Incentives
A good government will incentivize activities that produce a positive effect and discourage activities that produce harmful outcomes. For instance the government gives preferential tax treatment to retirement account contributions, but heavily taxes alcohol and tobacco consumption. The trick is to do so in a way that minimizes the market impact and other unintended consequences. Below we explore the largest and most impactful tax expenditures and subsidies and evaluate their consequences and effectiveness.
Employer sponsored healthcare deductions, banking subsidies, farm subsidies, and energy subsidies are the main subsidies which have a huge effect not just on the government budget sheet, but across the free market. Giving preferential tax treatment to employer sponsored healthcare encourages using more expensive than necessary health coverage for the consumer and gives employers leverage over the employees. Banking subsidies that pay interest on reserves to encourage banks to raise interest rates on mortgage loans are a double whammy they cost the tax payer money in the form of taxes and a higher mortgage. Farm subsidies create huge incentives to grow commodity products like corn and soy regardless of best land preservation techniques, nutritional value, or even market forces. And energy subsidies encourage uneconomical fuel sources and power plants to stay open. Addressing the negative consequences of subsidies would not only save the government money, but also fix market distortions that are causing health and climate problems.
Results and Conclusions
Facts
Employer Subsidized Healthcare Tax Expenditures
One of the biggest tax expenditures is employer subsided healthcare which the government subsidizes with a tax deduction that is worth $279 billion in 2018 in order to reduce premiums by as much as 30% for 155 million people who get healthcare from their job. However, this subsidy benefits middle to upper class Americans the most as the standard savings for a family making less than $30,000 is $1650, but the savings for a family making more than $200,000 is $4650. For comparison Medicare cost $581 billion and served about 55 million people and Medicaid cost $349 billion and served about 76 million people in 2017. Furthermore, it gives employers leverage by discouraging employees from leaving their jobs to better themselves or seek other employment for fear of losing benefits.
Other Tax Expenditures (Employer Contributions to Retirement Plan)
The employer contributions to a retirement plan either a pension, 401k, etc. are also tax deductible and are capped at a certain amount per employee, but they the employer’s share of contributions doesn’t fully vest until a certain period of time specified by the employer. This gives them leverage over the employee by discouraging employees from leaving their jobs to improve themselves or seek out better work for fear of losing thousands of dollars in employer contributions.
Banking
The Fed has a monetary tool in its belt that pays banks interests on their reserves to encourage them to increase their loan rates. This subsidy started off small around $500 million, but has ballooned to $30 billion. This cost the tax payers first for the $30 billion and then for the increased mortgage cost.
Food
One of the biggest subsidies not just in size, but an effect are the farm subsidies. The latest farm bill passed in 2014 focuses on subsidizing crop insurance which either insures that you sell your crops at or above an expected market price or you receive revenue for your yield at or above a certain expected revenue based on the types of crops your grow and your land usage. The government pays over 60% of the insurance premiums at a cost of about $6.7 billion a year and as a result farmers have paid less in premiums than they have received in insurance payouts.
The insurance heavily favors commodity crops with 94 % of farm program support going to just six commodities (corn, cotton, peanuts, rice, soybeans, and wheat) which only account for about 28 % of total farm receipts. Meaning, that the other 72% of crops receive just 6% of the support and do just fine.
Furthermore, farmer in general have higher median incomes and wealth than the average Americans $76,000 vs. $59,036 and $897,000 vs. $97,300 respectively for 2016. On top of that most of the subsidies go to wealthier farms with over 80% of the benefits going to commercial and moderate sales farms which have a median household wealth of $1.7 million. Trump new budget proposes lowering the adjusted gross income subsidy cutoff from $900,000 to $500,000 and that is being met with stiff opposition. So, not only do the subsidies only benefit a small number of crops, but they also disproportionately benefit wealthier Americans.
This not only cost billions, but creates dramatic market distortions. Since the government subsidizes prices for corn and certain other crops farmers produce more of them because of lower aggregate risk driving their price down which allows for downstream uses such as livestock feed and corn syrup production to be more attractive and increase as well. The increased demand works in favor for the government because it keeps prices closer to the cutoff for insurance payouts (meaning lower costs for the government) but it isn’t enough, so the government has created programs that encourage the use of these commodities such as the sugar to ethanol subsidy and most infamously the numerous ethanol subsidies (to be explored further in energy subsidies).
