President Alcazar announced an increase in the labor subsidy given to firms to t
ID: 1201968 • Letter: P
Question
President Alcazar announced an increase in the labor subsidy given to firms to try to boost employment and GDP. The subsidies received by a firm are in proportion to the number of workers it employs, that is equal to s N, where s is the subsidy rate and N the number of workers employed. The government pays subsidies to firms, whose post-subsidy profits are distributed to households as income. However, the subsidies are financed by a lump-sum tax on households. The lump-sum tax is such that the government budget is balanced. Show that, for any given level of real wages, the net direct effect of this policy, subsidies and corresponding lump-sum taxes, on household’s disposable income is negative.
Explanation / Answer
Government also uses taxes and transfers to achieve redistributive goals. Government consumption tax or tariff revenue finances either the provision of an imported public consumption good or income transfers. When consumption tax revenue finances the provision of a public good, marginal migration reduces social welfare in the source country and raises it in the host. When consumption tax revenue is equally distributed among domestic households in each country, then migration has an ambiguous impact on social welfare in either country. When tariff revenue in either country is either equally distributed among domestic households, or it is used to finance the provision of a public good, then migration has an ambiguous effect on social welfare in the host country, and is expected to reduce social welfare in the source. the effectiveness of these subsidies stems from the fact that they lower the wage rate faced by the firm while maintaining the real wage received by workers, which should enhance labour demand. The direct (firm-level) employment effect is determined by the wage elasticity of labour demand (or the elasticity of substitution in a multiple-factor input context) and the percentage by which the wage is subsidised. Benefits may also spill over into the rest of the economy. Higher employment raises aggregate household income, while the subsidy causes average unit production costs, and hence consumer prices, to decline (assuming competitive product markets). Wage subsidies may therefore ultimately stimulate consumption demand, which in turn leads to additional increases in labour demand as firms step up production. This is the indirect or scale effect of the subsidies which depends on consumer demand response to price and income changes. Positive scale effects cause the demand for all factors of production (such as capital investment) to increase, possibly even outweighing the negative substitution effects for non-targeted workers. Employment subsidies therefore have various positive downstream effects, which render them useful to address a number of issues directly and indirectly, including poverty allevation, income redistribution, and the stimulation of private investment and aggregate demand. Initially, the wage subsidy has no effect on the employment rate because the positive incitation effect of the subsidy is entirely compensated by the negative distortion effect of the tax. That is, under this policy regime, human capital investment declines because of the tax effect so that firms’ profit and then employment rate remain unchanged in spite of the wage subsidy increase. Furthermore, a subsidy on capital goods purchased by final firms has a non-monotonic effect on employment rate. Precisely, as human capital decreases under this program (because of taxation) while investment in capital goods may increase or decrease (depending on the level of the subsidy rate), the effect of the subsidy on firms’ profit and then on labour demand, depends on the relative returns of these two inputs. The results found in this study should be seen as complementary to those of Petrucci and Phelps (2005) arguing that a labour subsidy may temporarily increase inputs, but is neutral for steady state while a capital subsidy spurs capital and causes a temporary increase in labour demand which vanishes in the long-run. In the sequence of accounts, the balancing item of exports and imports according to SNA is recorded in a separate account as external balance of goods and services. Otherwise, the generation of income account follows, whose balancing item is again the operating surplus and mixed income. Note that the previously added goods taxes are subtracted here just like other taxes, such that the sectorial income accounts are comparable to the total. All subsidies are minus positions (minus items), what really matters is the net position of taxes minus subsidies. Uses - wages paid, goods taxes paid, other production taxes paid, goods subsidies received, other subsidies received, operating surplus and mixed income, net. Resources - net domestic product. The household saving rate is calculated by dividing household savings by household disposable income. A negative savings rate indicates that a household spends more than it receives as regular income and finances some of the expenditure either by incurring debt or through gains arising from the sale of assets (financial or non-financial,) or by running down savings which have been accumulated in the past. The financial crisis and subsequent recession had a significant impact on households. Besides the impact of lower employment and rising unemployment, households have been affected by modest wage growth, reduced access to borrowing, falls in house prices and equity markets and, more recently, through higher inflation which has eroded the real spending power of their incomes. Negative saving would seem to point to growing indebtedness and, ultimately, a decline in living standards, as Americans tighten their belts to pay off debts. We find that overall, many of the concerns about the negative saving rate may be unfounded. The negative value could also stem in part from the strain that the 2005-06 surge in energy prices has placed on household budgets. Further contributing to the uncertainty around the negative rate is the fact that some alternative saving measures show less of a decline recently. Negative saving rate means that U.S. consumers are spending more than 100% of their monthly after-tax income. The recent data are part of a trend of declining personal saving rates observed for two decades. During the 1980s, the personal saving rate averaged 9.0%. During the 1990s, the personal saving rate averaged 5.2%. Since 2000, the personal saving rate has averaged only 1.9%. The risks to future spending and household well-being may also be overstated. Despite the decrease in reported levels of personal saving, aggregate household wealth has exhibited a strong uptrend since the end of 2002. Moreover, statistical evidence presented here suggests that past periods of low personal saving rates have not been followed by a retrenchment in spending or slower growth in living standards. the persistence of the negative saving rate should not be regarded lightly. Low levels of household, private, and especially national saving may take a toll over the long run and thus bear watching now.