There are few, if any, studies which systematically evaluate the effects of the depletion allowance. In the absence of studies on the environmental consequences of the depletion allowance with respect to recycling, only crude guesses can be made. Suppose, for example, that the 15% iron ore depletion allowance translated into a 10% equivalent price subsidy. Suppose the allowance were eliminated. Prices, rents, profits, and cost depletion all change. After these adjustments have worked themselves out the price of iron ore becomes permanently higher, in a range say of 2 to 8%. By Sawyer's and Russell's estimates the resulting increase in sales of scrap iron might be rather large even for the low end of the range, in the neighborhood of 10 to 40%. It is conceivable, then, that elimination of the depletion allowance could double the market for scrap iron. However, it should be remembered that the required empirical work has yet to be done and this is only a crude guess. The effect of the depletion allowance is illustrated in figure 3, which is labeled in the same way as figure 2. Without the depletion allowance there would be s, material supplied, of which s2 is secondary and s ̧ is primary. Imposition of the depletion allowance is equivalent to a negative sales tax S, per unit of primary material supplied. This subsidy pushes down the supply curve B by proportion rate S to B'. The aggregate supply curve becomes C'. With the depletion allowance total material bought is Se, with S-S, less secondary material and s-S3 more primary material. The depletion allowance not only encourages more depletion of primary material and less utilization of scrap material, but also it encourages greater total material throughput (s) in the economy and hence larger total waste flows (A, B and C in figure 1). OTHER TAX ADVANTAGES ACCORDED TO PRIMARY MATERIALS The provisions below are considerably less easily converted into equivalent price subsidies. Without translating the subsidies below into equivalent price subsidies there is no sure way to analyze their effects on recycling, increased solid waste costs, and conservation. Nonetheless, some commentators have surmised that either foreign tax credits or expensing of exploration and development expenditures alone may equal the effects of percentage depletion upon recycling, waste costs and conservation. Because of the difficulties involved in translating the subsidies below into equivalent price subsidies little effort will be made in this paper to compute these equivalencies. Exploration and Development Costs Section 617 of the Internal Revenue Code permits all domestic exploration costs to be expensed as long as these costs occur before the mine reaches its development stage. In the absence of this provision, exploration expenditures would be recoverable through the depletion allowance, cost or percentage. In order to prevent a double deduction for exploration expenditures, the amount expensed is recaptured for tax purposes by adding it to later gross income or subtracting it from later depletion allowance deductions. The net effect of the provision is to advance the timing of the deduction for exploration costs. Without this provision exploration costs would otherwise be matched against future income and deducted later. The value to the mineral company of a deduction now rather than later is determined by how much the company discounts future income. At a 15% discount rate, a deduction today is worth twice that same deduction five years from now. Although the provision is a little different, Section 616 offers the same type of advantage for development expenditures. The two provisions together have much the same effect for hard minerals as expensing of intangibles, which are up to 80% of the development costs in the oil and gas industry. Capital Gains Nearly all the income of timber producers and much of the income of coal and iron lessors is subject to favorable capital gains treatment. Coal and iron also receive percentage depletion. By using capital gains rates, timber producers are able to lower their income tax rate from the 48% ordinary rate to roughly 30%.10 The Treasury estimates that the tax loss for timber alone was $150 million in 1972 and $175 million for 1973. It is not known how much of this advantage goes to paper production and what the effect of it is on the price of wood pulp at a point where it competes with scrap paper. Near the product level of competition between primary and secondary paper, Sunley tentatively estimates that the price effect is less than one percent. For a comparison closer to the raw material stage of unbleached fibers the price effect may be somewhat larger, perhaps several percent. At this point the impact of capital gains treatment on paper, scrap iron and steel, and energy recovery is still an unsettled question. Foreign Tax Credits In brief, the foreign tax credit allows companies to subtract the tax paid to foreign governments from the Federal tax liability. Of the $4 billion in foreign tax credits claimed by U.S. corporations in 1969, most of the subsidy went to extractive industries. Often the tax credit is defended on the grounds that it is a device to