All of these benefits especially for corn mean that over half of the 300 million acres of land are used for corn and soy, another 50 million for wheat, and only 14 million for “specialty crops” i.e. fruits and vegetables. This mismatch means generally healthier foods are more expensive and some argue has lead to the increase in adverse health effects such as diabetes due to the excess amounts of corn-fed livestock and high fructose corn syrup. The distortions also extend to land use and sustainability. Crop rotations, diversification, and manure fertilizer historically efficient ways of ensuring sustainable soil fertility have shrunk dramatically in favor of genetically modified monocultures and chemical fertilizers which decreases resistance to both pests and droughts.
Telecom
Telecommunication companies have been subsided to provide services such as phone and internet to places where it is too expensive to build or is simply under-served like poor neighborhoods and rural areas. These subsidies run to the tune of about $5 billion give or take depending on the year.
Energy
The energy subsidies affect both fossil fuels, renewable, and even nuclear production. Subsidies clearly encourage the production of whatever they are subsidizing so depending on your feelings about the fuel. Fossil Fuel direct subsidies total about $20 billion a year with the lion share of subsidies going to oil and gas (80%) and the rest going to coal. Critics argue indirect subsidies like pollution costs and military guarding oil shipping routes should be counted as well; however, these claims are hard to quantify. What is easy to quantify is that old and obscure accounting rules such as the master limited partnerships allow fossil fuels to save billions on taxes.
However, on the same note some of these incentives don’t offer the benefits of stabilization or jobs they simply allow uneconomic, usually high polluting plants to stay open. Fully amortized coal and even gas plants get paid just to have capacity even if it isn’t economic to run. These aren’t federal subsidies and are usually decided by a state.
Nuclear plants also technically receive subsidies, but in the form of insurance. The Price-Anderson Act insures nuclear energy against a nuclear meltdown to a tune of $13 billion with the rest to be picked up by the tax payers. However, of the nearly 100 nuclear reactors in the US in the almost 60 years of operation none have ever melted down. Nonetheless, without this insurance nuclear plants would have been never built since the risk and cost would have put off any private utility. The subsidy still exists but there are less than a handful of nuclear plants even scheduled for construction and the ones that exist have been providing cheap baseline power nearly every hour of the year for decades.
Renewable energy subsidies have fallen since 2013 from almost $15 billion to a little over $6 billion. Renewable subsidies include biofuels and of course wind and solar. Direct subsidies for renewables come almost exclusively in the form of utility scale solar plants. However, almost most of the renewable subsidies are in the forms of tax expenditures and almost half of renewable subsidies go to biofuels and not wind and solar. However, a significant portion of R&D subsidies go almost exclusively to solar and wind.
Auto
The auto industry is generally not specifically subsided more than any other industry, but critics point to how American cities have evolved that implicitly subsides cars. The government pays for roads, parking lot requirements, the highway system, and pollution contribute to the demand for cars. I’ll argue that these aren’t subsidies because roads and the highway system are public goods that go beyond the auto industry, but the externalities are not being paid for which could be done via some type of tax such as congestion pricing or higher parking spot costs. On the state level automakers are being subsided to bring jobs into the state, but not much more than any other business that provides a state with jobs.
However, electric cars are subsidized directly that have so far over the entire lifetime of the programs paid out $42 billion. The purchaser subsidies go mostly to the richer Americans since EVs are still relatively expensive, but the demand side subsidy has only cost $2 billion total. All the other money has gone to R&D to figure out how to drop the price down.
Excise Taxes
The government also creates disincentives via the form of excise taxes against certain activities (i.e. alcohol taxes, tobacco taxes, gambling taxes, marijuana taxes, etc.). Some of these “disincentives” are actually just taxes that help pay for some of the externalities associated with an activity like road maintenance or air traffic control (gasoline and airfare taxes).
