Category: subsidy

A Debate on Subsidies

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January 12, 2025

by Stephen Stofka

This is ninth in a series of debates on various issues. The debates are voiced by Abel, a Wilsonian with a faith that government can ameliorate social and economic injustices to improve society’s welfare, and Cain, who believes that individual autonomy, the free market and the price system promote the greatest good.

After a few pleasantries, Abel began, “Last week, we finished talking about the government’s role in the social contract. The scope of that role is the key difference between your group and mine.”

Cain nodded. “Your group thinks of the federal government as an insurance company. Our group tries to keep your group in check. It’s not easy.”

Abel replied, “Your group may believe in a more limited role for government as a general principle, but you advocate policies that contradict that principle. Take housing as an example. It is a private good that is heavily subsidized by the federal government.”

Cain tilted his head in an equivocating manner. “Let me stop you there. Are you asking whether our group supports federal underwriting of thirty-year mortgages? In principle, we shouldn’t. The federal government should have a minimal role in the exchange of private goods. As a practical matter, the entire housing market would collapse if the federal government did not underwrite most mortgages in the U.S.”

Abel interrupted, “But your group doesn’t support the federal government’s student loan program.”

Cain nodded, “That’s right. An education is a different type of good than a house. An education can’t be separated or alienated from a person. A house can. I would prefer that the federal government not be involved in the mortgage market, but few states have the resources to underwrite mortgages. Private banks prefer not to underwrite 30-year mortgages at low interest rates. Only the U.S. and tiny Denmark have 30-year mortgages at fixed interest rates (source).”

Abel said, “But the higher education market would collapse without federal student loans, grants and subsidies. That same practical reasoning supports the federal involvement in underwriting higher education loans.”

Cain shook his head. “Housing has a concrete public aspect to it. Education doesn’t. The Constitution specifies a role for the federal government. It is to provide for the ‘general welfare,’ not private welfare. An education is inseparable from a person’s private welfare.”

Abel objected, “But private welfare contributes to the general welfare. This is a sticking point between our two groups. Your group regards the general welfare as only those goods or services that are available to all. The sum of individual welfare is the general welfare.”

Cain replied, “Look, everyone who wants a subsidy claims that their private welfare will contribute to the public good. Car manufacturers want protective tariffs and subsidized loans, claiming that it will help preserve jobs. Ranchers want below market rates on grazing land for their catttle, claiming that they will be motivated to act as good stewards of that land and help preserve it. College students want subsidized loans and grants on the premise that their improved skills will contribute to a better society, a more productive work force.”

Abel argued, “But your group is more likely to support subsidies for ranchers and farmers.”

Cain shrugged. “The subsidy for grazing fees is about $100 million, according to one estimate. Americans have $7.5 trillion in federally backed mortgages at an interest rate that is at least 5% below market. That’s an indirect annual subsidy to homeowners of $350 billion, with a ‘b.’ Subsidies to farmers and ranchers are like drops in the bucket compared to the subsidies to homeowners. Divide that $350 billion by approximately 50 million federally backed mortgages and each mortgage holder gets an average annual subsidy of $7000. The federal government looks like it has deep pockets. Everyone wants to stick their hand in those pockets. It’s the road to ruin.”

Abel argued, “But the federal government has a long history of handing out subsidies. In the 19th century, they gave out vast tracts of western lands to the railroads for pennies an acre. After the tracks were built the railroads sold the land to developers for many times what the railroads paid. Then the developers sold the land for many times that to homesteaders. Subsidies are a tool of government.”

Cain interrupted, “Tools to achieve what? Policy goals. Who sets those policy goals? The politicians in Washington. What is their policy goal? To get re-elected. How do they get re-elected? By gettting subsidies of some sort for their constituents. What is the sum of those individual efforts by elected officials? A government whose main purpose is giving out subsidies. There has to be some principle in place to limit that kind of largesse.”

Abel asked, “So what? End all subsidies? That is not going to happen. America binds all these regional interests together by handing out subsidies to homeowners, students, farmers, ranchers, people of every business type. In an earlier era, Senate leaders inserted earmarks for those senators who held crucial votes. Former OMB director George Shultz quipped, ‘the budget process was a fight of the parts against the whole and the parts always won.’ (Behn 1977, 109).”

Cain interrupted, “That practice promoted increased spending and deficits. When the government borrows money, that increases the money supply and inflation. Then the Federal Reserve has to fight inflation by adjusting interest rates. Higher interest rates causes a drop in investment which can raise unemployment. There’s just a whole cascade of economic effects.”

