How Do Taxes & Subsidies Affect Supply?

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Supply and demand are forces that affect a business's willingness to sell and the prices it charges. They also affect a consumer's willingness to buy a product or service. Taxes and subsidies can play a significant role in how much of a product a business will produce for consumers to purchase.

Business Taxes Decrease Supply

  • Businesses can be taxed directly or indirectly through a variety of means: City or state taxes and taxes on corporate profits are just two examples. Any tax on a business will affect its supply. Taxes increase the costs of producing and selling items, which the business may pass on to the consumer in the form of higher prices. When costs of production increase, the business will decrease its supply of the item.

Subsidies Can Increase Supply

  • Subsidies generally are payments the government makes to businesses or industries to keep them producing or researching a product. For example, if an industry that the government deems important is struggling, the government might give these businesses a certain amount of money for every item they sell. This type of subsidy increases supply, because it decreases how much it costs the business to produce an item. When costs of production decrease, the business can make more of a product. It can also allow the business to reduce the price it's charging for the product. This can lead to greater demand -- and to greater supply to meet that demand.

When Subsidies Work in Reverse

  • Sometimes the government might actually pay a business to not produce something. For example, the federal government has a Conservation Reserve Program that pays farmers not to plant certain crops. In 2012, the government accepted 3.9 million acres into the CRP. This type of subsidy, which automatically decreases supply, was first used during World War II when crops were overproduced so farmers could feed people in Europe in addition to the United States. After the war ended, too many crops still were being produced despite the reduced demand, so the government wanted to provide incentives for growers to cut back on the supply. Today's program is meant to help protect groundwater in certain areas by reducing water runoff and sedimentation.

Internet Sales Tax

  • A tax doesn't always decrease supply. For example, retailers only charge tax on online purchases if they have a brick-and-mortar store in a sales-tax state. Politicians are pushing for taxes to also cover retailers who only sell online. This tax might have a disproportionate effect on supply. Some customers choose online stores over physical stores because of the tax savings; if the tax is implemented, they might shop more frequently at brick-and-mortar stores. In this way, the supply from physical stores could actually increase due to an online tax.

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