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3.4.1 Tax Penalties and Tax Subsidies

It is in the area of elimination of tax penalties
against reclaimed raw materials and tax subsidies
for industries mining virgin metals that the measures
probably most effective in reducing substantial mar-
ket distortions now exist. The effective tax rate
of mining industries is now about half that of in-
dustries reclaiming raw materials. This subsidy,

in tandem with the freight differentials listed above,
operates to prevent the development of a thriving
secondary materials industry.

a. Elimination of percentage depletion allowance
for minerals

The economic relationships based on the historical
tax subsidy awarded extractors of minerals are extra-
ordinarily complex and the perennial debate on their
proposed elimination or retention is quite fierce.
However, the graduated but effective elimination of
this subsidy most probably would tend to permit a more
freely functioning natural resources market.
The ex-
pected set of disruptions arising from a gradual, but

short-term elimination of the subsidy would have the
following effects:

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. disruptions in the price and demand for virgin raw materials and for reclaimed raw materials. Demand for the latter will greatly increase; demand for the former will stabilize. shifts in labor from mining to processing or manufacturing industries. This variable involves a potentially trying amount of disruption in the daily pattern of people's lives.

. diversion of capital into reclaimed materials, transportation and reprocessing facilities. This diversion should have a stimulating effect on the development of efficient separation, collection and reprocessing systems.

. disruption of the flow of capital into extractive

industries.

. potential disruption in foreign trade balances. Direct elimination of this subsidy is preferred to the creation of new benefits for reclaimed materials parallel to those now existing for virgin raw materials. A layer of compensatory subsidy to the secondary materials industry would compound the distortion of market forces, complicate transactions and add to the

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individual tax burden. Total elimination of the

subsidy would operate to maintain a position of

equitable competition between the raw materials market and other sectors of the economy.

b.

Elimination of capital gains treatment on the
sale of domestic iron ore.

The same policy considerations as above apply to the elimination of capital gains treatment on the disposition of domestic iron ore. The effect of this provision (Section 631 (c) of the Internal Revenue Code) is to consciously induce vertical organization in certain mining and processing industries, and to provide a clear incentive to mine and use virgin raw materials rather than reclaimed materials. The lower effective tax rate on the mining and disposition of domestic iron ore results in higher after-tax profits for a vertically organized industry, or in a lower purchase price to an unrelated purchaser. Management is thus forced to elect the use of virgin iron ore, rather than seek reclaimed materials.

C. Creation of a compensatory recycling tax deduction

The most popular proposal for eliminating the differential tax treatment between virgin and raw material

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is that of a compensatory recycling tax deduction. Under the proposal, the manufacturer using recycled raw materials would be entitled to a recycling tax deduction (or corresponding tax credit) computed as a percentage of the cost of the reclaimed raw material. The percentage would vary as a function of the level necessary to overcome the competitive advantage afforded corresponding virgin raw materials by existing depletion allowances. The purchaser is thus presumably left in the identical financial situation as he would be in,given a purchase of virgin raw materials. This approach has been endorsed by the 1972 Report to the President by the Citizen's Advisory Committee on Environmental Quality and various members of Congress who have in the past introduced similar legislation in this (Griffiths, Pettis, Rostenkowski and Schneebeli). For reasons stated above, this measure is considerably less effective than a total elimination of Federal subsidy in the extraction of virgin materials. It would grant an unwarranted subsidy to the raw materials industry as a whole, virgin and reclaimed, and would ultimately act to complicate transactions, to distort the efficient and free distribution of resources, and to increase the relative cost of raw materials.

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d. Five (5) year amortization for recycling
facilities

This measure would permit a taxpayer an election to
amortize a certified raw materials recycling facility
over a relatively short five year period, thus creating
an incentive to invest in such facilities and to improve
the underlying recycling technology. It has precedent
in a similar 5 year amortization provided by the 1969
Tax Reform Act for pollution control facilities (Sec-
tion 169 of the Internal Revenue Code). It appears
to be a sound measure with limited impact, and one
which would be most effective if enacted in tandem
with an elimination of depletion allowances.

3.4.2 Transportation Penalties and Subsidies

As previously indicated, there exist wide disparities
in both the rail and ocean freight rates for reclaimed
and virgin materials. In combination with the tax sub-
sidies discussed previously, these differential freight
rates operate to prevent the development of an efficient
secondary raw materials market.

The provisions of an existing proposal, S.1122 sponsored
by Cook, appear to be a reasonable resolution of freight
rate differentials. The measure directs both the Inter-
state Commerce Commission and the Federal Maritime