Abel argued, “In 2006, John Boehner, the former Speaker of the House, ended all earmarks in the House. Have deficits decreased? No, they have gotten worse. So has the polarization in the Congress and in the country. The public is like a pack of hungry dogs. Give each of them a little bit of meat and they won’t tear each other apart.”

Cain shook his head. “Tell the voters on the campaign trail that they are a bunch of dogs. The problem with your group is a lack of respect for the public and way too much respect for politicians and experts.”

Abel conceded, “Ok, maybe the hungry dogs imagery wasn’t the best, but look at the defense industry. It wields a lot of influence on Capitol Hill and your group is a big supporter of defense contractors. Defense is one of the few legitimate constitutional duties of the federal government, you say. Each individual representative in Congress votes for more defense spending if it will mean more federal tax dollars coming into their state. Each representative competes for defense dollars even if it is wasteful. It’s pork barrel politics.”

Cain said, “The saying goes, ‘something that can’t last forever won’t.’ The country can’t keep running deficits and borrowing money from the private sector. The interest on that debt keeps getting larger every year. It’s unsustainable. Deficit spending is a security issue. If and when a large war breaks out, the country will not be able to muster a strong response.”

Abel nodded. “Our group agrees that deficit spending is a problem. Your group thinks that earmarks are a big part of the problem. We don’t. Pork barrel politics joins people together. All the different constituencies in the country gather together to pull one of two ends of the rope. What we need is higher taxes on upper income households to afford those earmarks.”

Cain shook his head. “Higher taxes reduces investment.”

Abel interrupted, “So your group says. During the 1990s, both taxes and investment increased. In fact, investment increased at the highest pace since World War 2, and we had budget surpluses by the time Clinton left office at the end of the decade. Higher taxes do not reduce investment.”

Cain argued, “Look, the birth of the internet and the computer age was a special case. That exception does not support your case.”

Abel smiled. “Taxes and the effect of taxes is a whole other discussion. See you next time.”

Cain nodded and turned to leave. “Until then.”

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Photo by Anna Samoylova on Unsplash

A 2010 analysis by the Congressional Research Service found that few developed countries offer 30-year mortgages at fixed interest rates. https://crsreports.congress.gov/product/pdf/R/R41432/3

An analysis by the Center on Biological Diversity estimated an annual subsidy of $100 million to ranchers in below market rates for grazing fees. https://www.biologicaldiversity.org/programs/public_lands/grazing/pdfs/CostsAndConsequences_01-2015.pdf

Federally backed mortgages rose from $707 billion in 2009 to $5 trillion in 2010 and have risen steadily since then. https://fred.stlouisfed.org/series/BOGZ1FL403065005Q

Behn, Richard. 1977. “The False Dawn of the Sunset Laws.” The Public Interest (Fall): 103-118. doi: https://www.nationalaffairs.com/public_interest/detail/the-false-dawn-of-the-sunset-laws.

The Federal deficit as a percent of GDP https://fred.stlouisfed.org/series/FYFSDFYGDP

Tevlin, S., & Whelan, K. (2000). Explaining the investment boom of the 1990s. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.221415 In the seven-year period 1992-1998, investment growth averaged a record-breaking 11.2%. A copy of the paper can be found at https://www.federalreserve.gov/pubs/feds/2000/200011/200011pap.pdf

Subsidies and Deficits

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November 12, 2023

by Stephen Stofka

Note: at the end is a correction to last week’s letter.

This week’s letter continues to investigate the subsidies, both direct and indirect, that secure re-election for politicians but make deficits inevitable. This week there was weak market demand for $24 billion of newly issued 30-year Treasury bonds, forcing primary dealers like J.P. Morgan to absorb 24% of the debt, more than twice their usual participation rate. Treasury bonds carry little if any credit risk because the U.S. can always pay its debts by issuing more debt. However, long term debt exposes traders to market risk that they must offset by demanding a higher rate of interest for purchasing the debt. Higher interest payments narrow the budget space for subsidies and benefit programs that politicians dole out to gain constituent support. The long term outlook is that our arguments over fairness will cause greater fractures in our society.

As social animals we begin at an early age to form a sense of fairness that can test parents’ patience. An older sibling gets to stay up later at night and that is unfair. The level of chocolate milk is lower in one glass than in a sibling’s glass and that is unfair. We sympathize with animals who suffer the loss of their parents, their herd, or their environment. While we may have an instinctive ability to recognize unfairness, we must be taught how to construct rules that are based on fairness. These involve conflicts over sharing toys, a playroom, or a TV game console. Through experience and temperament, we build a framework of fairness that is unique. As we grow older we glue these values together with justifications and associate with others who share similar values. We form interest groups that compete for federal, state and local benefits, reasoning that our welfare is the general welfare.

