How Business Tax Subsidies Work

Economies across the globe strive towards progress and economic development. This is also often the prime goal or focus of governments, both state and local.

Government officials are always striving towards attracting firms and businesses to help them grow and flourish.

In doing so, they often end up offering financial incentives to potential firms and businesses. One of these most commonly provided incentives include tax subsidies.

What Is A Tax Subsidy?

Before knowing how business tax subsidies work, it is imperative to understand what exactly a tax subsidy is.

Simply put, a tax subsidy is typically seen as a type of financial aid in which governments provide sums of money or grants to firms in an attempt to boost up their business. Tax subsidies are often provided with a belief that they will help firms create more jobs and increase overall investment. This is because subsidies share a firm’s financial burden and they lower the cost of doing business. As a result, an increased return on investment can be expected.

How Does A Business Tax Subsidy Work?

Since the basic goal here is to lower the costs associated with taxation, and increase expected returns on investment, the government does this through various different methods.

1.     Tax Credits

A tax credit is simply a deduction in the amount of money that taxpayers (businesses and firms) owe to their government. The value or amount of the tax credit usually depends on the type of credit being provided, based on what industry or business it is.

While tax credits are similar in nature to tax exemptions and tax deductions, they actually reduce the amount of tax owed than reducing the amount of taxable income.

2.     Modifying the Tax Rates

Altering the tax rates involves allowing a certain business entity to pay a lower amount in tax than other entities. This acts as a massive advantage for the form or business with the lower tax rate.

This is done using three main approaches:

·         Exempting certain activities from taxation

This includes removing taxes from certain products or activities, for instance, governments may provide partial exemption in motor fuel taxes.

·         Decreasing tax rates

As the name suggests, certain activities and firms are expected to pay a lower tax percentage than others.

·         Exempting certain entities from taxation

In this approach, entire entities are given an exemption from paying taxes. An example of such an entity could be publicly owned utilities.

3.     Changing the Taxable Source

Governments intervene to reconsider which activities should be made part of the taxable basis in order to lower the net profit figure to which the tax was initially applied. This helps firms and businesses to focus on those activities that will reduce their final tax bill.

4.     Redefining Who Pays the Tax

Taxpayers are given a chance to combine their tax returns in ways that may help equalize the discrepancy faced through taxable income in one area with losses from another. In many cases, taxpayers may also choose to consolidate gain more from reduced taxes.

Although business tax subsidies aim to reach a socially optimal in the production of goods and services, there is a big question mark on whether if it’s truly beneficial or not.  However, like all economic decisions, tax subsides also have an opportunity cost!

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