy. Because foreign currencies are worth 

less in terms of the dollar, the world demand curve, measured 

in dollars, shifts downwards to W*. The new dollar price of 

coal, at the appreciated exchange rate, is P2 • At this 

price, consumption increases to c1 , product ion declines to 

a 2 , and exports of coal decrease from the short-run postsubsidy, but pre-adjustment level of c 0a1 to quantity c1a 2 . 

Because of the subsidy, and the corresponding exchange rate 

adjustment, U.S. consumption has increased from c0 to c1 , 

U.S. production has increased from a0 to a2 , and u.s. exports 

of coal have increased from coao to cla2. 

It is clear that exports have increased because the 

initial impact of the subsidy, before any exchange rate 

adjustment, is to keep consumption at c0 and increase production to a1 . Exports are clearly larger than at the 

initial equilibrium c0a0 . The induced appreciation in the 

exchange rate will not completely offset the rise in coal 

exports, because the impact of the exchange rate change will 

be spread over all u.s. exports and all u.s. imports. In 

equilibrium, additional u.s. coal exports will be partly 

offset by smaller exports of other products and larger u.s. 

imports of various goods. Thus, the coal subsidy encourages 

coal exports. 
-146-

The long-run incidence of the subsidy is t 1 on U.S. 

producers and t 2 on u.s. consumers, with t 0 = t 1 + t 2 • The 

subsidy partly increases the return to producers and partly 

decreases coal prices. If the U.S. were a large supplier of 

coal on world markets, the world demand would be less than 

perfectly elastic, and the increased exports could only be 

sold at a lower world price, with part of the subsidy going 

to foreign consumers of coal. 

The effect of the tax subsidy on coal prices will be 

small if increased U.S. coal exports: 

(1) have a minor effect on the foreign exchange value of 

the dollar: and 

(2) can be sold at the going world price. 

Under these conditions the tax subsidy is dissipated in 

increased output with 1 it tle or no shift in relative prices 

favoring virgin materials consumption . The main effect of 

the subsidy is to increase our exports of coal. 

Tax Subsidy on an Imported Product 

The analysis is symmetrical with respect to an imported 

product, such as bauxite . This situation is depicted in 

Figure 3 . 4. If there were no international trade in bauxite, 

domestic demand and supply would be in equilibrium at price 

P0 and quantity q. But since the world price, P1 , is below 

P0 , the u.s. imports quantity a 0c 0 of bauxite. The world 

supply of bauxite imports also is assumed, in this case , to 

be perfectly elastic. 
Price 

of Bauxite 

(Dollars) 

-147-

Quantity of 

Bauxite (tons) 

Figure 3.4 Partial equilibrium effect of a subsidy on an imported product 
-148-

Suppose the U.S. provides a subsidy equal to t 0 for the 

mining of bauxite. As before, the domestic supply curve 

increases or shifts downward to S* because of the subsidy. 

Imports fall to a1 c 0, and in the short-run pre-adjustment 

period, the producer gets the full benefit of the subsidy. 

The reduced imports cause an appreciation in the dollar and a 

consequent fall in the world price of imports to P2 . At this 

new long-run equilibrium price, the U.S. imports quantity 

a 2c1 of bauxite. Because of the subsidy and corresponding 

exchange rate adjustment, u.s. consumption has increased from 

c 0 to c1 , production has increased from a0 to a2 , and imports 

of bauxite have fallen from a 0c0 to a 2c1 • The conclusion 

that imports have fallen is based on the same reasoning that 

led to the conclusion that a subsidy induced an export 

increase. 

The long run incidence of the subsidy is t 1 on u.s. 

producers and t 2 on U.S. consumers. This subsidy partly 

increases the return to domestic producers and partly 

decreases world bauxite prices. If the u.s. were a large 

importer of bauxite, the world supply would be less than 

perfectly elastic, and the reduced volume of imports could be 

purchased at a lower world price. Then, the subsidy would 

lower the world price of bauxite, both by its effect on the 

exchange rate, and by retarding the demand for imports. 

Still, the effect of the subsidy on bauxite prices would 

be small if reduced u.s. imports of bauxite: 

(1) have a minor effect on the foreign exchange 

value of the dollar, and 

(2) have little or no effect on world prices. 
-149-

Under these conditions, the tax subsidy is dissipated in 

increased output, with little or no shift in relative prices 

favoring virgin material consumption. The main effect of the 

subsidy is to reduce bauxite imports. 

Rough Approximation of Effect of International Markets on 

Domestic Price Change 

To compute the effect of international markets on 

materials price changes reported in Chapter 3, we applied 

Equation (3.3), with a modified value of the elasticity of 

demand. The modified demand elasticity, d1 * was assumed to 

equal d1/ (Q/D), where d1 is the world demand elasticity for 

the commodity, and Q/ D is the share of world output accounted 

for by U.S. producers. The term "d1 *" is meant to represent 

the elasticity of demand facing U.S. producers from the 

entire world. 

The rationalization of this approximation is as follows. 

