U.S. Agricultural Policy: Issues & Outlook Dr. Kelly Tiller Agricultural Policy Analysis Center The University of Tennessee Philip Morris USA Richmond, VA March 14, 2007 Agricultural Policy Analysis Center ● The University of Tennessee ● 310 Morgan Hall ● Knoxville, TN 37996-4519 www.agpolicy.org ● phone: (865) 974-7407 ● fax: (865) 974-7298

Agenda Overview of U.S. farm policy evolution Ag policy today: the 2002 Farm Bill Outlook for 2007 Farm Bill Farmer decision analysis General discussion

What a Farm Bill Does Provides USDA the authority to operate food and farm programs using provisions specified in the bill For most programs, authority is temporary; permanent authority for some Provides upfront ALL of the funds needed to provide benefits for a “mandatory” program during its authorized life Funding can be as needed (entitlement) or a fixed amount Authorizes the appropriation of funds for “discretionary” programs Must address “permanent law” provisions of the Agricultural Act of 1949 either through a temporary suspension or repeal

US Farm Bills Primary vehicle for setting medium-term US agricultural policy Typically about 4-6 years Scope of farm bills has expanded over time 1981-1990 FBs: separate titles for each commodity 2002 FB: 10 titles, single commodity title Margin of victory shrinking over time Senate passed 1977 FB 63-8 2002 FB conference report passed 64-35

Omnibus Policy Usually in a Farm Bill Commodity programs Conservation programs Ag trade programs Food stamps & other nutrition programs Ag research May be in a Farm Bill or separate legislation Rural development programs Crop insurance programs Forestry Ag labor programs Agri-energy programs

Why Have Commodity Programs? Farmers have the power to extract money from Congress—so they do Food is a national security issue Supply and demand characteristics of aggregate agriculture cause chronic price and income problems Uneven growth in supply and demand Agriculture sector cannot right itself when capsized by low prices

Market Failure Logic Technology expands output faster than population and exports expand demand Market failure: lower prices do not solve the problem Little self-correction on the demand side People will pay almost anything when food is short Low prices do not induce people to eat more Little self-correction on the supply side Farmers tend to produce on all their acreage

Ag Policy Did Not Start in 1932 Historic policy of plenty Land distribution mechanisms – 1620 onward Canals, railroads, farm to market roads Land Grant Colleges – 1862, 1890, 1994 Experiment Stations - 1887 Cooperative Extension Service – 1914 This policy of plenty often results in production outstripping demand

When Policy of Plenty is Too Much Given agriculture’s inability to quickly adjust to overproduction and low prices, there are 3 policy strategies: Supply side Demand side Just pay money

Historical Policy Components Policy of Plenty: Ongoing public support to expand agricultural productive capacity through research, extension and other means Policy to Manage Plenty: Mechanisms to manage productive capacity and to compensate farmers for consumers’ accrued benefits of productivity gains

Traditional Farm Policy Elements From 1973 (or earlier) to 1996, U.S. domestic farm policy generally included the following elements: Target price for major crop commodities Deficiency payments for the difference between target price and market price Base acreage Acreage reduction / set-asides Nonrecourse loan Government storage of commodities

Review: Price Support Policies Nonrecourse price support loan Loan rate becomes price floor Problems ?? Where/how to set loan rate Rates tend to ratchet up (reduces exports, creates surplus) Costly to store Government purchase program Dairy products Problems with price support levels Problems with capitalization (into price of land, cows)

Review: Production Controls May be voluntary or mandatory Acreage allotments and marketing quotas Slippage Capitalization into land or quota value Land retirement programs Short term or longer term Usually have benefits in addition to payments Soil conservation, environmental, hunting leases Conservation Reserve Program Annual acreage set-asides

Deficiency Payments The difference between the average market price and a target price Target price A guaranteed level of returns per unit of commodity For a specified time periods On a portion of acreage (up to 100%) Target prices support only income, not price Deficiency payment calculation uses base acreage and yields Congress generally sets target prices

All of that changed … 1996 Freedom to Farm

Key 1996 FB Policy Changes Eliminated the target price program Decoupled transition payments with virtual flexibility Eliminated acreage set-aside program Eliminated the Farmer-Owned Reserve (FOR)

Policy Changes In the past, farm policies included Floor price Supply management tools Price stabilization Recent policy trends (especially since 1996) Eliminated all three – because of expectations Set prices free to fall well below cost of production Provided revenue supplements to compensate when prices are low

