The Hidden Cost of Government Subsidies: A Tilted Playing Field

U.S. federal, state, and local governments are estimated to provide tens of billions of dollars of subsidies to businesses each year.[1] For example, just last year Virginia subsidized the data centers located in the state’s “Data Center Alley” by allowing them to not pay approximately $1.6 billion in sales tax they would otherwise owe the state.[2] News headlines tend to focus on whether subsidies like these provide net benefits for the taxpayers footing the bill. A less commonly asked question is what these subsidies mean for the firms in competition with subsidy recipients. New research sheds light on this question, and the findings indicate that non-subsidized firms are harmed by the subsidies given to their competitors.

But before we dive into those results, let’s step back a bit and consider why we only have an estimate of the tens of billions of dollars in government subsidies given to firms each year. An estimate is required for two reasons. First, there is no financial reporting standard or law that requires governments to disclose all subsidies awarded or firms to disclose all subsidies received.[3] And even if there were such a standard or law, we would still have to deal with the fact that reasonable people can disagree as to what should be considered a government subsidy.

So what is a government subsidy?

            The answer to this question depends on who you ask. Let’s start with a neutral source – the Merriam-Webster dictionary, which defines a subsidy as “a grant by a government to a private person or company to assist an enterprise deemed advantageous to the public.”[4] Two aspects of this definition deserve clarification. First, which types of activities are “deemed advantageous to the public”? The answer to that question is generally the types of activities the political party in power favors when a subsidy is created. While some subsidies receive bipartisan support (for example, the CHIPS and Science Act of 2022 provides federal government subsidies for U.S. domestic chip manufacturing in part due to U.S. national security concerns), many subsidies fall along partisan lines. Energy subsidies illustrate this point. In the U.S. in recent years, a Democratic-led federal government has used subsidies to prioritize clean energy production (e.g., the Inflation Reduction Act of 2022 offers subsidies for wind energy, solar energy, and battery storage),[5] while a Republican-led federal government has used subsidies to prioritize other forms of energy production (e.g., the One Big Beautiful Bill Act of 2025 offers subsidies for oil, gas, and coal production).[6]

Second, in this definition, the term “grant” refers to bestowing or transferring resources. Some subsidies are direct transfers from a government to an entity, either through a cash outflow (commonly referred to as a grant) used by the recipient to do something a government cares about, or through a reimbursement for costs the recipient has already incurred to do something a government cares about. Other subsidies are tax incentives, where an entity does not have to pay a specific type of tax that it would owe a government absent the subsidy. Virginia’s data center subsidies fall into this category. All three types of subsidies – cash grants, cost reimbursements, and tax incentives – benefit recipients while costing taxpayers. Governments can also offer loans, which give recipients access to capital (often at favorable terms), although this form of subsidy is much less common at the state and local government level.

            Another complication in the public discourse on subsidies is that different groups use different terms. Economists often describe them as an “industrial policy” tool, firms that receive them often use the term “government incentives,”[7] and critics call them “corporate welfare.”[8] As you can see, what a subsidy is and how it is discussed depends on who you are talking to, and the term they use generally reflects their view of the subsidy itself.

So who gets subsidies?

            Many subsidy programs are open to any firm that engages in the activity “deemed advantageous to the public.” At the federal government level, subsidies are often industry-specific. Examples include subsidies to the railroad industry in the 1850s and 1860s (to ease transportation frictions in the U.S. during the period of westward expansion),[9] the agricultural industry beginning in the 1930s (in the interest of stabilizing U.S. crop prices following the Great Depression),[10] and the semiconductor industry with the recent CHIPS and Science Act of 2022 (to reduce U.S. reliance on foreign-produced semiconductor chips).[11] State and local government subsidies can also be industry-specific. The Virginia legislature’s Data Center Retail Sales and Use Tax Exemption and data centers’ ability to use single sales factor apportionment allow the data center industry to pay lower sales and income tax to the state each year.[12]

            Many state and local government subsidies focus on retaining or creating jobs in a particular geographic location. In some instances, a single firm can prompt a government to create a package of subsidies tailored to benefit that firm. To illustrate, in 2003 the Washington state government awarded the U.S. domestic aerospace industry (i.e., Boeing and its suppliers) a multi-billion-dollar tax incentive package to ensure the firm’s final assembly of its 787 airplanes occurred in Washington.[13] While it’s the billion-dollar subsidies that frequently appear in media headlines, many subsidies are available to any firm in any industry that meets the subsidy criteria. For example, the federal government[14] and many state governments[15] offer tax incentives to organizations that employ U.S. veterans.

How subsidies affect non-subsidized competitors

            In a competitive market, firms try to win customers by offering goods and services at a better quality or lower price than their competitors. Government subsidies reduce the costs that recipient firms bear when implementing their competitivestrategies. This means that if one firm receives a subsidy and its product market competitors do not, the subsidized firm has a competitive advantage and the non-subsidized firms are at a competitive disadvantage. So while governments offer subsidies to “assist an enterprise deemed advantageous to the public,” these subsidies may have an unintended consequence of harming non-subsidized competitors.

