For GRN: Virgin Subsidies
Fri, 22 Jan 1999 16:19:51 -0500

TO GRN folks
FROM Bill Sheehan

[The following from Frank Ackerman concerns virgin material subsidies,
as will be published in a new book in December.
We might want to check our end-welfare-for-wasting paper with this.]

My take on virgin material subsidies is that the current subsidies are
not big enough to explain much; perhaps historical subsidies were more
important, especially before the 1986 tax reform. But in general I argue
that there is only limited opportunity to make recycling a market-driven,
profitable activity by tinkering with incentives; much more important is
to revalidate the concept of doing the right thing for the environment
without putting price tags on things. (A great recent academic economics
article on this subject is called "Choices without Prices without
Apologies", a phrase I wish I had thought of).

Enclosed is the text from Chapter 2 on current subsidies; I'm afraid the
footnotes didn't come through in this version.


Virgin material subsidies and taxes

While unit pricing seeks to influence household disposal decisions,
other incentives aim to affect producer choices among materials. Existing
tax codes, laws, and regulations often favor virgin materials over
recycled ones, resulting in an unfair competitive advantage. Eliminating
all preferences for virgin materials would create a level playing field ,
improving the competitive position of secondary materials in the
marketplace. Internalizing the externalities associated with virgin
material production, either by subsidizing secondary materials or by
taxing virgin ones, would go even further, tilting the playing field in
favor of recycling.

Changes in virgin material subsidies and taxes are politically
difficult to implement, and the discussion has remained largely
theoretical. Still, there have been several studies of the magnitude of
existing virgin material subsidies and their effects on recycling. These
studies have generally found that, while virgin material subsidies pass
the Dirksen significance test ("A billion here, a billion there, soon you
re talking real money", as the late Senator Everett Dirksen once said),
they are not important barriers to recycling.

The EPA s Agenda for Action, among its many recommendations, called
for an assessment of existing obstacles to recycling. One result was a
study, Federal Disincentives: A Study of Federal Tax Subsidies and Other
Programs Affecting Virgin Industries and Recycling, performed in 1989 but
only released in 1994 after extensive review and revision. The study notes
that the 1986 federal tax reform eliminated many provisions that had
favored extractive industries; tax advantages for virgin materials
presented a more serious obstacle to recycling before that date.

Examining the laws and regulations in effect in 1989, the study found
that energy subsidies were the most important federal disincentive, while
other federal tax provisions and regulations were too small to affect
recycling markets. In the case of the paper industry, total federal
subsidies to virgin production amounted to no more than 2.6% of the
industry's cost of materials, with energy subsidies accounting for more
than half of that amount. Energy subsidies are potentially barriers to
recycling because extraction and processing of virgin raw materials uses
far more energy than recycling and processing of secondary materials.
Thus if subsidies for energy use were removed, virgin materials would
become more expensive relative to their recycled counterparts, improving
the market position of recycling.

Two studies have tried to measure federal energy subsidies. The
Department of Energy's Energy Information Administration identifies
subsidies worth $5 to $13 billion a year, while the Alliance to Save
Energy, an energy conservation advocacy group, obtains estimates of $23 to
$40 billion (in 1992 dollars). Energy subsidies in the tens of billions
of dollars are large enough to warrant public debate; they are not
insignificant when compared to the budget and tax cuts that are the
subject of ongoing controversy in Washington. But subsidies of this
magnitude do not, in most cases, create a noticeable advantage for virgin
over secondary material production.

An article by Douglas Koplow, exub.oing energy subsidies to the
aluminum industry, appears to make the opposite point, finding a
significant effect on aluminum prices. In fact, his analysis of aluminum
is the exception that proves the rule. Aluminum production is extremely
energy-intensive, requiring three to six times as much energy per ton as
the production of steel, paper, or plastics. The cost of electricity
represents 25% to 30% of the cost of aluminum made in the United States.
Moreover, recycling saves 95% of the energy required to produce virgin
aluminum, an unusually great savings. As a result, one would expect the
importance of energy subsidies to be far greater for aluminum than for
other materials industries.

Koplow analyzes the aluminum smelters that buy electricity from the
Bonneville Power Administration (BPA) in the Pacific Northwest. Federal
subsidies to BPA, passed on in lower prices for electricity, could be
important to these producers. For the BPA's customers, federal energy
subsidies amounted to 5% to 13% of the market price for primary aluminum
in 1989, the year for which Koplow's data were developed, or 7% to 18% of
the price of scrap aluminum in 1994. The difference between the high and
low estimates reflects the cost advantage of public power, the biggest
item that Koplow counts as a subsidy. As a governmental entity, BPA can
borrow money at lower interest rates than a private utility, and does not
have to earn a profit; hence it can and does charge its customers less for
electricity. The higher estimates include this advantage, while the lower
ones exclude it.

