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The Economics of Subsidies in Ontario’s Automotive Industry

Author

Listed:
  • Leslie Shiell

    () (Department of Economics, University of Ottawa)

  • Justin Stuart

    (Department of Economics, University of Ottawa)

Abstract

We compare the choice between granting subsidies to the automotive industry and using the funds instead to implement a permanent reduction in the sales tax on capital goods, one of Ontario’s most distortionary taxes. Our results depend critically upon how workers respond to the withdrawal of subsidies. Either workers agree to reduce their wages to offset the lost subsidies or they refuse to adjust. Our cost-benefit analysis shows the best outcome for the economy is to eliminate the subsidies, have workers adjust, and reduce the deadweight loss of taxation. The second-best outcome is to subsidize, maintain high wage levels in the industry, but forgo the benefits of tax reform. The worst outcome would be to withdraw subsidies, have workers refuse to adjust, and then experience lost employment and production. In contrast, the best outcome for the affected workers is to maintain high wages through subsidies. Therefore workers have an incentive to act strategically, by refusing to adjust their wages. For this reason, the government’s openness to subsidies likely contributes to an environment in which subsidies become inevitable.

Suggested Citation

  • Leslie Shiell & Justin Stuart, 2008. "The Economics of Subsidies in Ontario’s Automotive Industry," Working Papers 0812E, University of Ottawa, Department of Economics.
  • Handle: RePEc:ott:wpaper:0812e
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    More about this item

    Keywords

    subsidies; Ontario; automotive sector;

    JEL classification:

    • H2 - Public Economics - - Taxation, Subsidies, and Revenue

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