Subsidies and Taxes Used to Alter Incentives
This approach is used to influence behavior to address market failure.
Supply-side taxes can be issued to those who produce goods and services in two broad ways.
1. Output taxes. These are taxes placed on goods that exhibit externalities that negatively affect marginal social costs. They force firms and consumers in a free market to determine how much of the good will be produced to limit the amount of taxes and prices paid.
a. Problems can arise due to information asymmetry on the part of the government and the degree of taxation that may be required to address the externality problem. It may require a period of trial and error to determine the right amount of taxation, resulting in increased costs to implement and monitor the process.
b. Problems aside, if the taxation is effective, it can stimulate firms to lower their costs, innovate and gain knowledge, minimize government intrusion, and minimize administrative complexity.
2. Tariffs. A tax imposed in foreign imports either as a percentage of the price or a fixed amount. This approach is usually undertaken to protect the health of domestic industries from more productive or monopolistic international industries. But, it can also be pursued due to other factors such as values or retribution.
a. This approach is decreasing as nations pursue trade agreements under organizations such as the General Agreement on Tariffs and Trade (GATT) and its successor, the World Trade Organization (WTO)