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.
We gratefully acknowledge support from the Agency for Healthcare Research and Quality (R03-HS024800). We are grateful to David Card, Pietro Tebaldi, Mark Shepard, and Keith Ericson for their discussions of the paper, and seminar participants at Daniel McFadden 80th Birthday Conference, Junior Health Economics Summit, Ohlstadt Workshop, Stanford University, London School of Economics, American Society of Health Economists, Yale University, University of Connecticut, Columbia University, Bates White Life Sciences Symposium, University of Munich, 2018 REStud Reunion Conference, Rice University, University of Utah, University of Leuven, Georgia State University, UNC Chapel Hill, SUNY Stony Brook, University of Toronto, 2019 Penn State-Cornell Econometrics \& IO Conference, NBER Health Care Meetings, and NBER Public Economics Meetings for helpful comments. We thank Alan Jaske Lynn Hua, and Vinni Bhatia for excellent research assistance. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.