Economic systems can be likened to ecological systems. In the steaming jungle that defines the borderland between private industry and government, camouflage and parasitism are common adaptive responses to competition. Subsidy hybrids, particularly instruments that exploit the tax system to lower the costs of private investment, are an inevitable result of those evolutionary forces.
At the base of the evolutionary ladder are tax-free government bonds. A bond is a financial instrument that promises its holder a fixed annual dividend over a specified period of time, typically 10 to 20 years. National governments issue bonds to help finance their general activities. Municipalities, sub-national governments and their agencies (e.g., air-pollution control districts) also issue bonds, more commonly tied to specific projects, like water-treatment plants. The dividends paid to holders of such bonds are not taxed. Since tax-free status raises the net return on investment, particularly for bond holders in high marginal income-tax brackets, the bonds can offer a lower rate of interest than would have to be offered to buyers of private, commercial bonds in the same risk category.
Tax-free bonds are used also in some places to finance private investment: a corporation borrows money from a private lender, the bond buyer, which is issued by a public authority to become tax free.
Higher up the evolutionary ladder are instruments like tax increment financing (TIF), a peculiar form of subsidy found in the United States. Tax-increment financing enables a city to split off future additional property tax revenues associated with a designated development and to provide a loan to the company undertaking that development, using the future incremental tax revenues as collateral. In effect, this revenue stream is diverted away from normal property tax uses, such as the funding of schools, and into the TIF district.