In an era when the virtues of privatization are held to be almost
beyond dispute, it is startling to stumble across evidence that public
enterprises sometimes provide basic services more cheaply than
profit-making private businesses. It seems perverse to describe this
savings, the economic return on an earlier optimism about public
investment, as an unfair subsidy. In any case, the advantage of cheap
public power is only available to industries and other electricity
consumers in a few rigidly defined geographical areas. It is not part of
the story of subsidies to virgin material industries in general.

Excluding the local advantages stemming from public ownership of BPA,
Koplow finds that energy subsidies amount to 7% of the price of scrap
aluminum -- in effect, a 7% price penalty on recycling. In other
industries, where the energy saved by recycling accounts for a much
smaller proportion of production costs, the barrier to recycling due to
energy subsidies is proportionately smaller, likely in the range of 1% of
prices or less.

Another perspective on the issue is provided by a Tellus Institute
study of state virgin material incentives in California, performed for the
California Integrated Waste Management Board (CIWMB). The qualitative
conclusion is the same as in the federal case: while state incentives cost
California taxpayers huge amounts annually, this does not affect the
competitive position of secondary materials in the California economy.

We found that three industries -- crude oil, natural gas, and timber
-- together account for more than two thirds of the value of raw materials
produced in California, and receive virtually all of the quantifiable
state subsidies and incentives. The timber industry receives preferential
tax treatment, subsidized fire protection, and other timber management
services, worth $70 million or 8% of the value of timber harvested in
1990. Several provisions of the state tax code are in effect subsidies to
the oil and gas industry; depending on one's view of a local tax
controversy, the total subsidy to oil and gas production might be as much
as $255 million, a little under 5% of sales in 1990.

Yet these amounts have almost no effect on recycling, for two
reasons. The first is what we called the mismatch between virgin and
secondary material production. Almost none of the subsidized virgin
materials compete with the state's recycling efforts. Oil and gas are
used almost entirely for fuel, while California timber is used almost
exclusively to make lumber rather than paper. Thus while subsidies to
oil, gas, and timber drain the state s budget and undoubtedly promote
excessive use of these materials, this has almost no direct effect on

Second, even in the few cases where subsidized virgin materials do
compete directly with recycled materials, the state incentives are too
small to make a difference. Other factors are far more important in
determining the profitability of recycling. Lumber recycling is
apparently confined to unusual market niches where a steady supply of
clean lumber is available, such as recycling of Hollywood studio sets, or
to sporadic opportunities such as post-earthquake salvage. The supply of
recyclable lumber is the limiting factor, and would remain so even if all
state subsidies to virgin lumber production were removed.

A small amount of oil and gas is used to make plastics and asphalt,
two areas where virgin and recycled products do compete directly. In the
case of plastics we estimated that, at $17 per barrel, the price of oil
represented 9% to 18% of the price of three common plastics. So
California's incentives for crude oil production, worth just under 5% of
the value of crude oil, would be less than 1% of the value of plastics --
hardly a decisive factor in the competition between virgin and recycled

The situation is similar in the case of asphalt, which is made up of
a lot of rock and sand aggregate mixed with a little bitumen, a crude
oil-derived product. The cost of crude oil used to make bitumen
represents about 16% of the price of asphalt, so again a 5% subsidy to
California crude oil production represents less than 1% of the price of

The traditional technique for repaving roads involves scraping off
the old pavement and transporting it to a landfill, then bringing in new
aggregate and bitumen to make new asphalt. Alternatively, it is possible
to use the old pavement in one of several recycling techniques, producing
new pavement with 15% to 100% recycled content. Asphalt recycling is
profitable for many California communities in part because it avoids
transportation costs, both for bringing new aggregate from remote quarries
and for taking old pavement to landfills. If California's incentives for
oil production were fully passed on to asphalt buyers, it would become
cost effective to bring in virgin materials from only five minutes farther
away. In short, asphalt recycling, like plastics recycling, is barely
affected by California's virgin material subsidies.

Subsidies to virgin material production have been much greater in the
past; speculation about the historical importance of subsidies is
presented in Chapter 3. But the most important past subsidies have
gradually been reduced or abolished. At this point, removal of the
remaining incentives for virgin material production, creating a level
playing field between virgin and secondary materials, would do little to
promote recycling -- with the interesting but apparently isolated
exception of aluminum. Ironically, aluminum already has the highest
recycling rate among common materials; the sole obvious effect of
eliminating all virgin material incentives would be to increase aluminum s
high recycling rate still further. Elimination of subsidies to extractive
industries is generally a worthwhile objective for other reasons, but is
unlikely to do much to promote recycling.