prevent double taxation by achieving the same total tax burden for foreign and domestic operations. However, taxes paid to foreign governments are of a different nature than taxes paid to governmental units inside the U.S. From the 10 Emil Sunley, "The Federal Tax Subsidy of a Timber Industry," in The Economics of Federal Subsidy Programs, a compendium of papers submitted to the Joint Economic Committee, Part 3-Tax Subsidies, July 15, 1972. point of view of the U.S. economy, taxes paid to the federal government are transfers; the tax payments do not involve resources lost to the economy. Taxes paid to foreign governments, on the other hand, send dollars overseas which eventually will be redeemed by U.S. goods and services. From the point of view of the U.S. economy taxes paid by U.S. businesses to foreign governments are costs of business just as much as wage payments. A dollar paid out for a foreign laborer has the same effect on the U.S. economy as a dollar paid out to a foreign government. Because tax payments to foreign governments have economic effects different from tax payments to the U.S. government, allowance of foreign tax credits is an important subsidy. Percentage depletion allowances, by themselves, can only halve the federal tax rate, due to the 50% of net income limitation. Foreign tax credits, in addition to depletion allowances, permit many extractive companies to pay little or no Federal tax.11 Freight rates There is little doubt that secondary materials bear higher freight. rates than their primary material counterparts. For just one example, the 1966 average rail revenue per 100 pounds of iron and steel scrap was 20.6 cents, while the rate for iron ore was 8.2.12 Scrap iron and steel account for about 80% of all the secondary material shipped by railroads. Similar disparities, though not all of this size, exist for many other pairs of competing secondary and primary materials. There is also little doubt that the cost of transportation is a significant proportion of the total cost of a secondary material (about 10% for secondary aluminum and scrap iron and steel, 20-30% for some grades of secondary paper). Consequently freight rate differentials between primary and secondary materials have a large impact on the amount of material recycled. Mere existence of a rate difference does not mean that there is discrimination against secondary materials, however. If the cost of shipping a secondary material is twice the cost of shipping its primary material competitor, then the efficiency criterion indicates that the rates should reflect this difference. In its environmental impact statement on recycling, the ICC noted the disparities in rates between primary and secondary. But then it argued that these disparities are justified on the grounds of differences in cost. Trade groups of secondary industries have counterargued that the disparities are too great to be explained only in terms of cost. They argue that other factors, such as the greater bargaining power of the primary industries, have widened the gap unfavorably for secondary materials. Unfortunately this debate is far from resolution. The ICC's data, though voluminous, is not collected in such a way that the costs of shipping various materials can be computed easily, if at all. The problem is not entirely due to deficiencies in data collection, however. Allo 11 For a discussion of the mechanics of foreign tax credits see Graville, Jane, "Special Provisions of the Federal Income Tax Affecting the Oil and Gas Industry: A Study of Provisions. Pros and Cons, and Selected References," Congressional Research Service, Library of Congress, August 25, 1972. 12 Interstate Commerce Commission, Ex Parte No. 281, Draft Environmental Impact Statement, March 13, 1973, p. 15. cation of the very large joint costs and the long run capital costs would be very difficult in any case. Moreover, it should be pointed out that the criterion of economic efficiency, made operational by marginal cost pricing, has never been accepted as the only or even the most important basis for transport rate making. The ICC's first report, in 1887, sanctioned value-ofservice rate making. This basis for rate making has nothing to do with cost. Value of service charges "what the traffic will bear." Highervalued products, for which transportation is a lower fraction of total cost, absorb higher rates more easily and hence bear higher rates. Value of service rate making benefits both secondary and primary materials compared with much higher valued manufactured goods and encourages more material throughput, both primary and secondary, than would be the case with marginal cost rate making. It is still an open question whether value-of-service pricing benefits secondary materials more or less than primary materials. It is also still an open question whether or not the large discrepancies in rates between primary and secondary materials can be justified in terms of cost difference. The most that can be said at this point is that justifications in terms of cost have not yet been made. Even if it were found that the discrepancies were based on cost differences rather than differences in bargaining power, the