“Program” Crops Crops for which Federal support programs are available to producers Peanuts* Sugar Tobacco** Wool & Mohair Honey Wheat Corn Barley Grain Sorghum Oats Cotton (ELS & Upland) Rice Oilseeds

Income Support Payments Why movement in 1970s to direct payments? To lower price supports to restore export competitiveness Deficiency payments Marketing loan payments Loan deficiency payment (LDP) Marketing loan gain (MLG) Fixed payment AMTA contract payments Direct payments Countercyclical payments (CCP)

Marketing Loan Payments Pays farmers the difference between the market price and the loan rate, as a direct payment, when the market price is below the loan rate Marketing assistance loans designed to provide producers interim financing at harvest time to meet cash flow needs without having to sell commodities when market prices are typically at harvest-time lows Designed to facilitate more orderly marketing of commodities throughout the year Were an embedded feature of the nonrecourse loan program until prices plummeted in the mid-1990s

Loan Deficiency Payments Uses localized posted county prices Some daily, some weekly Uses local (county) loan rates Allows a farmer to take the payment without taking out a CCC nonrecourse loan (LDP) Alternatively, the farmer can put the crop under a 9-month nonrecourse loan and set the LDP at a later date By itself, the loan rate becomes the minimum revenue (per unit) a farmer will receive

Fixed Payments Initially established in the 1996 Farm Bill Designed to address the over production effect of direct (deficiency) payments Annual amount of each payment (1996-2002) was set in the 1996 FB Payments declined over period Eligible farmers entered into contracts and received the payments regardless of which (or any) crops planted Benefits still capitalized into land values Effect on output?

Acreage Response to Lower Prices? Four Crop Acreage Index (1996=100) Four Crop Price Since 1996 “Freedom to Farm” Aggregate US corn, wheat, soybean, and cotton acreage changed little despite a wide fluctuation in price

U.S. Gov’t Payments by Program

What about Exports? US Domestic Demand US Population US Exports Index of US Population, US Demand for 8 Crops and US Exports* of 8 Crops 1979=1.0 US Population US Exports US Domestic Demand *Adjusted for grain exported in meat

What about Exports? US Thousand Metric Tons Developing Competitors Developing competitors: Argentina, Brazil, China, India, Pakistan, Thailand, Vietnam 15 Crops: Wheat, Corn, Rice, Sorghum, Oats, Rye, Barley, Millet, Soybeans, Peanuts, Cottonseed, Rapeseed, Sunflower, Copra, and Palm Kernel

U.S. Federal Deficit/Surplus

2002 FB General Approach No set-asides No stock accumulation No market price support Some payments decoupled from production, other payments tied to production and level of price 6-year lifespan (2002-2007)

Commodity Provisions Continues fixed annual payments Continues deficiency payments when prices go below the loan rate Institutes new Counter-Cyclical Program (CCP) with target prices Allows for updating acreage and yields and addition of oilseed acreage for CCP

Countercyclical Payments New in 2002 Farm Bill Pays producers the difference between the target price (set by Congress) and the higher of: The 12-month average market price, or The loan rate plus the per unit fixed payment Based on farmers’ previous acreage and yields (allowed to update some in 2002 FB) Farmer does not have to plant the crop to receive the payment “Countercyclical” because they “kick in” when market prices are low

Fixed Payments & Target Prices Wheat (bu) $0.52 $3.86 $3.92 Corn (bu) 0.28 2.60 2.63 Sorghum (bu) 0.35 2.54 2.57 Barley (bu) 0.24 2.21 2.24 Oats (bu) 0.024 1.40 1.44 Rice (cwt) 2.35 10.50 Soybeans (bu) 0.44 5.80 Upland Cotton (lb) 0.0667 0.7240

Marketing Loan Rates 2001 Rates 2002-2003 2004-2007 Wheat (bu) $2.58 $2.80 $2.75 Corn (bu) 1.89 1.98 1.95 Sorghum (bu) 1.71 Barley (bu) 1.65 1.88 1.85 Oats (bu) 1.21 1.35 1.33 Rice (cwt) 6.50 Soybeans (bu) 5.26 5.00 Upland Cotton (lb) 0.52

Direct Payments Replaces decoupled payments established in 1996 farm bill (AMTA, PFC) Paid at a fixed rate per crop on 85% of base acres, includes additional crops Receive direct payments whether you plant a crop or not Option to update base acres, must use “old” program yields DP = (base acres * 85%) * old FPY * DP rate

