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More Subsidies for Prosperous Farmers

Wednesday, May 1, 2013

In the face of deficits not seen since World War II, we should question proposals to provide billions of taxpayer dollars to support an industry that is enjoying record profits.

The U.S. Department of Agriculture estimates that farm income in 2013 will be more than double what it was in 2009. The nation’s farmers are enjoying the benefits of high crop prices, massive crop insurance subsidies, and technological advances that have made crops more resistant to drought. As a result, farming’s record level of income far surpasses that of comparable non-farm sectors.

Yet much of the debate over new farm legislation seems oblivious to these facts. The latest farm bill would give farmers even greater subsidies. In 2012, the Senate and the House failed to reach a consensus on a farm bill and instead passed a compromise extension of expiring law. The hope was that the agricultural committees would then develop a traditional omnibus farm bill package of legislation. The extension is set to expire on September 30; House and Senate leaders have pledged to complete a bill this year and the House will hold a markup this month.

Today, as has increasingly been the case since the early 1980s, U.S. farmers are protected from significant yield and price losses by a massive and heavily subsidized crop insurance program. The program offers most producers the option to guarantee up to 85 percent of their projected yield or revenue. The most popular form of crop insurance guarantees revenue and promises to replace yield losses at the greater of the expected price at planting time or the actual price at harvest. As crop prices and farm incomes have increased to record levels, so too have the revenues guaranteed to farmers under these insurance contracts and the subsidies paid by taxpayers.

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Yet these generous benefits are viewed by most agricultural committee members as being insufficient. The 15 percent deductible inherent in the current program — a feature common to most insurance plans — is supposedly too onerous. A key component of the Senate version of the new farm bill was a “shallow loss” program known as “Agricultural Risk Coverage,” or ARC. This program would add an additional guarantee that makes payments if revenues fall beneath 90 percent of the previous five-year average. Cotton growers were offered their own special set of benefits in the form of the “Stacked Income Protection Plan” (STAX) that would increase coverage to 90 percent of revenue. A similar version of shallow loss protection known as “revenue loss coverage” was also a component of the House version of the bill. Various versions of the legislation differ in terms of their level of support, but in every case the intent is to increase coverage and taxpayer subsidies above the current annual average of $9 billion in crop insurance subsidies. The form of legislation to be considered in 2013 is not entirely clear but such shallow loss programs continue to characterize the debate.

Much is made of the fact that the new legislation was predicted to reduce spending if prices do not fall. The National Cotton Council argues that the STAX plan would reduce cotton program spending by 30 percent. However, the proponents of shallow loss coverage usually ignore the potential for rising taxpayer costs if prices were to fall. In earlier work with Vincent Smith and Bruce Babcock, I found that a decrease in prices from current levels to the average over the 1996-2011 period would offset any budgetary savings and lead to even more costs than the current direct payment program. More fundamentally, in an era of record farm incomes, significant budget shortfalls, and very generous crop insurance subsidies, few legislators seem to question the wisdom of increasing the guarantees offered to farmers — generally a wealthy segment of society. The program, much like the misguided “Average Crop Revenue” or ACRE program of the 2008 Farm Bill, has the perverse feature of increasing support levels when incomes rise.

The extension of one subsidy, at least, remains doubtful. In late 2011, many farmers and farm lobbies seemed to have accepted the fact that direct payments — subsidies that do not even require farmers to grow crops — were politically untenable in the current federal budgetary environment. These payments have been a fixture of U.S. farm policy since 1996, when they were introduced in the Agricultural Market Transition Act. Initially, the payments were structured to decline throughout the five-year life of the legislation, and many naïve observers (this author included) believed they would end as the bill expired, thus signaling the supposed “transition to a free market” for which the bill’s supporters had argued. Nevertheless, direct payments persist to this day. As Milton Friedman once observed, “nothing is so permanent as a temporary government program.”

