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U.S. urban transit systems receive operating and capital subsidies from various levels of government. Each firm minimizes its cost net of subsidies subject to its production function. The first order conditions from this minimization give a set of equations that are estimated using a stochastic frontier approach. From the results are calculated technical and allocative inefficiencies. The allocative inefficiencies are further decomposed among two sources, subsidies and factors internal to the firm. The analysis reveals large allocative inefficiencies between labor, fuel, and capital. Furthermore, it finds that subsidies lead to excess use of labor relative to capital and excess use of fuel relative to capital and labor Also, most allocative inefficiencies in firms are due to internal factors and not subsidies, and the sizes of the inefficiencies vary substantially among transit firms. (JEL L92, H21)
I. INTRODUCTION A recent debate on balancing the federal budget over the next seven years brings attention to how and where to cut expenditures. The new farm bill shows that Congress and the administration are reviewing all federal subsidy programs. Congress views many federal subsidy programs as wasteful because they provide little benefit to society. In its view, subsidies help only firms and individuals to lobby to get more subsidies. In addition, many economists argue that most subsidies create economic inefficiency by diverting scarce resources from more productive uses and lead to rent-seeking behavior. On the other hand, supporters of subsidies argue that subsidies maintain the level of output desirable for society.
Economic analysis suggests that government subsidies to firms may create inefficiency in production, in the market, and in the economy. The types and magnitude of inefficiency depend on the types of subsidies the government provides. In partial equilibrium models, a lump-sum subsidy does not affect the firm's production decision and, therefore, results in no effect on efficiency. However, lump-sum subsidies under a rate of return regulation lead to allocative inefficiency, and subsidy per unit of output creates deadweight loss in partial equilibrium models. In general equilibrium models, subsidies create allocative inefficiency in the economy because they transfer resources from industries paying taxes to industries receiving subsidies. Further, inputspecific subsidies create allocative inefficiency in firms, and rent-seeking by subsidized firms results in technical inefficiency.
Inefficiency in a firm's...