We have been taught since childhood that public laws and public monies should be spent on the public good. We may not recognize property arrangements that advantage one group by disadvantaging another group, or at the expense of the general public. The exchange of goods and services take place in a web of property rights whose density obscures the dependencies between parties. Those rights are instituted and enforced by a network of government institutions – a legislature or council, an executive agency, the courts and a police force. Those rights favor a majority according to some characteristic, or an effective interest group that directs public money and property to their cause.

At the heart of most contentious Supreme Court decisions is the reality that one group of people in this country are going to indirectly subsidize others. One group of people will have to give up something – call it rights, power or a sense of safety – for other people to enjoy rights, power or greater security. More than 200 years ago, Adam Smith wrote that a well governed society with a respect for private property could produce a greater prosperity for everyone in the society. His was a long term vision. In the short term empowerment is a zero sum game and that is why so many issues in our society are contentious.

When a subsidy benefits a relatively small group of people, they fight hard to protect that subsidy. When the costs for the subsidy are spread over a large group, there is little opposition to the subsidy. An interest group becomes part of an Iron Triangle to protect the subsidy. This triangle consists of the interest group, a legislative subcommittee and an executive agency. An example is the ethanol subsidy. Department of Energy data shows that, in 2022, 35% of the corn crop in America was devoted to the manufacture of ethanol. Over its life cycle, ethanol added to gasoline reduces greenhouse gas emissions (GHG) by 40%, according to several studies. Farmers receive a maximum subsidy of $20 per dry ton of corn or other feedstock that they sell to biofuel plants. Biofuel producers receive a tax credit of 46 cents per gallon of ethanol. The consumer’s cost for the 10% addition of ethanol is small. The benefits to the ethanol blenders and farmers is large. A senator or representative in a farm state like Iowa is expected to protect that subsidy.

As I noted last week, just six tax expenditures reduced tax revenue to Treasury by almost $700 billion last year, more than half the total deficit. The largest expenditures were the exclusion of employer paid pension contributions and health insurance premiums. How many of us will agree to give up their tax exclusion in the interest of making tax rules uniform? Homeowners can enjoy 30-year mortgages at low rates because the federal government effectively underwrites those mortgages. In Britain, homeowners do not enjoy the protection of decades-long mortgages. According to a recent article in Forbes, 800,000 fixed rate mortgages in Britain were due in 2023, and 1.6 million will be due in 2024. Homeowners will have to remortgage at higher rates.

The slim Republican majority in the House cannot agree within their own caucus to bring a bill before the House for a vote. Lawmakers prefer to complain about spending because that is a popular stance with their constituents. A lawmaker’s abiding concern is getting re-elected by their constituents. Few will complain about raising tax revenues if the revenues are to come from a broad group of taxpayers. Democratic politicians argue for higher taxes on a small group of the rich for fear of antagonizing the majority of their voters. Reducing revenue by subsidies and tax exclusions is as much a policy choice as spending appropriations. Without a continuing resolution in the next week, the federal government will begin to shut down non-essential facilities. The House has not been able to produce a budget on time in thirty years because lawmakers have limited choices. Taxpayers, favored industries and social welfare interest groups will oppose a lawmaker who advocates the elimination of a tax exclusion, a subsidy reduction for producers or households.

We are a nation competing for space at the public trough. For at least a generation, our federal government will be unwilling to collect enough revenue to meet spending commitments. Buyers of U.S. debt will realize the inevitability of deficits rising faster than economic growth and reduce their holdings of long term bonds.

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[Photo by Anna Samoylova on Unsplash

Keywords: ethanol, subsidy, tax expenditures, deficit

Correction: In last week’s letter I wrote “ twice last year’s deficit of $118 billion.” The link was to the average monthly deficit. That should have read “twice last year’s average monthly deficit of $118 billion,” not the deficit for the entire year. The total deficit for last year was $1.375 trillion.

Subsidies and Fairness

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November 5, 2023

by Stephen Stofka

This week’s letter is about subsidies and fairness. The culture of Western civilization emphasizes individual effort and achievement while downplaying our reliance on others. In the past two weeks, I have questioned an economic assumption that workers are paid the value of their marginal product. This week I will extend that analysis toward other commodities in our lives. Our society is a network of cross-subsidies; we often don’t pay the marginal cost of what we buy or pay our fair share of taxes into the public pot because of tax subsidies we receive. We judge the fairness of a subsidy by the recipient of the subsidy and we tend to favor ourselves as deserving of the subsidies we receive.

