Subsidies are bad… mmmkay?

I had the opportunity to type out a primer on subsidies and play around with Microsoft Paint. Here is what I came up with:

What is a Subsidy?

Subsidies are government spending and tax policies designed to increase the production and consumption of particular goods or services and/or benefit specific industries or businesses. Economists stress that the legal recipient of a subsidy does not change its economic impact, therefore it does not matter whether the producer or the consumer initially receives the funds from the government.

Subsidies come in many forms. Categories include tax credits, grants, bailouts, and other forms of cash or benefits that can only be secured by government.

Why are Subsidies Harmful?

subsidy-graphic

Subsidies are harmful to the economy and well-being of society primarily because they waste resources. Subsidies create four forms of resource waste. First, subsidies increase the production and consumption of goods or services beyond what would occur naturally. Goods and services are produced at a price-level that is beyond what consumers would otherwise be willing to pay and the subsidy covers the difference. This means that the cost in resources to provide the subsidized good or service exceeds the value it creates to the consumer. In short, the resources used to produce the good or service, such as the steel in subsidized car, have a use somewhere else in society that consumers would value more.

Secondly, subsidies must be financed through taxes. The government must either collect money to distribute as a subsidy or raise taxes to offset lost-revenue from subsidies created through tax breaks. These taxes reduce the ability of consumers to spend money on products and services they value the most, harming well-being.

The third way subsidies create waste is through moral hazard. Moral hazard is a phenomenon that occurs when decisions towards one outcome increase the risk of another, generally negative result. An example of moral hazard is a person riding their bike less carefully when they are wearing a helmet, as they feel more protected.  Subsidies also act like protection against poor decision-making by businesses and consumers. The problem is that the government, and therefore taxpayers are paying for this protection. Businesses may feel liberated by subsidies to make more risky investments or deliver a lower quality of product or service, resting assured they will receive a bailout or other assistance. Consumers may not budget appropriately and waste resources on things they would not value at the given price-level absent the subsidy.

The final way subsidies waste resources is through rent-seeking. Oftentimes synonymous with lobbying, rent-seeking is defined as the pursuit of resources or other benefits from the government that would not otherwise exist in the market. Instead of investing resources in producing goods or services consumers value, businesses spend those resources on lobbying the government for a subsidy.

Examples of Subsidies

Automaker Bailouts- In 2009, the federal government spent nearly $80 billion to prevent General Motors and Chrysler from collapsing into uncontrolled bankruptcy. By keeping these companies afloat, the government compensated the difference between the cost of what these companies were producing and the value they created to consumers, essentially rewarding inefficient behavior. Instead of allowing the resources these companies were using, such as labor, steel, and factories, to shift to sustainable companies and other industries, these resources continued to be employed in ways that were not their most valuable use. In addition, estimates are that the government lost over $10 billion on these bailouts.[1]

California Water Subsidies- Subsidies also exist at the statearound with  and local government level and can be just as problematic. In California, for example, farmers receive over $400 million in subsidized water supply.[2] This has led to over-consumption of water and other inefficient practices such as growing water-intensive crops in areas of California where such crops would otherwise not naturally survive.[3]

[1] http://www.libertylawsite.org/2014/01/13/the-corporatist-legacy-of-the-auto-bailouts/

[2] http://www.ewg.org/research/california-water-subsidies

[3] http://www.economist.com/news/united-states/21596955-drought-forcing-westerners-consider-wasting-less-water-drying-west

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