Tax Breaks vs. Subsidies

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A lot of liberal people have a hard time with the difference between tax breaks and subsidies. The concept really isn’t that hard, if you look at it from the business’s point of view.

A tax break, or a tax cut, is a reduction in the tax revenues collected. It can also be a reduction in the tax rate. A subsidy, however, is money given to an individual or business for a specific purpose.

Let’s look at the motivating factors of each.

First, consider a business owner or executive. They have a bunch of ideas in their head, and some of them might be pretty good. Sometimes they have a good idea, except it won’t make business sense because the tax rates are too high to sustain the business. In this case, the businessman walks away, and the idea rarely leaves the idea stage.

If government cut taxes in a way that lowers the tax rate for their business idea, then they might decide to execute on it after all.

Since the margins for success are usually thin, a small change in the tax rate will have a huge effect on the amount of activity related to that tax. A good example is what happened when the Bush Administration and Republican congress cut the capital gains tax in the early 2000’s. Almost immediately, people began buying, selling, and trading stocks. The amount of tax revenue for that particular tax reached an all-time high.

The reason why people did this is very easy to understand. Under the old capital gains tax rate, if they bought, sold and traded stocks, they would have lost money. Under the new rate, they can make money doing the very same thing.

If government ends up collecting more revenue than before, did they really give a net financial gift to the businesses? No. Government and businesses both end up making more money in the end. Tax cuts are not a zero-sum game, since the economic activity that high tax rates stifle can produce wealth that didn’t exist before.

Let’s look at subsidies. Subsidies take the limited funds that government has, and dedicates it to individuals and companies, usually with specific restrictions in place. This is different than the government purchasing goods or services at market prices. For instance, the defense industry is not subsidized.

The idea behind this is that the economic activity is a net benefit to the nation as a whole, and so the government wants to see more of it by creating an incentive program for it.

The problem here is the net potential benefit for the economic activity is likely very low. That’s why few, if any, people do it. Adding subsidies to the mix helps make the cost a little lower, and may even make the activity profitable.

However, there is a limit to how much money the government will spend on the subsidy. If, for instance, they offered a subsidy and the economic activity became very popular, then government would withdraw the subsidy and maybe even raise taxes on the activity.

The end result of this is that businesses aren’t going to stick their necks out for a limited pot of money. Whereas potential profits are endless, government has a fixed budget that they can and already have exhausted.

The upside to accepting a subsidy is low, and the downside is very high. wise businessmen do not chase government dollars. There is much, much more money to be made in delivering valuable, superior goods and services at a lower price.

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