Effective or unnecessary? - A study is published on the effects of business subsidies

According to a study published on 17 June by the Government Institute for Economic Research (VATT), research and development tax subsidies and direct subsidies seem to have a positive impact on companies’ innovation activities. For small businesses in particular, the effects are significant. Most of the subsidy funds go to large companies, however. According to the study, correctly targeted subsidies can promote economic growth effectively.

Around EUR 1.3 billion in direct business subsidies is distributed in Finland annually. In addition, tax subsidies influencing business activity amount to around EUR 6 billion. Of these, value-added taxation accounts for around EUR 3 million and excise duty taxation for around EUR 2 million, with the remainder being various business tax subsidies.

The VATT study has estimated the effectiveness of direct subsidies and tax subsidies in the light of economic research literature. The study was carried out as part of the implementation of the Government’s 2014 plan for analysis, assessment and research.

Investment subsidies do little to increase the number of new investments

The study found that investment subsidies do little to increase new investments, and public aid received by large companies often displaces private funding in investments. According to the study, employment and low-wage subsidies have no impact on employment or business productivity. The subsidies are partly transferred to pay, but to an even greater extent they seem to remain with the companies. It would be important in the future to examine how subsidies affect companies’ total productivity over the longer term.

A broad tax base supports the growth better than tax subsidies

Tax subsidies can influence business directly or indirectly. In business taxation, the only significant corporate tax subsidy is support granted through accelerated depreciation. According to the study, development-area additional depreciation or fixed-term elevated depreciation have no evident impact on companies’ investments. The excise duty levels in Finland are among the highest in the EU countries, so the tax subsidy is justified by companies’ competitiveness factors. According to the study, similar support could be implemented by reforming the subsidy structure of environmental taxation.

The study also considered reduced rates of value-added tax to be tax subsidies that affect companies’ actions. They have a strong adverse impact on economic activity and growth, and the equalisation of income distribution sought by using them has proved to be costly and ineffective. Exemptions from value-added tax in accordance with EU directives are not considered to be a tax subsidy in Finland. They do, however, narrow the tax base and increase tax rates. A broad tax base and single tax rate model would seem to have a positive impact on growth, employment and the budgetary balance. This is due to the fact that the standard rate can thereby be reduced by several percentage points while maintaining tax revenue.

How can the effects of subsidies be assessed?

The study presents a draft of an assessment framework in accordance with the principles of good subsidies. The framework is designed to be suitable for assessing the effects of both tax subsidies and direct subsidies. A subsidy that influences business activity may simultaneously have a number of objectives, and therefore an overall assessment of a subsidy should be presented in relation to both individual objectives and general principles set for business subsidies (externalities, market failures). For example, a subsidy might act weakly from a business perspective, but it may have positive effects on other sectors of the economy. For this reason, all of a subsidy’s objectives and effects should be taken into account in its overall assessment. The economic benefit to a subsidy’s recipient is in no circumstances sufficient justification for a subsidy. Central to the assessment of a subsidy is to measure the benefit that is achieved at the expense of all taxpayers.

“The assessment and effectiveness of business subsidies” – a study (in Finnish)

For further information, please contact the Government’s Analysis, Assessment and Research Activities, Prime Minister’s Office

Inquiries: Timo Rauhanen, Senior Researcher, Government Institute for Economic Research (VATT), tel. +358 295 519 441, and Sari Löytökorpi, Project Manager (Government’s Analysis, Assessment and Research Activities), Prime Minister’s Office, tel. +358 295 160 187