Subsidy

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In economics, a subsidy is generally a monetary grant given by a government to lower the price faced by producers or consumers of a good, generally because it is considered to be in the public interest. Subsidies are also referred to as corporate welfare by those who oppose their use. The term subsidy may also refer to assistance granted by others, such as individuals or non-government institutions, although this is more usually described as charity. A subsidy normally exemplifies the opposite of a tax, but can also be given using a reduction of the tax burden. These kinds of subsidies are generally called tax expenditures or tax breaks.

Subsidies protect the consumer from paying the full price of the good consumed, however they also prevent the consumer from receiving the full value of the thing not consumed – in that sense, a subsidized society is a consumption society because it unfairly encourages consumption more than conservation. Under free-market conditions, consumers would make choices which optimize the value of their transactions; where it was less expensive to conserve, they would conserve. In a subsidized economy however, consumers are denied the benefit of conservation and as a result, subsidized goods have an artificially higher value than expenditures which do not consume. Subsidies are paid for by taxation which creates a deadweight loss for that activity which is taxed.

Overview

In standard supply and demand curve diagrams, a subsidy will shift either the demand curve up (subsidized consumption) or the supply curve down (subsidized production). Both cases result in a new, higher equilibrium quantity. Therefore, it is essential to consider the price elasticity of demand when estimating the total costs of a planned subsidy: it equals the subsidy per unit (difference between market price and subsidized price) times the higher equilibrium quantity. One category of goods suffers less from this effect: Public goods are — once created — in ample supply and the total costs of subsidies remain constant regardless of the number of consumers; depending on the form of the subsidy, however, the number of producers demanding their share of benefits may still rise and drive costs up.

Examples of subsidies include utilities, gasoline in the United States, welfare, farm subsidies, and (in some countries) certain aspects of student loans.

Tax breaks and corporate welfare

As previously stated, a common form of subsidy is via a tax break. This is a reduction in the normal rate of a particular class of taxes targeted towards an individual or group of companies. Often this is described as "corporate welfare", although that term is also used as a blanket term for all other forms of subsidies. Larger companies who are planning to open a new factory, for example, shop around for a location which will provide them with the biggest tax breaks in a process called a race to the bottom. Locations provide these tax breaks because they often feel that the benefits of job creation will more than offset the decline in tax revenues. Often subsidies are given as protection to smaller producers, as otherwise they would fail to compete with larger producers who are operating at lower costs.

Another way that the government subsidizes industry is by failing to regulate externalities. For example, when a company pollutes, it generates savings for itself at public expense, in the form of environmental degradation and public health costs. Thus a cost of production is absorbed by the public. Some economists argue that this is a form of subsidy of producers. (Since producers are not paying the full social cost of production)

Subsidies due to the effect of debt guarantees

Another form of subsidy is due to the practice of a government guaranteeing a lender payment if a particular borrower defaults. This occurs in the United States, for example, in certain airline industry loans, in most student loans, in small business administration loans, in Ginnie Mae mortgage backed bonds, and is alleged to occur in the mortgage backed bonds issued through Fannie Mae and Freddie Mac. A government guarantee of payment lowers the risk of the loan for a lender, and since interest rates are primarily based on risk, the interest rate for the borrower lowers as well.

Controversy

One of the most controversial subsidies, especially in publications like The Economist, are the subsidies used in first-world countries and targeted towards farmers. Charitable institutions like Oxfam often criticize the high subsidies dumping millions of surplus commodities (like sugar) on world markets destroying opportunities for farmers in developing and poor countries, especially in Africa. For example, currently, the EU is spending €3.30 in subsidies to export sugar worth €1 Source: Oxfam briefing paper. These subsidies have remained in place even though many international accords have reduced other forms of subsidies or tariffs. Many developing nations who are dependent on exports of farm produce argue that subsidies given to farmers in rich nations are the biggest single contributor to their continued poverty. The subsidies drive down the global market price to the point where farmers in poor nations, who do not receive subsidies, can no longer earn a living by selling their products. As a result not only are they unable to work their way out of poverty by selling their products, but they also become dependent on imports of subsidised goods because they are cheaper than locally produced goods. Most rich nations are reluctant to change their policy of giving subsidies though, because their inherently higher labour costs make their domestic farmers unable to compete globally without the subsidies. Removing the subsidies would mean lost jobs, and with powerful lobby groups and popular support to consider, few politicians are willing to change the status-quo in favour of poor farmers abroad, at the expense of local farmers and companies.

Conversely, many poor people consume subsidized produce, which would become more expensive without subsidies.

Another view, held by Austrian economists and other free-marketers, is that subsidies do, in general, more harm than good by distorting natural economic signals.

Sometimes people believe profitable companies to be 'bullying' governments for subsidies and rescue packages; this is the case with Australian rail operator Pacific National that threatened the Tasmanian Government with a pull out of rail services unless a subsidization was made. Despite the fact Pacific National is owned by Toll Holdings an extremely profitable multi-national company.

Historical meaning

In the 1500's the subsidy was a tax invented in England by Thomas Wolsey in 1513 that taxed based on the ability to pay. It was created in order that Henry VIII could pay for war with France.

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External links

Oxfam How EU sugar policies hurt poor countries

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