Subsidy Targeting with Market Power

While regulatory authorities have largely focused on the efficiency losses associated with the exercise market power, less attention has been given to the possible distributional implications. This issue may be particularly salient in settings where private intermediaries provide goods and services that are differentially-subsidized to consumers based on observable characteristics; the distributional objectives of the government reflected in the subsidy schedule may be distorted by market power. In this paper, we develop a conceptual framework for assessing the channels through which market power influences efficiency and equity, and apply that framework to the market for health insurance plans under the Affordable Care Act. We find that market power leads to a modest (2%) loss in total welfare, but a much larger (8.5%) loss in consumer surplus. Critically, the loss in consumer surplus is regressive, with consumer surplus and insurance take-up falling disproportionately among lower-income, older, and sicker consumers. We also document that consumers only receive 50% of the subsidy spending, with the remainder captured by firms. Under a utilitarian metric, we show overall surplus would increase with income-invariant subsidies. However, with sufficiently high social preferences for redistribution, means-tested subsidies may be optimal. We conclude with a brief discussion of what our findings imply for the anti-trust regulation in product markets.