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The Economics of Government Subsidies: The Case of Rural Electric Cooperatives and the Propane Gas Industry

3 min readBy: William P. Orzechowski

Download Background Paper No. 37

Background Paper No. 37

Executive SummaryA TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. Foundation report concludes that taxpayers are paying subsidies in the neighborhood of $225 million annually just so that rural electric co-ops can enter the propane market, despite abundant evidence that customers of propane were well served by the pre-existing private market.

The study appears in the Tax Foundation Background Paper series as one of a series of reports the Tax Foundation has published on government-supported enterprises that use their tax subsidies and other special privileges to break into markets not originally contemplated when their subsidies were granted.

Titled “The Economics of Government Subsidies: The Case of Rural Electric Cooperatives and the Propane Market,” by economist William P. Orzechowski of Orzechowski & Walker, the study analyzes the considerable distortions that are occurring in the propane market as a result of the co-ops’ entry.

Rural co-ops now supply approximately 11 percent of the nation’s electricity. Their special privileges include federal and state income tax exemptionA tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the Internal Revenue Service (IRS), preventing them from having to pay income tax. s, loan guarantees and interest rate subsidies, preferential access to federal power, and even monopoly franchises.

Orzechowski points out that many scholars question the need for subsidies at all, asserting that co-ops were successful at delivering power to remote rural areas long before the subsidies were enacted. Nevertheless, once enacted, the subsidies should be passed along in savings to the rural consumers of electric power.

Instead, co-ops have used these funds to invade ancillary markets, such as the propane gas market, creating considerable controversy. With assets accumulated during their taxpayer-subsidized provision of rural electricity – a huge customer base, managerial expertise and equipment – co-ops are perfectly equipped to enter the propane market.

In response to protests from existing propane suppliers that the co-ops’ special privileges make competing with them nearly impossible, co-ops have set up propane subsidiaries for the express purpose of claiming that their propane businesses do not benefit from the co-ops’ subsidies.

The most common justification for government provision of consumer goods is “market failure,” that is, for various reasons, the private market fails to provide an essential good or service to all potential customers. Orzechowski shows that in no way could the propane gas business be characterized this way. Evidence indicates that the market is fiercely competitive, with a large number of small and medium sized firms participating in a market that is open to entry by new competitors.

Orzechowski demonstrates that in addition to the obvious waste of economic resources that occurs when taxpayers fund the expansion of an industry that already offers good value due to competitive pressure, more waste occurs in the form of “rent-seeking.” Rent-seeking is an economic term that refers to the time and money that both the co-ops and their private sector competitors will inevitably spend in the political arena fighting over the special privileges that give the co-ops a leg up in the market.

Ironically, these rent-seeking costs can multiply so rapidly that they devour all but a tiny fraction of the taxpayer-provided subsidy that could have been available to customers as discounts.