This month oil refiners are selling unleaded gasoline near a breakeven cost to wholesalers at $2.20 per gallon, reported the Wall St. Journal. A week ago, the spot price of WTI crude was about $83.00, making the per gallon cost almost $2 per gallon (see oil notes at end). The public uses less gasoline during the winter months so the slack demand reduces pricing power at the wholesale and retail level. A 20 cent profit on a gallon of gasoline does not allow oil refiners to meet their “hurdle rate,” the expected return on investment. The users of diesel and jet fuel, business customer whose demand is less seasonal, make up the difference in profits. The heaviest users of these products are trucking companies, power plants and the airlines. The users of diesel and jet fuel are effectively subsidizing the lower gasoline prices for consumers.

Is it fair that women should spent double the amount of time caring for children that men do, according to the American Time Use Survey. Is it fair that tax revenues from some states are used to subsidize the incomes of people in other states? Vermont, W. Virginia and Alaska rely on federal grants for more than a third of their budget, according to a recent report from the Office of Management and Budget and the Census Bureau. Less than a sixth of Colorado’s budget relies on federal aid.

Many subsidies are indirectly awarded through the tax system. Three of the biggest items are employer contributions to pension plans, employer-paid health insurance premiums and imputed rental income, or owner’s equivalent rent. Employers write off their contribution to an employee’s pension plan but the employee does not report the income. The U.S. Treasury estimated the tax subsidy of the various types of pension plans and IRAs was $228 billion in 2022, a sixth of last year’s deficit of $1,378 billion. Employers write off health insurance premiums they pay for their employees but that expense is not included in personal income. In 2022, the tax loss was estimated at $221 billion. Homeowners make a capital investment in their homes but do not report the annual rental income – termed an imputed rental income – they receive from that investment. In 2022, the Treasury estimated that tax subsidy at $131 billion. We may complain about the deficit but no one lobbies to reduce these subsidies.

Long-term capital gains from investments are taxed at lower rates than ordinary income. That tax exclusion favors the top half of taxpayers and had an estimated cost of $108 billion in foregone tax revenue in 2022. Tax law allows beneficiaries to inherit stocks and other investments at current valuations so that heirs are not responsible for the capital gains accrued during the lifetime of the deceased. That method of valuation is called a step-up and cost the government an estimated $44 billion in 2022. Certain service providers like lawyers and accountants enjoy a 20% deduction on their business income. This pass-through income exclusion had an estimated cost of $56 billion in 2022, about the same amount as the deduction for charitable contributions. In contrast, federal agricultural subsidies were only $15 billion, about ¼% of total federal spending. Like foreign aid, people often overestimate how much the U.S. government subsidizes farmers.

Libertarians devoted to methodological individualism or an 18th century ideal of the yeoman farmer reject the notion of an income tax subsidy. The income belongs to the individual, not the government, and the government cannot rightfully extract a tax without the consent of the individual. A person can avoid or reduce the burden of a sales or excise tax by not buying something or buying a lower cost item. An income tax is levied on someone’s effort. Religious conservatives might reject the legitimacy of an income tax for that very reason. They argue that it was God who commanded that we work after ejecting Adam and Eve from the Garden of Eden. A tax on our effort then is an affront to God’s own commandment.

Some discredit the legitimacy of any tax if they don’t like how the tax money is spent. In 1964, the singer Joan Baez refused to pay 60% of her income tax because the government was using the money for the war in Vietnam. In 1967, writers and editors protested the “Vietnam war tax,” a 10% surcharge on telephone service each month. In response to Bush’s War on Terror, the Code Pink campaign and other tax protesters refused to pay a portion of their taxes. Some were jailed and others had their bank accounts and wages seized by the IRS.

We can’t always stipulate why we think something is fair or unfair but we know it when we see it. Each of us builds a personal framework of justifications for our beliefs and opinions, then finds others with similar frameworks. Our opinions of fairness don’t matter unless we can join with others who have the same criteria we do. Finding others who share our fairness preference validates our sense of justice and raises our personal preference closer to that of a universal law. The more people who share our outrage at an injustice confirms our convictions. However, our assessments of fairness are not universal or eternal. They can change with our circumstances – our age or income, our access to resources. This idea – that justice is a communal agreement about what is fair – disturbs those who prefer to believe that there are universal truths. There may be universal facts like gravity but there is only one universal truth – on average, people give greater consideration to whatever is closer to them.

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Photo by Andrew Moca on Unsplash

Keywords: oil, subsidy, sales tax, income tax, tax protest, tax expenditures

Oil notes: A barrel of oil is 42 gallons is different than a drum, which typically has a 55 gallon capacity. The price of a barrel of oil divided by 42 is the spot price of a gallon of oil. WTI crude closed slightly lower at the end of this week at $80.51.