Assumptions
We mostly make the argument that a subsidy is good or bad and that bad subsidies should be eliminated. However, for some cases we also suggest small changes to mitigate the negative effects of a subsidy. For all suggestions we assume a subsidy will be finite over large enough period for industry to plan a reasonable ROI, but not too long so that it becomes a permenant distortion. Furthermore, we also assume our suggested changes do not create other unintended distortions. These are obviously hard to prove, but intuition tells us our suggested changes are small enough that these assumptions should be fine.
Results
Employer Subsidized Healthcare Tax Expenditures
Eliminating this subsidy and using the money for Medicaid, to reduce the deficit, or some combination of the two would lower health costs and give more power to the worker not the employer. I have written in length about flaws in the medical system in the US and what can be done to change it; however, this tax expenditure shows how incentives built into the tax code have created incentives at the expense of the average American worker.
Other Tax Expenditures (Employer Contributions to Retirement Plan)
Eliminating this tax deduction entirely would erase many positive effects. Instead the deduction should only be given if the contributions are immediately fully vested. Employers can still delay contributions until after a given time-period, but once they are given out they shouldn’t be allowed to take them back.
Banking
Some have argued removing the ability for the Fed to pay interest on bank’s reserves and instead allow banks to trade their reserves on the free market as they have done in the past. I tend to agree $30 billion is a lot of taxpayer money to use to raise mortgage interest rates for taxpayers.
Food
Ideas from both the left and the right attempt to address the problems with our massive farm subsidy programs. Solutions range from incorporating more specialty crops to changing the payout formula, to eliminating the subsidy altogether. The CBO has a range of policy suggestions as well, but I believe one of the simplest ones is the best capping the insurance payout to $50,000 which they estimate would save $3.4 billion a year. Since there are about 2.1 million farms and have been since the 80s a cap would discourage farms especially the large ones to farm to the magnitude they do now. Nonetheless, eventually it can be argued that they should be eliminated altogether most farms receive trivial amounts of subsidies and they still survive, why do commodity growers need such a vast subsidy system? Maybe they don’t and getting rid of any incentive would force commodities to compete on the open market then perhaps more healthier crops would be grown.
Telecom
While on its face paying companies to provide services to those who otherwise wouldn’t receive them seems like a good idea, critics argue companies take these subsidies and get away with the bare minimum services. Furthermore, that company now has a monopoly in that area allowing them to charge whatever price they see fit. I tend to agree, I’ve argued some services should have public options and the internet is one of them. It is hard enough to create competition among telecommunication companies when an area is relatively easy to serve due to various exclusive rights deals these companies negotiate with states and cities. Paying them to provide substandard service and the right to have a monopoly seems downright foolish. Ensuring a minimum standard for these subsidies and then taking over then licensing the distribution for a set fee over a set time period allowing other companies to bid to provide service after the infrastructure has been built makes a lot more sense. It is what is done in the power sector for the majority of states, famously Texas, and it should be applied to telecommunications as well especially if we are going to subsidize it.
Energy
Allowing uneconomical power plants to remain open to recover investment capital or to be able to be run in case of a shutdown is the type of incentive that should be criticized because they provide no benefits to anyone, but the investor. Eliminating incentives that keep uneconomic fuels or power plants operation is a must. However, removing all incentives for fossil fuels although it can be argued from a economic perspective would cause more harm than good now. Fossil fuels still employ a large number of people letting them slowly die out due to the lowering cost of renewables is easier and more politically feasible.
However, the nuclear insurance program is an example of a subsidy that helps with the implementation of beneficial technology and doesn’t cost billions of dollars every year.
As we mentioned before in the farm subsidies, biofuels are not a very efficient use of land and are not energy efficient either. Solar and wind are rapidly declining in price due to the massive amounts of R&D investment in these technologies (almost $1 billion / year from the federal government), but the subsidies for solar and wind pale in comparison to those for biofuels. While the original idea to research what renewables could be used instead of oil was a good one, experience has taught us biofuels cause more problems than they solve, and their subsidies should be eliminated or added to those for solar and wind.