To Update Or Not To Update Tradeoffs, primarily because entire farm must be updated, not selected commodities Updating often adds income for one commodity at the expense of another Decision is extremely farm-specific Updated program yields not used to calculate direct payments, just CCPs Direct payments and CCPs made on 85% of base acres

Counter-Cyclical Payments Establishes a vehicle for “automatically” distributing the emergency/ad hoc payments that have been made since 1998 Do not have to produce commodity to receive CCP Commodity specific based on a national price trigger (target price) Payment rate depends on the effective price for the commodity, where effective price is the direct payment rate plus the higher of the market price or national loan rate Target price - effective price = CCP rate ($/unit) CCP = (base acres * 85%) * program yield * CCP rate

Target Prices Target price is not a guaranteed price Target price is merely a number used to calculate other possible payments As price rises, the difference between market price and revenue received narrows Maximizing farm program benefits more intertwined with market direction and marketing decisions than ever before

Corn Price/Revenue Example* Cash Price: $1.80 Cash Price: $2.50 Revenue Received: $2.54 Revenue Received: $2.65 $2.65 Target Price = $2.60 Direct Payment $2.54 $2.50 Counter-Cyclical Pmt $2.27 Direct Payment County Loan Rate = $2.12 $2.12 LDP $1.80 Market Price Market Price * Assumptions: “Old” Farm Program Yield = 80 Actual Yield 1998-2001 = 125 Updated CCP Yield = 117 Payment Limits Not Applicable “Old” Program Base Acreage = 1,200 Updated Base Acreage = 1,080

Corn Price/Revenue Example* National Loan Rate = $1.98 County Loan Rate = $2.12 Revenue = Cash Price + DP + CCP + LDP Target Price = $2.60 Cash Price = Price Received * Assumptions: “Old” Farm Program Yield = 80 Actual Yield 1998-2001 = 125 Updated CCP Yield = 117 Payment Limits Not Applicable “Old” Program Base Acreage = 1,200 Updated Base Acreage = 1,080

Implications of Commodity Policies No price floor No emergency reserves No price ceiling Supports incomes, not prices Subsidizes livestock and other users Subsidizes agribusiness input suppliers and output processors

Conservation Provisions Total conservation price tag: $17.1 billion Basically expands most existing conservation programs and adds several new programs Emphasis of conservation spending shifts from land retirement to working lands

Conservation Programs Conservation Reserve Program (CRP) Cap raised from 36.4 to 39.2 million acres Land automatically eligible for re-enrollment Wetlands Reserve Program (WRP) Cap raised from 1.075 to 2.275 million acres Permanent easements, 30-year easements and/or restoration cost-share

Conservation Programs, cont’d Env’l Quality Incentive Program (EQIP) $9 billion mandated 60/40 split between livestock and crop producers Priority areas eliminated Animal unit cap eliminated Conservation plan requirement retained 1 to 10 year contracts Total payments capped at $450,000

Conservation Programs, cont’d Farmland Protection Program (FPP) Purchase conservation easements $985 million Requires partnership with non-profits Wildlife Habitat Incentive Program (WHIP) Grasslands Reserve Program (GRP)

Conservation Programs, cont’d Conservation Security Program (CSP) Incentives to maintain and increase stewardship practices $2 billion Begins in FY03 Land in CRP, WRP, GRP and animal waste facilities not eligible 3-tiered participation, up to 10 year contract, annual cap up to $45,000

Payment Limits The maximum amount of commodity program benefits a person can receive annually by law First enacted in 1938 farm bill, reinstated in 1970 “Persons” are individuals, members of joint operations, or entities, such as limited partnerships, corporations, associations, trusts, and estates, that are actively engaged in farming “3 entity” rule

Payment Limits Current maximums $40,000/person/FY for direct payments $65,000 for counter-cyclical payments $75,000 for marketing loan benefits Effective annual cap is $360,000 per person per year In reality, virtually unlimited Producers with 3-yr average adjusted gross income > $2.5 million not eligible for payments Unless > 75% of AGI is from agriculture

Other Provisions Peanut quota buyout Maintains/increases most trade, rural development and nutrition programs Adds new energy title to the legislation Addresses bioterrorism / biosecurity Relaxes rules to make more borrowers eligible for federal farm credit assistance

Outlook for 2007 Farm Bill

What/Who Influences Policy? Ag producer lobby General farm organizations Commodity organizations Cooperatives Agribusiness lobby General agribusiness organizations Commodity agribusiness organizations Public interest lobby Consumer food lobby Nutrition, food safety, and quality lobby Hunger lobby Resource and environmental lobby

