Subsidy Targeting with Market Power

In-kind public transfers are commonly targeted based on observable characteristics of potential recipients. Increasingly, goods subsidized by such transfers are provided by private firms. We show that when the subsidized good is provided by intermediaries with market power a subsidy-induced “demographic externality” arises and can distort the incidence and efficiency of targeted transfers unless perfect price discrimination is possible. We examine the effects of market power on targeted transfers empirically in the context of means-tested subsidies for privately-provided health insurance under the Affordable Care Act (ACA). In ACA Marketplaces we estimate the pass-through rate of subsidies to consumers of less than 50 percent, with a $6 billion deadweight loss. Critically, we find that market power disproportionately redistributes away from poorer consumers, leading to lower consumer surplus and rates of insurance in the population targeted by transfers. Our results highlight potential concerns with re-distributional policies in environments with imperfectly competitive intermediaries.

With Maria Polyakova.

Version: December 2020 [PDF]