My research with Elisa Casi (NHH Norwegian School of Economics) and Costanza Cincotta (CUNEF Universidad) provides evidence consistent with this type of harm. We identify approximately 1,600 publicly traded U.S. companies that received roughly $278 billion in U.S. federal, state, and local government subsidies over two decades (2000 through 2021). We find that subsidies are pervasive, in that three out of four non-subsidized firm-years had at least one subsidized competitor. We then look at the financial performance of the firms that compete in the same product market as subsidized firms, yet do not receive any U.S. subsidies. Our primary finding is that as competitors’ subsidies increase, non-subsidized firms’ profits decrease. The magnitude is large – when subsidies to a firm’s competitors increase by a substantial amount (a standard deviation, to be precise), the non-subsidized firm experiences a 12 percent decrease in profit and a 5 percent decrease in its share of product market sales. These findings are consistent with subsidies having negative spillover effects on non-subsidized competitors. The lower operating performance is in part driven by an increase in research and development spending, suggesting that non-subsidized firms try to innovate their way out of a tough competitive environment. We also find that the type of assistance matters, as only subsidies that do not have to be repaid (e.g., tax incentives, cash grants, and cost reimbursements) negatively impact non-subsidized competitor profits. We also ask which non-subsidized competitors bear the most negative consequences. We find that financially constrained firms experience a greater decline in profit, and that the decline in sales market share is driven by non-subsidized firms operating in less competitive product markets.

Our finding that competitor firms pay a price is a consequence that rarely enters the U.S. subsidy discussion. All of this suggests that in addition to thinking about what is “advantageous to the public,” policymakers should also consider whom the subsidy disadvantages. One potential way for governments to mitigate the negative externalities that non-subsidized competitors face is to structure subsidies as repayable transfers, as lower non-subsidized competitor profits are found only when subsidies do not have to be repaid. Governments could also explicitly consider a product market’s competitiveness before offering subsidies to any firm in that market, as non-subsidized firms’ decline in market share is driven by subsidies awarded in less competitive markets. In addition, taxpayers who ultimately fund government subsidies should consider not only which firms receive subsidies and what recipients do with the money, but also how subsidies affect the competitors that do not receive them. Subsidies can carry costs for non-subsidized competitors, tilting the playing field in ways that never appear in any government budget.

References:

Bartik, T.J.2017. A New Panel Database on Business Incentives for Economic Development Offered by State and Local Governments in the United States. Kalamazoo: W.E. Upjohn Institute.

Jensen, N., 2018. Bargaining and the effectiveness of economic development incentives: An evaluation of the Texas Chapter 313 program. Public Choice 177.

Jensen, N.M., Malesky, E.J., 2018. Incentives to pander: How politicians use corporate welfare for political gain. Cambridge University Press.

Slattery, C., and Zidar, O., 2020. Evaluating state and local business incentives. Journal of Economic Perspectives 34, 90–118.

Story, L., 2012. As companies seek tax deals, governments pay high price. The New York Times URL: www.nytimes.com/2012/12/02/us/how-local-taxpayers-bankroll-corporations.html

[1] Examples of estimates include those by Story (2012), Bartik (2017), Jensen and Malesky (2018), Jensen (2018), and Slattery and Zidar (2020).

[2] https://www.multistate.us/insider/2026/2/4/states-rethink-data-center-tax-incentives-as-costs-soar

[3] There has been some movement towards greater transparency by both governments and firms regarding subsidies. GASB 77 (issued in 2015) requires state and local governments to disclose forgone tax revenues due to tax incentive awards (one type of subsidy), and ASC 832 (issued in 2021) requires firms to disclose government financial assistance (excluding income tax subsidies). Despite these financial reporting standards’ good intentions, their limited scope means that subsidy disclosures by both governments and firms remain incomplete.

[4] https://www.merriam-webster.com/dictionary/subsidy

[5] https://www.bdo.com/insights/tax/inflation-reduction-act-of-2022-includes-numerous-clean-energy-tax-incentives

[6] https://www.instituteforenergyresearch.org/regulation/summary-of-key-provisions-in-the-one-big-beautiful-bill-act/

[7] https://www.sec.gov/Archives/edgar/data/50863/000005086325000074/intc-20250329.htm

[8] https://www.cato.org/policy-analysis/corporate-welfare-federal-budget-0

[9] https://www.archives.gov/milestone-documents/pacific-railway-act

[10] https://usafacts.org/articles/federal-farm-subsidies-what-data-says/

[11] https://www.congress.gov/crs-product/R49031

[12] https://www.streamdatacenters.com/resource-library/glossary/virginia-state-data-center-tax-incentives/

[13] https://www.heraldnet.com/2009/06/19/how-the-787-was-won/

[14] https://www.irs.gov/businesses/small-businesses-self-employed/work-opportunity-tax-credit

[15] https://bestmilitaryresume.com/blog/hiring-veterans/state-tax-incentives-hiring-veterans