The UN Decade on Ecosystem Restoration (2021–2030) aims to prevent the degradation of ecosystems, such as grasslands, which play a key role in the provision of biodiversity, forage, and cultural ecosystem services. However, woody plant encroachment increasingly causes the loss of grasslands, which provide forage, are biodiversity hotspots, and are of high cultural value. In this paper, we evaluate the effect of agricultural policies in the form of farm subsidies on halting the loss of grasslands due to woody plant encroachment. To this end, we assemble a novel panel dataset that connects the farm-level census data of Swiss alpine summer farms and high-resolution remotely sensed woody plant encroachment data. To deal with the endogenous selection of claiming subsidies, we leverage an agricultural policy reform that abruptly and unevenly increased subsidies, allowing us to estimate the causal effect of subsidies at the farm level on woody plant encroachment. Our results show that an increase in subsidies causes a loss of 2% of grassland due to woody plant encroachment, which corresponds to an average loss of 4.7 ha of grassland per farm. Hence, our study highlights that the effect of subsidies can be complex and lead to unintended and not desired policy outcomes, which should be considered by policymakers.