ICC has wide latitude to depart from cost-based rates when it deems it in the public interest or is so instructed by Congress. The same type of problem exists with scrap and primary materials shipped overseas in freighters. With ocean freight there are also charges of discrimination against scrap in favor of primary materials. FAILURE TO INCLUDE DISPOSAL COSTS One of the most obvious failures of the price system is the failure to include disposal costs in a product's price. In years past when the costs of waste disposal were very much lower, this failure in the price system hardly mattered. In rural 19th century America each farm had its own open dump; the little solid waste which accumulated could be thrown away at virtually zero cost. Now the cost of waste collection and disposal is approaching $30 a ton in New York City. And besides increasing in volume per capita, the waste is becoming more "exotic". modern solid waste contains more cadmium, arsenic, PCB and an increasing number of other substances which can impose further social costs after treatment and "disposal". The price of a cadmium flashlight battery should include not only the sanitation department's cost of collection and incineration but also the cost of health hazard created by the cadmium vapor emitted from the incinerator smokestack. While it hardly mattered a century ago, the failure to include disposal (and post disposal) costs in a product's price has become a serious failure of the price system. Another way of saying the same thing is to say that disposal costs have become a significant fraction of the total cost of many products. As a result there is too much material throughput in the economy and too little recycling. And the composition of products is shifted toward bulkier, heavier, and more toxic materials than would be the case if disposal costs were to be somehow point of view of the U.S. economy, taxes paid to the federal government are transfers; the tax payments do not involve resources lost to the economy. Taxes paid to foreign governments, on the other hand, send dollars overseas which eventually will be redeemed by U.S. goods and services. From the point of view of the U.S. economy taxes paid by U.S. businesses to foreign governments are costs of business just as much as wage payments. A dollar paid out for a foreign laborer has the same effect on the U.S. economy as a dollar paid out to a foreign government. Because tax payments to foreign governments have economic effects different from tax payments to the U.S. government, allowance of foreign tax credits is an important subsidy. Percentage depletion allowances, by themselves, can only halve the federal tax rate, due to the 50% of net income limitation. Foreign tax credits, in addition to depletion allowances, permit many extractive companies to pay little or no Federal tax.11 Freight rates There is little doubt that secondary materials bear higher freight rates than their primary material counterparts. For just one example, the 1966 average rail revenue per 100 pounds of iron and steel scrap was 20.6 cents, while the rate for iron ore was 8.2.12 Scrap iron and steel account for about 80% of all the secondary material shipped by railroads. Similar disparities, though not all of this size, exist for many other pairs of competing secondary and primary materials. There is also little doubt that the cost of transportation is a significant proportion of the total cost of a secondary material (about 10% for secondary aluminum and scrap iron and steel, 20-30% for some grades of secondary paper). Consequently freight rate differentials between primary and secondary materials have a large impact on the amount of material recycled. Mere existence of a rate difference does not mean that there is discrimination against secondary materials, however. If the cost of shipping a secondary material is twice the cost of shipping its primary material competitor, then the efficiency criterion indicates that the rates should reflect this difference. In its environmental impact statement on recycling, the ICC noted the disparities in rates between primary and secondary. But then it argued that these disparities are justified on the grounds of differences in cost. Trade groups of secondary industries have counterargued that the disparities are too great to be explained only in terms of cost. They argue that other factors, such as the greater bargaining power of the primary industries, have widened the gap unfavorably for secondary materials. Unfortunately this debate is far from resolution. The ICC's data, though voluminous, is not collected in such a way that the costs of shipping various materials can be computed easily, if at all. The problem is not entirely due to deficiencies in data collection, however. Allo 11 For a discussion of the mechanics of foreign tax credits see Graville. Jane, "Special Provisions of the Federal Income Tax Affecting the Oil and Gas Industry: A Study of Provisions. Pros and Cons, and Selected References," Congressional Research Service, Library of Congress, August 25, 1972. 12 Interstate Commerce Commission, Ex Parte No. 281, Draft Environmental Impact Statement, March 13, 1973, p. 15. |