Subsidy Targeting with Market Power
In-kind public transfers are commonly targeted based on observable characteristics of potential recipients. This paper argues that when the subsidized good is provided by imperfectly-competitive firms, targeting can give rise to a “demographic externality,” creating unintended redistribution of surplus and distorting efficiency. We illustrate this mechanism empirically in the context of means-tested subsidies for privately-provided health insurance plans under the Affordable Care Act (ACA). Using a structural model of supply and demand, we show that market power increases the welfare loss from subsidy targeting, vis-a-vis income-invariant subsidies, by 33 percent.
Document Object Identifier (DOI): 10.3386/w26367