Subsidy
A subsidy, subvention or government incentive is a type of government expenditure which redistributes from tax payers to individuals, households, or businesses.
Subsidies take various forms, such as direct government expenditures, tax incentives, soft loans, price support, and government provision of goods and services. For instance, the government may distribute direct payment subsidies to individuals and households during an economic downturn in order to help its citizens pay their bills and to stimulate economic activity.
Although commonly extended from the government, the term subsidy can relate to any type of support – for example from NGOs, or international organizations. Subsidies come in various forms including: direct and indirect. Furthermore, they can be broad or narrow, legal or illegal, ethical or unethical. The most common forms of subsidies are those to the producer or the consumer.
All countries use subsidies via national and sub-national entities through different forms such as tax incentives and direct grants. Likewise, subsidies have an economic influence on both a domestic and international level. On a domestic level, subsidies affect the allocation decision of domestic resources, income distribution, and expenditure productivity. On an international level, subsidies may increase or decrease international interaction and integration through trade.
Generally, subsidies can take up a substantial portion of government expenditure. Among OECD countries in 2020, the median value of subsidies and other transfers such as social benefits and non-repayable transfers to private and public enterprises was 56.3 percent of total government expenses which was 34.9 percent of GDP in the same year. The number of subsidies in force have been rapidly increasing since 2008.
Types
Production subsidy
A production subsidy encourages suppliers to increase the output of a particular product by partially offsetting the production costs or losses. The objective of production subsidies is to expand production of a particular product more so that the market would promote but without raising the final price to consumers. This type of subsidy is predominantly found in developed markets. Other examples of production subsidies include the assistance in the creation of a new firm, industry and even the development of certain areas. Production subsidies are critically discussed in the literature as they can cause many problems including the additional cost of storing the extra produced products, depressing world market prices, and incentivizing producers to over-produce, for example, a farmer overproducing in terms of his land's carrying capacity.Consumer/consumption subsidy
A consumption subsidy is one that subsidizes the behavior of consumers. This type of subsidies are most common in developing countries where governments subsidise such things as food, water, electricity and education on the basis that no matter how impoverished, all should be allowed those most basic requirements. For example, some governments offer "lifeline" rates for electricity, that is, the first increment of electricity each month is subsidized. Evidence from recent studies suggests that government expenditures on subsidies remain high in many countries, often amounting to several percentage points of GDP. Subsidization on such a scale implies substantial opportunity costs. There are at least three compelling reasons for studying government subsidy behavior. First, subsidies are a major instrument of government expenditure policy. Second, on a domestic level, subsidies affect domestic resource allocation decisions, income distribution, and expenditure productivity. A consumer subsidy is a shift in demand as the subsidy is given directly to consumers.Export subsidy
An export subsidy is a support from the government for products that are exported, as a means of assisting the country's balance of payments. Usha Haley and George Haley identified the subsidies to manufacturing industry provided by the Chinese government and how they have altered trade patterns. Traditionally, economists have argued that subsidies benefit consumers but hurt the subsidizing countries. Haley and Haley provided data to show that over the decade after China joined the World Trade Organization industrial subsidies have helped give China an advantage in industries in which they previously enjoyed no comparative advantage such as the steel, glass, paper, auto parts, and solar industries. China's shores have also collapsed from overfishing and industrialization, which is why the Chinese government heavily subsidizes its fishermen, who sail the world in search of new grounds.Export subsidy is known for being abused. For example, some exporters substantially over declare the value of their goods so as to benefit more from the export subsidy. Another method is to export a batch of goods to a foreign country but the same goods will be re-imported by the same trader via a circuitous route and changing the product description so as to obscure their origin. Thus the trader benefits from the export subsidy without creating real trade value to the economy. Export subsidy as such can become a self-defeating and disruptive policy.
Adam Smith observed that special government subsidies enabled exporters to sell abroad at substantial ongoing losses. He did not regard that as a sound and sustainable policy. That was because "… under normal industrial-commercial conditions their own interests soon oblige loss-making businesses to deploy their capital in other ways – or to move into markets where the sales prices do cover the supply costs and yield ordinary profits. Like other mercantilist schemes and devices, export bounties are a means of trying to force business capital into channels it would not naturally enter. The schemes are invariably costly and damaging in various ways."
