The efficiency case for transit subsidies in the presence of a ‘soft’ budget constraint

Andrés Gomez-Lobo

Working Papers from University of Chile, Department of Economics

Abstract: The main contribution of this paper is to discuss the implications of a ‘soft’ budget constraint on optimal transit fares and subsidies. We find that the effect of productive inefficiencies on optimal fares and subsidy levels depends critically on the way cost reducing effort enters the cost function and on the institutional environment (as measured by the ‘tightness’ of the budget constraint faced by operators). In particular, recognizing that subsidies may have an adverse effect on productive efficiency does not necessarily imply that transit subsidies should be eliminated. Unsurprisingly, there will be a trade-off between the negative cost efficiency effects of transit subsidies and the welfare enhancing allocative efficiencies related to these subsidies. Under certain conditions optimal subsidies may be higher when operators face an intermediate budget constraint than when they face a ‘tight’ budget constraint. We illustrate this last result using a simple numerical example.

Pages: 33 pages
Date: 2017-07
New Economics Papers: this item is included in nep-tre
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