Rebirth of Reason


Subsidy Versus Investment
by Merlin Jetton

Let's start with a firm.  It could be a "for profit" or "non-profit" one. The following analysis can apply to either. "Non-profits" have revenues and costs like "for profits." To be sustainable they have to obtain enough revenues to cover their costs.

A "for profit" clearly seeks revenues, R, greater than costs, C (or spending). A "non-profit" seeks R at least as large as C, and often R > C, to allow for R < C in some future time interval.  For either the focus can be the same, R - C.

When a firm gets a subsidy, it could be viewed as increasing R or reducing C. It does not matter for R - C.  Suppose a firm gets a subsidy during one time interval.  In order to remain viable, the firm must do one of the following in future time intervals -- it increases R, it reduces C, or it needs to continue getting the subsidy.  It could possibly be a combination of these, R increasing more than C, or R decreasing less than C. However, I don't believe it weakens the analysis if only the three simpler cases are considered. After all, R - C is what is important.

Suppose the firm and its supporters, who might also provide the subsidy, believe that R will increase, or C will decrease, in the future such that the subsidy is no longer needed. This may turn out to be true. On the other hand, if R does not increase, or C does not decrease, then the subsidy must continue. I say this is overwhelmingly the case for government subsidies. Politicians persist in subsidizing money-losing ventures, while proclaiming how catastrophic it will be if they don't or how much better it will be if they do. Amtrak is a great example.

Governments sometimes subsidize healthy firms for whom R - C >= 0 even without the subsidy.  However, this is often an unpopular thing to most people. The subsidized firm and its supporters likely approve, but they are a minority. The subsidy may be largely hidden to the public, e.g. special tax breaks or "earmarks" few know about.  A good example here is price supports for agriculture. But even politicians risk not being re-elected if they are caught doing something very unpopular.

Contrast with investment. While it might seem investment is a kind of R, it is not generally so accounting-wise for "for profits", and may not be for a "non-profit" as well. Suppose a firm sells bonds in order to finance a capital investment. The money from selling the bonds is not R accounting-wise and it does not increase income, R - C. Indeed, the capital spending becomes a part of C, spread out. Assume the firm buys some equipment useful for 10 years. Then the cost is "expensed" accounting-wise as a part of C for 10 years, e.g. 1/10th of the equipment's cost each year. R is expected to be higher as a result of selling the product or service the equipment enables.

In "for profit" firms, and often in "non-profits", the investment is made with the hope or expectation that consequently R will increase enough or more than enough to cover the cost of the equipment. A "non-profit" example could be hospital buying an MRI machine. Investment is a revenue inducer, or at least intended as such, for the firm itself.

Contrast this with politicians portraying government spending as "investment."  A little of the money may come back as taxes, but they are extremely vague about how this "investment spending" will be recouped via increments to R in future years. Chances are the present value of the increments to R is much less than C. Somebody's R is increased, but it is usually not that of the government, and consequently, not taxpayers in general. In other words, the "investment" is a revenue agent for somebody else, not the government itself. "Subsidy" is the proper word. (An example to consider here is a municipal government financing, or helping to finance, a pro sports stadium. The government's "investment" is more likely than not a "subsidy." Examples easily come to mind for the federal government, e.g. "investments" in alternative energy.)

This is not to say a government could not invest in the usual sense. Suppose one sold bonds to build a toll road and the costs, including principal and interest on the bonds, were recouped by tolls (plus any other incidental revenues like rent for space at oases).  In such case all revenues would be voluntary and R - C >= 0.

"Non-profits" like hospitals and colleges rely significantly on donations for their funding. Charities do even more so. Donations are like subsidies for R - C. Of course, a significant part of the donations are spent, becoming C. Such donations are voluntary. If they come from government, then they aren't really donations, but subsidies. The money is obtained coercively.
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