Import subsidy
An import subsidy is support from the government for products that are imported. Rarer than an export subsidy, an import subsidy further reduces the price to consumers for imported goods. Import subsidies have various effects depending on the subject. For example, consumers in the importing country are better off and experience an increase in consumer welfare due to the decrease in price of the imported goods, as well as the decrease in price of the domestic substitute goods. Conversely, the consumers in the exporting country experience a decrease in consumer welfare due to an increase in the price of their domestic goods. Furthermore, producers of the importing country experience a loss of welfare due to a decrease in the price for the goods in their market, while on the other side, the exporters of the producing country experience an increase in well-being due to the increase in demand. Ultimately, the import subsidy is rarely used due to an overall loss of welfare for the country due to a decrease in domestic production and a reduction in production throughout the world. However, that can result in a redistribution of income.Employment subsidy
Employment or wage subsidies keep the employment relationship ongoing even during financial crisis. It is particularly beneficial for enterprises to recover quickly after a temporary suspension following a crisis. Workers are prevented from losing their jobs and other associated employment benefits such as annual leave entitlements and retirement pensions.Employment subsidies allow individual beneficiaries a minimum standard of living at the very least. However, less than half of active jobseekers in around 50% of OECD countries receive unemployment support. The effect of employment subsidies may not be evident immediately. When employers received grants to subside a substantial part of the wages for retaining their employees or to create new jobs during severe recessions such as the Great Recession, there were minor impacts on employment during the first year. However, the subsidy began to yield positive effects on employment, particularly a decrease in the unemployment rate, in the second year as employers began to properly utilise the subsidy.
Tax subsidy
Tax subsidies, also known as tax breaks or tax expenditures, are a way for governments to achieve certain outcomes without directly providing cash payments. By offering tax breaks, the government can incentivize behavior that is beneficial to the economy or society as a whole. Tax subsidies can also have negative consequences.One type of tax subsidy is a health tax deduction, which allows individuals or businesses to deduct their health expenses from their taxable income. This can be seen as a way to incentivize people to prioritize their health and well-being. However, it can also create distortions in the economy by encouraging people to spend more on health care than they otherwise would.
Another type of tax subsidy is related to Intellectual Property. Base Erosion and Profit Shifting is a particular form of tax subsidy that involves companies shifting their profits to low-tax jurisdictions in order to reduce their overall tax burden. The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting is a treaty signed by half the nations of the world aimed at preventing this type of tax avoidance.
While tax subsidies can be effective in achieving certain outcomes, they are also less transparent than direct cash payments and can be difficult to undo. Some argue that tax breaks disproportionately benefit the wealthy and large corporations, further exacerbating income inequality. Therefore, it is important for governments to carefully consider the potential consequences of offering tax subsidies and ensure that they are targeted towards achieving the greatest public good.
Tax subsidies can have unintended consequences, such as creating market distortions that favor certain industries or companies over others. For example, if a government offers tax breaks to incentivize investment in renewable energy, it may lead to a glut of renewable energy projects and an oversupply of energy in the market. This, in turn, can lead to lower prices for energy and financial losses for investors.
Tax subsidies can be difficult to monitor and enforce, which can lead to abuse and fraud. Companies may claim tax breaks for activities that do not qualify, or may use complex legal structures to shift profits to lower tax jurisdictions. This can result in lost revenue for governments and a lack of fairness in the tax system.
Despite these concerns, tax subsidies remain a popular tool for governments to promote various policy objectives, such as economic growth, job creation, and environmental sustainability. The use of tax subsidies is often debated in political circles, with some arguing that they are necessary to support certain industries or to incentivize certain behaviors, while others argue that they create inefficiencies and distortions in the economy.
In conclusion, tax subsidies are a powerful tool for governments to achieve policy goals, but they come with their own set of challenges and limitations. It is important for policymakers to carefully consider the potential unintended consequences of tax subsidies and to design them in a way that maximizes their benefits while minimizing their costs. Additionally, strong monitoring and enforcement mechanisms are needed to ensure that tax subsidies are used appropriately and do not result in abuse or fraud.