The world is viewed as a single market for the commodity, 

with the u.s. account i ng for a fraction of world output. If 

the U.S. accounted for 25 percent of world output of coal, 

and U.S. output rose by 10 percent, world output would rise 

by about 2.5 percent. If the world elasticity of demand were 

-1.0, a 2.5 percent rise in world output, corresponding to a 

10 percent rise in U.S. output, would depress price by only 

2.5 percent. In effect, the elasticity of demand facing U.S. 

producers is about four times the elasticity of demand in the 

entire world market. At one extreme, if u.s. producers 

accounted for a miniscule share of world output, changes in 

U.S. output would have no effect on world price, and producers would face an infinitely elastic demand curve. At the 

other extreme, if u.s. producers accounted for the entire 

world market, they would face the world demand elasticity. 
-150-

The revised elasticity estimate, d1 *, is then substituted for d1 in Equation {3. 3) to compute the effect on the 

world price of a shift in the domestic supply curve. Because 

the absolute value of d1 * is greater than the absolute value 

of d1 , Equation {3.3) yields a smaller pric~ effect. 

The exchange rate effect discussed above was ignored in 

these computations, because it is probably very small. This 

may slightly understate the price effect; however, the price 

effect is overstated by ignoring the effects of changes in 

the world price on output supplied from other countries. 

III. Effect of Change in Price of Virgin Input on Recycling 

Recyclable Input Treated as Imperfect Substitute for Virgin 

Input 

As noted in the text, econometric models estimated in 

the 1 iter ature generally treat virgin and recyclable materials as separate goods, each with a distinct demand and 

supply curve. This section illustrates the effect, in such 

models, of the change in the price of a virgin material input 

on the equilibrium level of output and price of the recyclable input. 

Figure 3. 5 illustrates the impact of virgin material 

price changes on the amount of recycling. A reduction in the 

price of virgin materials lowers the demand for recyclable 

inputs from o1 to o2 , reducing their price and output. The 

decline in output is relatively greater the more elastic 

{flatter) the supply curve, and the less elastic {steeper) 

the demand curve. 
Price of 

Recycled 

Input 

s 

0 

-151-

Output and Consumption 

of Recycled Input 

0 , = demand curve for recycled inputs at initial virgin mineral prices 

0 2 = demand curve for recycled inputs at lower virgin material prices 

P,,P2 = pre-subsidy and post-subsidy prices of recycled Inputs 

0,, 0 2 = pre-subsidy and post-subsidy output and consumption of recycled inputs 

S = supply curve for recycled inputs 

Figure 3.5 Effect of Reduction in Virgin Material Prices on Recycling 
-152-

The effect of changes in virgin material prices on the amount 

of recycling can be derived from a two-equation model of the 

market for recyclable inputs: 

•.• Equation (3.4) 

•.. Equation (3.5) 

In equations (3.4) and (3.5), w is the price of virgin 

materials; P is the price of recyclable inputs, Q is the 

quantity of recyclable inputs produced and consumed; v1 and 

v2 are vectors of exogenous variables affecting supply of and 

demand for recyclable inputs, respectively; and a0 , a1 , a2 , 

b0 , b1, b2 , and b3 are constants. The term a 1 represents the 

supply elasticity of recyclable inputs, b1 is the own-price 

elasticity of demand for recyclable inputs, and b2 is the 

cross-elasticity of demand for recyclable inputs with respect 

to the virgin material price. The supply equation expresses 

quantity of recyclable inputs as a function of their price, 

and other variables, including consumption of the finished 

goods, which generates scrap potential. The demand equation 

expresses use in production of recyclable inputs as a function of their price, the price of competing virgin materials, 

and other variables, including current primary product 

production. 

Solving Equations (3.4) and (3.5) for Q, we obtain: 

log(Q) = ~0~1~1~3~2~0~1~2~1~1 

(al - bl) 

+ 2 log(W) 

(al - bl) 
-153-

Finally, differentiating with respect to W, the percentage change in recycling for any percentage change in the 

price of the competing virgin material can be expressed as: 

•.•• Equation (3.6) 

where (dlog (Q) /dlog (W)) is the elasticity of amount of 

recycling with respect to virgin material price. Because a 1 

and b 2 are positive and b1 is negative, (dlog(Q)/dlog(W)) is 

positive, i.e., a reduction in the virgin material price 

reduces the amount of recycling. It can be seen from Equation (3.6) that the effect of virgin material price changes 

on the amount of recycling is larger for higher values of the 

elasticity of supply of recyclable rna ter ial s ( a 1 ) and the 

cross-elasticity of demand for recyclable materials (b2 ), and 

for lower absolute values of the own price elasticity of 

demand for recyclable materials (b1 ). 

Recyclable and Virgin Inputs as Perfect Substitutes 

As the text notes, virgin 

regarded as perfect substitutes. 

and scrap 

In this 

copper can be 

case, the percentage change in recycling equals the percentage change in 

the price of the material, multiplied by the supply elasticity of the recyclable material (dlog (Q) = a 1 dlog (W)). The 

price of the material will be the same whether obtained from 

a virgin natural resource or by recycling. 
Depatnat ol the Tn~~UrJ 

W.hinaton, D.C. 20220 

011111111 ...... 

...................... FIRST CLASS