Do Subsidies Work?

Frequently when prices get too high in some sector governments are called upon to provide subsidies to those who can't afford to pay.

In the US there are a large number of these. Heating fuel subsidies, food stamps, housing rental assistance and Medicaid (not Medicare) are aimed at necessities. There are also government subsidies such as Pell Grants to help pay college tuition. With the sudden downturn in the housing market there are proposals to subsidize existing mortgages. So these actions work?

I'm going to keep this brief and not overload the discussion with lots of statistics, so just take this as a working hypothesis. If you are especially interested in one program or another, or in experiences elsewhere, then please feel free to contribute data.

I claim that subsidies only work when the proportion of people receiving them is small enough (within a market) so that the demand changes only slightly. Otherwise since these items are now more affordable the prices rise and, essentially, eat up the subsidy.

There is also the flip side of this, raising revenues through alternate avenues to alleviate the need for higher taxes. The most common has been the adoption of state lotteries. These were promoted as a way to raise additional funds for education. Original claims were that 50% of the gross revenue would be devoted to education. What has happened is that the percentage going to education has declined as the operating costs have increased and as competition has forced lotteries to increase payouts. In addition regular state budgets for education have not kept up with expenses since legislators know that much of the shortfall will be covered by lottery revenues. Education spending has not improved.

College tuition has increased much faster than inflation for over a decade, especially at state schools. As the subsidies (and loans) increased, the out-of-pocket expenses of attending decreased. Raising tuition just brought the burden back to what it was before. For those who couldn't afford this a system of two-year (less expensive) schools was created; a "lower quality" system at less cost. It is "lower quality" because the schools don't attract senior faculty, don't have the library and research facilities of universities, and don't even have the intangibles like a residential student community and sports programs. What happens in a classroom is only part of higher education.

Housing subsidies increase the demand for better quality apartments which means that prices will rise as those getting subsidies compete with the rest of the market.

So, if subsidies get eaten up by price rises what can be done to achieve the aims of providing a minimum standard of living for all?

The other approach to ensuring affordability has been some sort of price control. In the current climate of "free market" worship this is regarded as an obvious mistake. However, even the most "free market" society has price controls. The Medicare system has a schedule of payments for every treatment. Agricultural systems impose limits on acreage (which is a type of price control). State public service commissions put limits on everything from electricity rates to road tolls. Price controls already exist, they just aren't usually called this explicitly.

Whether controls or subsidies "work" depends upon what the goal is. If the goal is to make things affordable for the poorest sectors then it may be possible to provide subsidies without distorting the market. What usually happens is that in order to get such social programs enacted it is necessary to extend the benefits to the middle class as well. At this point the effect on the market becomes significant, and the subsidies lose effectiveness.

Some societies seem more comfortable with the concept that social benefits should be directed disproportionately so that the neediest get the most help, but in the US and UK there seems to be much resentment over such programs. As a result they are underfunded, ineffective, and end up subsidizing service providers, not the needy. Why such class resentment exists is a topic for another day...

Meta: 

Comments

Some thoughts

Firstly the topic is too broad and one will get the libertarians saying no in absolutes and probably some absolute yeses.

I also think some assumptions are incorrect. Take for example, community colleges. While they maybe cheaper the reality is their mastery attainment bar is considered lower. That's really the issue, in the classroom.

I know one program that does not work, which is government retraining programs. One reason is corruption. I saw a community college obtain $750k of funding to retrain people in STEM who already had a Bachelors college degree, in restaurant service. Now to give some institution that much money to retrain qualified technical professionals to be burger flippers is pathetic.

It used to be that employers provided retraining, for increased labour mobility within their own organizations Now they want ready made skills, preferably the obtainment of those skills was also outsourced (educated abroad).

Somehow (and I don't know how) that retraining, continual education, new skill sets have to be incentives, subsidies in the US and not dumped upon the worker in terms of costs.

We have a huge initiative to privatize and globalize higher education, it's a trillion dollar market potentially ( right behind financials). Once again we have institutions that used to support a society being turned into private, for profit entities, not answering the needs to who is funding them in many cases (state governments, Fed) and the additional cost is dumped onto the taxpayer and the student.

I also question this claim of market distortion for the immediate thought was corporate welfare and just how much that distorts the market.

Then, there is real effectiveness per program. EPI
found that living wage ordinances actually decrease the total net income because it kicks people out of the food stamp program as well as the earned income tax credit.

So, obviously many of these subsidies need a graduated reduction, not an absolute number where then the benefit is denied.

Take Pell Grants. Both Obama and Clinton have a to reduce paperwork for applying to financial aid, a major burden in obtaining a Pell Grant and Clinton goes further to award Pell Grants to non-traditional students. That's a fantastic idea because so often the income bar to obtain financial aid means you are dead or homeless because the income levels to qualify are much too low. Then, if one obtains a Pell, it's simply not enough to live on, yet if you work a job, wala, you no longer qualify for the Pell. A true catch-22 system.

One thing you claim which I question is when benefits are extended to the middle class somehow they lose their effectiveness. I question that.

But on the other hand, it appears there is little monitoring and analysis on the effectiveness of studies. There needs to be an expansion on data collecting, statistics generally and more expansion of the GAO, creation of an additional trade accountability office to analyze these programs for their actual effectiveness.

Here's one thing I think is stuck on stupid, many of the state, federal functions, such as maintaining the food stamp program are offshore outsourced. Now, how stupid is that? Why not hire some of the people receiving food stamps, let them work from their homes to answer questions on the food stamp program and keep those taxpayer dollars within the US domestic economy?

I'm sure if we went through each program, one by one, we will find stuck on stupid legislation and policy in most of these areas.

So my general response is devil in the details in that the US does not enact smart policy, strategic policy or monitor effectiveness, adjust accordingly, by objective metrics.

Ya know I cannot count the number of papers, books I've read describing problems after the fact, but strategic, policy, analysis, recommendations that have a dynamic adjustment or will actually dramatically change the status quo, those are few and far between.