Subsidies: Cui Bono?   

An important principle often used in legal cases is Cui Bono (“Who gains?”). It is frequently the key to motive, in the troika of means, motive, and opportunity in criminal cases. But Americans could also benefit from its use when it comes to evaluating government benefit programs.

The primary reason is that when discussing benefit programs, the rhetoric typically focuses on how they will provide gains to the needy, poor, underprivileged, or other deserving beneficiaries, because invoking pity or compassion is an effective way to sell such political policies to citizens other than the direct beneficiaries.

The economic analysis of incidence (who actually gains and loses, regardless of who is identified as intended beneficiaries or groups targeted to pay the tab), however, often reveals that a great deal of the benefits of such programs go to the suppliers of such programs, rather than the demanders.

Incidence analysis is most commonly applied on the cost side of government, in terms of who will actually bear the burdens of taxes (or regulations that serve to increase firms’ costs much like taxes). Because people do not want to be hit by unwanted burdens, the essence of the analysis is understandable in terms of dodgeball.  

When a tax is imposed, everyone potentially in its crosshairs, from buyers to sellers to workers and other suppliers of inputs to firms, wishes to avoid the burdens. They thus have incentives to dodge them by changing their choices of what, how, or where to buy, and what, how, or where to produce and sell to reduce those burdens. The better one side of a market can dodge in such ways, the less of the total burden they will bear and the more others will bear. 

In an economic sense, the ability of buyers to dodge a tax is indicated by the elasticity of demand in a market. Without invoking the technical and measurement details involved, it reveals how well buyers could reduce their burdens by switching whom they buy from, what they buy, when they buy, where they buy, or how they buy. The more easily buyers can adjust their purchases in those dimensions, the more elastic is demand (the more responsive the quantity of a particular good purchased is to changes in price) and the better they can dodge the tax. 

The analysis is similar for suppliers. The ability of sellers to dodge a tax is determined by the elasticity of supply in a market. It reveals how well sellers could reduce their burdens by switching whom they sell to, what they sell, when they sell, where they sell, or how they sell. The more easily sellers can adjust their sales in those dimensions, the more elastic is supply (the more responsive the quantity of a particular good supplied is to changes in price) and the better they can dodge the tax. 

In the case of taxes, one could briefly summarize incidence analysis by saying the more inelastic side (supply versus demand) of the market cannot dodge as well, so it will bear the majority of the burdens of a tax.

For the case of government benefit programs, however, we are talking about subsidizing certain groups rather than taxing certain groups (although the former cannot be done without also doing the latter). And in that case, the more inelastic side of the market will capture the majority of the benefits, rather than the majority of the burdens.

The underlying reason is that while market participants want to dodge away from taxes, they want to lean in the direction of subsidies. Buyers will want to buy more if something is subsidized. If supply is more elastic, buyers will largely be able to buy more and prices won’t rise much. But if supply is less elastic, buyers’ efforts to buy more will not be as successful, instead mainly bidding up the market prices paid. That, in turn, would mean most of the gains go to the sellers, even if buyers are the ones policy advocates claim to be helping.

One good example is higher education subsidies. Those pushing for such programs dole out a cornucopia of reasons for why students should be subsidized, many of which are false. But even if they were true, for the benefits to primarily go to students would require that the elasticity of supply of higher education be high enough to produce substantially more education. The less that is so, the more the gains will go to higher education providers rather than students, as has been so clearly indicated in the sharply upward path of tuition and other educational costs. 

The key is to ask how easily the extent of recognized-to-be-high-quality higher education can be expanded in a reasonably short period of time. How long would it take for a new provider to earn a good reputation, when many of the effects on students take a long time to show up in clearly measurable ways? How long would it take to get accredited, especially given the overemphasis on inputs, rather than outputs, of higher education by accrediting agencies? How long would it take for alumni associations (who have an obvious interest in raising the perceived quality of an institution’s graduates) to grow enough to have a substantial impact? Even for existing schools with good reputations, how long would it take to build a new classroom, lab, facilities and even student housing to accommodate a major influx of new students? And how long would it take to build up endowments to finance them?

Higher education hardly exhausts the set of examples. Some constantly harp on the need for many people to be better housed, with long lists of why. But at the same time subsidy policies are implemented as alleged “solutions,” it is hard to even count the ways in which policies restrict increasing the supply of housing, making supply far more inelastic, so that such subsidies mainly produce higher prices rather than more housing for intended groups. Similarly, affordable housing mandates act to reduce the supply of new housing, disguised by the few lucky winners of lower income housing. And rent-control laws, not to mention the growing host of restrictions imposed on rental housing providers, undermine incentives for landlords to create or maintain rental housing. 

Unions also have similar effects. They are among the leading voices for subsidizing “the poor” or “the working class,” but their actions harm most workers, and are the leading voices for protectionist policies, which also harm most workers, who are primarily affected by the higher prices it forces them to pay. Their many self-interested policies restrict non-union producers (the vast majority) from increasing output, resulting from project labor agreements to attacks on non-union apprenticeship programs to a host of restrictions that would be imposed with the PRO Act. That makes the supply curves in such industries more inelastic, resulting in higher union incomes far more than increases in output that would benefit workers as consumers. 

These areas illustrate the importance of thinking in terms of incidence when we consider policies that claim to benefit “worthy” beneficiaries. There is no guarantee that they will actually be the primary beneficiaries. Suppliers, particularly in cases where supply is quite inelastic, will often be the primary beneficiaries. And mainly benefiting suppliers of certain goods because we want to help the buyers of those goods is not an effective approach to effective public policy. If we want to actually help such buyers, we would be better served by addressing all those policies that unnecessarily make supply more inelastic in such industries. That would actually help the buyers we claim to want to help by enabling them to pay lower prices.