[2362] Consumer subsidy, corporate subsidy and… tax incidence

There is an argument in the Malaysian political sphere that goes like this: reduce corporate subsidy first and only then reduce consumer subsidy if need be.

It is a fair point. Yet, the validity of the point depends on which corporate subsidy.

This is due the tax incidence concept. I will not thoroughly go into it but I will summarily state that it does not matter who is taxed or subsidized. Whether it is the producer or the consumer, the answer to the question whose welfare will decrease or increase depends on a person’s — producer and consumer alike — sensitivity to price change.

If subsidy to sugar producer is removed, it is very likely that welfare of a person will go down the same way how a consumer subsidy removal will reduce the same welfare (assuming it is welfare enhancing to the consumers in the first place). That is to say that the removal of subsidy for sugar producer has the same welfare effect as the removal of subsidy for sugar consumer.

To put it more concretely, say a subsidy enhances consumer welfare and both producer and consumer are subsidized at the same time. If you reduce consumer subsidy, the consumer’s welfare will decrease. If you reduce producer subsidy, the consumer’s welfare will decrease all the same.

Removal of subsidy from anybody does not shift the welfare effect from one side to the other. It merely increases or reduces the effect.

This is a point those arguing “corporate subsidy first” need to be mindful because they are the ones whom oppose increase in prices and the eventual reduction in consumer welfare.