Broader Interests Represented USDA—first substantive set of policy proposals in decades Inside agriculture Specialty crop producers American Farmland Trust Outside agriculture Chicago Council on Global Affairs American Enterprise Institute Oxfam USA

(What/Who)’s MOST Influential? What counts is relative influence at the time the bill is being developed

Increasingly Important Influences Budgets and deficits Farm economy (prices, trends) Trade / WTO considerations Expanding/competing ag interests Balance of power in Congress Energy prices / renewable energy

Farm Bill Timeline 2002 Farm Bill expires September 30, 2007 Trade Promotion Authority expires June 30, 2007 Budget baseline haggling through April Likely to mark up bills through May and June Need to have bills passed in both Senate and House and ready for conference by August recess Must resolve differences in Conference quickly in September

Budget Constraints Very different budget situation than in 2002 Got $79 billion ABOVE the baseline in ‘02 Farm Bill January CBO baseline $30 billion less for commodity title spending over last year’s baseline Diverse groups attempting to obtain more funds in FY08 budget resolution Even if Congress doesn’t cut, it won’t increase, affects how the pie is sliced Divisive for the ag sector But maybe not as bad as 2012, 2017 ??

US Budget Projections, 2008-2017 Source: CBO: The Budget & Economic Outlook: Fiscal Years 2008-2017, Jan. 2007

Future “Current” Situation What matters most is the situation At The Time the bill is written Crop prices much higher Up from historical lows, reduces “costs” of continuation Driven largely by non-ag demands (ethanol) Export prospects (China) improving ?? Costs of production high Especially energy-related costs Interest rates higher Labor/immigration policy pressures Doha negotiations in WTO may not be resolved, but trade issues still very important

U.S. Corn Ethanol Production Total Capacity (as of 11/27/06) = existing + under construction + under expansion 2012 RFS: 7.5 B gallons Source: Renewable Fuels Association

Expected Net Returns Source: USDA, OCE, January 2007

U.S. Corn Ethanol Production Total Capacity (as of 11/27/06) = existing + under construction + under expansion 2012 RFS: 7.5 B gallons Could potentially double corn-ethanol capacity Crop farmers benefit from corn-ethanol, wherever plants are located Livestock farmers face higher costs There’s a limit to the amount of corn-based ethanol we can sustainably produce without disrupting the ag sector Source: Renewable Fuels Association

Distribution of Subsidies Renewed push for payment limits Last year: necessary to hold down costs This year: some reform necessary for damage control Pressure to shift funds from program crops to specialty crops while reducing overall spending 39% of farms receive government payments (Source: ERS, 2006) 10% of farms receive nearly 75% of payments (Source: EWG, 2005) Agricultural voting impact Number of farms and farmers continues to shrink Many representatives in the House do not have farm constituents

Distribution of Subsidies, cont’d Pressure to shift payment basis from production to conservation Influenced by WTO commitments Pressure to address WTO compliance challenges Pressure to reduce the impacts of subsidies on land values and cash rents (transfers to landowners) Since 2000, Illinois farm real estate values have increased 68% 1994-1999: increased between 4.2% and 9% 2000-2003: increased between 1.3% and 3.4% 7.4% in 2004, 27.6% in 2005, 14.1% in 2006

USDA FB Proposal Proposal developed by the Secretary of Agriculture, released 6 weeks ago A continued “safety net” “Similar” programs, lower loan rates Addresses “inequities” in payments Eliminates planting restrictions Reduces payment limits (lower AGI cap, eliminates 3-entity rule) Moves toward more WTO compliance More conservation dollars, higher direct payments, larger energy title

Possible 2007 FB Reforms Farm income Conservation Renewable energy Revenue, rather than price, programs May be only current program crops, may include specialty crops and livestock Conservation Continued shift toward green payments, especially those that are clearly WTO green box Renewable energy Expand programs in 2002 FB, add incentives to move from corn-based ethanol to cellulosic ethanol

Farmer Decision Analysis Price expectations Expected returns Includes government payments Labor Rotations Expectations beyond next year

Expected Net Returns Source: USDA, OCE, January 2007

2002 Total Cropland

2002 Base Acres

Share of Base Acres Planted 2005, Corn

Share of Base Acres Planted 2005, Corn

Share of Base Acres Planted 2005, Cotton

Share of Base Acres Planted 2005, Cotton

Share of Base Acres Planted 2005, Soybeans

Share of Base Acres Planted 2005, Soybeans

www.agpolicy.org