I recently had the pleasure of observing a panel discussion of several areas farmers. It was part of a county leadership program, and this particular event was designed to give the “class” some background on the agriculture industry in the area. The discussion and subsequent tours were nothing short of fascinating. (If you have a chance to look up “precision farming” involving GPS, it is a real marvel of technology.)
At one point, someone in the audience asked what the panel members thought of government farm subsidies. I don’t know what was more interesting: the answer or the fact that each of the seven panelists responded immediately with both unanimity and laughter. Once the initial reaction subsided, one of the farmers explained it in a single sentence, “Subsidies only subsidize those who don’t pay taxes.” For my own part, I was intrigued, so I couldn’t help but ask what the farmer meant by this. Another panel member offered a a more detailed explanation.
Suppose that we can farm a product for $200 an acre. When the product is new, prices may fluctuate. Eventually, however, after this farmer and that farmer starts to charge less in order to be competitive, the price stabilizes for, let’s say, $300. In other words, farmers don’t drop below this price because they can’t drop below this price and still make a living. We need $100 an acre just to support our family and earn a respectable income. Looking at our modest $100 profit, the government kindly decides that us hard working farmers deserve more, so they institute a $50 subsidy. It sounds good at first. We get $100 profit for each acre plus the $50 hand-out from Uncle Sam. We have more income, yes? Here’s the problem. It only takes one farmer to think, “I don’t need to sell my crops for $300 an acre. I was doing just fine on a $100 profit. If I charge $275 an acre, I can undercut the competition and still earn $125 an acre ($75 “pure” profit plus the $50 subsidy), which is more than I was getting before.” You can see where it goes from here. The new competitive price becomes $275 per acre … until the process repeats. Eventually, the market kicks in and the farmers end up selling their crop for $250 an acre. They won’t drop below this, of course, because at this level they are making, with the government subsidy, the minimum $100-per-acre profit ($50 pure profit plus the $50 subsidy) needed to support the family.
Now, while the subsidy had a net change of $0 on the farmer’s well being, it was not entirely neutral. It did produce a product that is now on the market for $50 less than it was otherwise. (Before the subsidy, the crop went to market at $300/acre, and afterwards it went for $250/acre.) The consumer benefits from this subsidy, correct? Well, says the farmer, not all consumers benefit. The $50 per acre came from somewhere, because, contrary to popular belief, the government cannot simply create money out of nowhere. (These were his words, not mine.) In the end, it comes from the tax payers. Thus, if you are someone who pays federal income tax, then you essentially break even in this deal. The only people that actually benefit in the end are those who don’t pay any federal income tax. Thus, in the words of the first gentleman, “Subsidies only subsidize those who don’t pay taxes.”
Admittedly, the economics is probably a bit more complicated than this. For one thing, those who pay federal taxes are not all in the same tax bracket, so a pro-rating of sorts would probably be appropriate to figure out who comes out ahead. Second, the farmers’ “minimum price for supporting a family” is not the only economic force at work in this equation. There is also the amount of crop produced in a given year, the maximum price people are willing to pay for an individual product, etc. On the other hand, we should figure in the bureaucratic overhead involve in collecting and processing the taxes needed for the subsidy, a figure that is often notoriously high for the federal government. Nevertheless, the farmers have a point: subsidies are often not all they are cracked up to be, and the best way to handle market forces is to simply let the market work. The free market will work on its own to drop the price of commodities, but it will do so through innovation rather than compulsory subsidies. Attempts at interference rarely make a difference – at best they offer a compelling illusion. (Unfortunately, it is often compelling enough to win votes.)
The follow up question from the audience was predictable: if subsidies make not difference, then why do you take them? “Ah,” says the concise farmer, “It only takes one to accept them, and then we all have to.” In other words, once individual farmers accept a subsidy, they can then produce the product at a much lower price than those who are not accepting them, effectively putting the second group, those that want to earn their money honestly, out of business. Ain’t government grand?