Congress seems intent on removing as much of the risk from farming as possible, or at least as much as is palatable to the taxpaying public and to representatives from non-agricultural districts. This is not to say that these non-agricultural representatives do not receive a significant share of the benefits of the farm bill. The largest component of spending in the bill occurs through food stamp programs that direct taxpayer support to urban districts and the rural poor. The wisdom of tying nutritional support to farm subsidies is questionable from a public policy perspective, but the political reality of providing such support is obvious.

A market economy allocates resources to their most productive use. Risk plays an important role in this process. Businesses that fail to properly manage their risks will likely be replaced by those that better manage their resources so as to maximize profits. Business failures are a reality of living in a market economy. Those that do a poor job of managing risk are replaced by those that are superior, and society as a whole benefits through a more efficient allocation of resources. Other systems of managing resources, such as central planning, have been found to misallocate resources to the extent that such systems have largely collapsed or, in the case of socialism, have found themselves in an untenable budgetary situation.

Farm businesses exercise less care in their decisions when they know the taxpayer has to step in with subsidies if output or prices turn downward.

The problem is that government intervention often distorts incentives. Subsidizing risk allocates resources inefficiently because it encourages people to take more risks, since they don’t bear all the costs of their actions. Moral hazard is an obvious problem. Farm businesses exercise less care in their decisions when they know the taxpayer has to step in with subsidies if output or prices turn downward. A clear role for the government exists when markets fail to properly enforce property rights or when transaction costs associated with private exchanges are higher than when the government regulates the market. Such cases certainly do arise but, aside from congressional rhetoric arguing for the necessity of farm programs, advocates of these subsidies offer little explanation why farm-related markets have failed and subsidies are needed — largely because there is no reason for them. In addition, efforts to collect the tax revenues necessary to support such subsidies also generate distortions. Where to draw the line on marginal tax rates is another topic for debate, but it is clear that higher tax rates have the potential to further distort markets.

Shallow loss programs attempt to use subsidies to remove much of the risk from farming. In the face of deficits not seen since World War II, even the most casual observer should question whether providing billions of dollars to support an industry that is enjoying record profits and wealth is wise or sustainable. Further, it is rare to see subsidy programs that automatically increase income guarantees when earnings rise.

Generous farm subsidies may have been justifiable from a public policy perspective when farm earnings were half of those in non-farm sectors, as was the case when the first farm bill was implemented in 1933, or in developing economies where agricultural earnings are far below those realized in the United States. However, we should question policies that continue to ratchet up income guarantees in a highly productive, innovative, and wealthy sector such as U.S. agriculture.

Last year, when much of the country experienced a severe drought, many advocates for farm subsidies pointed to crop losses as additional justification for generous taxpayer support. In fact, farm earnings continued to be robust and farm incomes remained at their recent record and near-record levels. In 2009, U.S. farmers earned $63 billion in net farm income. By 2011, this figure had risen to $117.9 billion, the USDA estimates. In 2012, reflecting to some extent the effects of the drought, net farm income slipped all the way down to $112.8 billion — 79 percent above 2009 net farm income and 40 percent above 2010 net income.

Shallow loss programs have the potential to increase taxpayer spending and distort farmers’ production and marketing decisions. As farm policy currently stands, taxpayers end up providing subsidies to a sector that enjoys higher incomes and more wealth than almost any other characterized by small, independent businesses. Myths regarding the need for such subsidies to “save the family farm” have worn thin. Taxpayers and legislators should be skeptical about exactly what these policies are intended to do beyond guaranteeing reelection for members from agricultural districts. Shallow loss programs have the potential to result in deep losses for taxpayers.

Barry Goodwin is William Neal Reynolds Distinguished Professor in the departments of economics and agricultural and resource economics at North Carolina State University.

FURTHER READING: Goodwin also writes “Field of Schemes: The Taxpayer and Economic Welfare Costs of Shallow-Loss Farming Programs” with Vincent H. Smith and Bruce A. Babcock. Smith contributes “The Grim Reapers of Crop Insurance” and “U.S. Sugar Program Turns Valentine’s Day Sour” and Daniel A. Sumner comments on “'The World's Most Outdated Law': Why the Next Farm Bill Should Be the Last.”

 

Image by Dianna Ingram / Bergman Group

 

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