Auto
The EV subsidies are an example of what subsidies are supposed to do incentivize a positive result that would be too costly otherwise. As long as they help EV prices go down (they have) and eventually phase out once they can compete on the open market (they do) this subsidy is fine.
Excise Taxes
For the most part these extra excise taxes do their job help pay for externalities or limit negative behaviors. However, some taxes like the soda tax can have unintended consequences or as technologies evolve create unfair benefits for other goods. For instance, as cars become electric their effect on roads and highways won’t be accounted for with the current gas taxes. Furthermore, the biggest observation from our current federal excise taxes are its exclusions namely the carbon tax. As greenhouse gases increase taxing the effect of pollution could curb detrimental behavior.
Methods and Sources
The methods used for our suggestions are mostly qualitative. The biggest suggestion the elimination of employer sponsored healthcare was examined in detail in our medical insurance article. All other suggestions either have empirical evidence of working in the past or are minor changes that would be unlikely to have major effects.
Employer Subsidized Healthcare Tax Expenditures
http://www.latimes.com/la-na-pol-trump-obamacare-questions-20171013-htmlstory.html
http://www.crfb.org/blogs/top-ten-tax-expenditures-jct-releases-its-annual-report
Other Tax Expenditures (Employer Contributions to Retirement Plan)
https://www.taxpolicycenter.org/briefing-book/what-are-largest-tax-expenditures
Subsidy
https://www.thebalance.com/government-subsidies-definition-farm-oil-export-etc-3305788
Banking
Farm
https://www.washingtonpost.com/lifestyle/food/why-do-taxpayers-subsidize-rich-farmers/2018/03/15/50e89906-27b6-11e8-b79d-f3d931db7f68_story.html?utm_term=.78bec651317f
https://www.cbo.gov/system/files/115th-congress-2017-2018/reports/53375-federalcropinsuranceprogram.pdf
https://www.washingtonpost.com/lifestyle/food/farm-bill-why-dont-taxpayers-subsidize-the-foods-that-are-better-for-us/2014/02/14/d7642a3c-9434-11e3-84e1-27626c5ef5fb_story.html?noredirect=on&utm_term=.1924e1b4d07e
https://www.npr.org/sections/thesalt/2016/07/18/486051480/we-subsidize-crops-we-should-eat-less-of-does-this-fatten-us-up
http://www.crfb.org/blogs/tax-break-down-preferential-rates-capital-gains
https://www.heritage.org/agriculture/report/what-you-should-know-about-who-receives-farm-subsidies
https://www.downsizinggovernment.org/agriculture/subsidies
Telecom
https://www.wired.com/story/the-dangers-of-big-city-subsidies/
https://www.reuters.com/article/us-usa-telecom-idUSKBN1702QR
Energy
https://www.eia.gov/todayinenergy/detail.php?id=35952
https://www.vox.com/2016/1/27/10849564/renewable-energy-tax-credits-big-deal
https://thehill.com/opinion/energy-environment/351728-federal-energy-subsidies-go-to-far-more-than-nuclear-and-coal
https://www.vox.com/energy-and-environment/2017/10/6/16428458/us-energy-coal-oil-subsidies
https://www.forbes.com/sites/williampentland/2018/04/29/federal-subsidies-for-solar-and-wind-fell-sharply-in-recent-years-says-new-report/#54f277e7fa9a
https://www.eia.gov/analysis/requests/subsidy/pdf/subsidy.pdf
Auto
https://www.planetizen.com/news/2018/07/99718-attacking-auto-dependency-attacking-auto-subsidies
https://www.reuters.com/article/us-toyota-mazda-jobs-factbox/factbox-u-s-states-woo-automakers-with-17-billion-in-subsidies-since-1976-idUSKBN1AK2BI
https://www.prnewswire.com/news-releases/government-electric-car-subsidies-are-costly-subsidies-for-the-rich-finds-new-study-300597683.html
Excise Taxes
https://www.taxpolicycenter.org/briefing-book/what-are-major-federal-excise-taxes-and-how-much-money-do-they-raise
https://www.vox.com/energy-and-environment/2017/6/15/15796202/map-carbon-pricing-across-the-globe
