USDA Offers Its Two Cents (Give or Take a Few Billion) on 2007 Farm Bill

Not surprisingly, the USDA did not propose an overhaul of farm programs, mostly adjustments to existing programs. In presenting its recommendations, the USDA listed perceived problems inherent in the existing programs. The problems most often cited were, broadly speaking: 1) spending needs to be reduced; 2) payments are not distributed equitably, especially among large and small producers; 3) current programs potentially run afoul of World Trade Organization (WTO) commitments.

Commodity Marketing Loan Rates

The current marketing loan program leads to very large payments to producers in years of low prices. Since payments are a function of current prices and production, it is clearly viewed as a production- and trade-distorting policy by the WTO. Therefore, the USDA proposed a new formula to calculate loan rates. Fundamentally, the USDA is suggesting a return to the old way of setting loan rates, which is to base them on actual market prices in recent years. The USDA proposes to set the loan rate at 85% of the five-year Olympic average (last five years minus the high and low). The loan rate would also be subject to a maximum level, in case prices stage a sustained rally. The following table illustrates the USDA's proposed changes to loan rates for some major crops.

Current and Proposed Marketing Loan Rates

After one or two glances, some of the numbers in the table looked very familiar. That is because the loan rates for corn and wheat would basically return to their pre-2002 Farm Bill levels. The big decline is for cotton. This is not terribly surprising, because the level of spending on cotton supports has come under a great deal of WTO scrutiny. The USDA is attempting to realign cotton supports away from production-distorting "amber box" mechanisms toward more fixed "blue box" payments.

Direct Payments

In exchange for the reductions in marketing loan rates, the USDA proposes to raise direct payment rates for program commodities. For (apparently) budget reasons, direct payment rates would be left unchanged for most crops in the first two years of the new farm bill, but then raised. Since cotton loan rates take a disproportionate hit, cotton gets a much bigger increase in the level of direct payments.

Current and Proposed Direct Payment Rates

Planting Flexibility

Another USDA proposal that is a direct result of WTO compliance concerns is a change in planting flexibility provisions on program base acreage. Although the 1996 Farm Bill went a long way toward removing restrictions on what farmers could plant on their program base acreage, it did not allow farmers to plant fruit or vegetables on eligible base acreage. This became a problem when the WTO ruled that this restriction on farmers' production decisions meant that even fixed, direct payments to farmers were classified as production-distorting, "amber box" payments. This reclassification pushed the overall level of government support for cotton over the allowable limit.

Revenue-Based Counter-Cyclical Payments

While the aforementioned proposals mostly consist of tweaking existing programs, the USDA's proposed change to the counter-cyclical program represents a step in a new direction. The existing counter-cyclical payment program, which was introduced in the 2002 Farm Bill, represents the old way of supporting producer incomes by focusing on prices. Payments are based on the difference between a target price and the current year's market price. This approach falls short of truly supporting producer income because it ignores changes in yields. The program tends to pay out well in years of high yields, because high yields usually translate into lower prices. When yields are low, however, market prices rise to levels that produce little, if any, government payments. Wheat producers, in particular, have not fared well under this system in the past few years, as their yields have lagged while market prices were high enough to not trigger payments.

The USDA proposes to replace the existing counter-cyclical price support payment with a counter-cyclical revenue support payment, which would pay out when market revenue (actual yield times market price) falls below a target level. Unlike the proposed mechanism for calculating loan rates, the calculation of the target revenue would be based on levels during the 2002–06 period and would remain fixed at that level through the duration of the 2007 Farm Bill.

To arrive at the target revenue for each program crop, the USDA proposes to use the five-year average national yield for each crop from 2002 through 2006, dropping the high and low year. The price component of the revenue calculation would be the target price that was used in the counter-cyclical program minus the direct payment rate. The following table presents a rough calculation of the annual target revenues based on those parameters.

Target Revenues Using Formula Proposed by USDA

Like the existing counter-cyclical program, payouts would be based on national results, and not on an individual producer's results. Therefore, this program would not provide the level of revenue "assurance" that some have proposed. Each year's realized revenue for each program crop would be calculated as the national average yield for the crop, times the higher of the national season-average market price or the marketing loan rate.

It does seem a bit odd that the price component of the revenue calculation uses target prices for the base period, and actual prices for the implementation period. Just as a point of interest, the following table shows what the target revenue would be if it was calculated using the season-average market price or the loan rate (whichever was higher), instead of the target price less the direct payment rate.

Annual Average National Revenues Using Actual Prices

Since higher target revenues will translate into higher payouts during the farm bill period, cotton producers would fare much better with the USDA's proposed calculation method than if the USDA used actual market prices and loan rates from 2002 through 2006. That is not surprising, since cotton prices were below the loan rate of $52/cwt. for much of the 2002–06 period, while the target price less the direct payment rate for cotton during that period was $65.73/cwt. Corn and rice producers also would gain a higher target revenue under the proposed method of calculation, while wheat and soybean producers would be worse off.

The biggest potential criticism of the target revenue concept is that it is calculated at a national level, and is not based on individual yields. In that way, it is not truly a revenue assurance program, and certainly is not a substitute for individual crop insurance or revenue insurance.

Summary

On balance, the USDA's proposal shifts spending toward fixed annual payments and away from payments that rise and fall in inverse proportion with market prices. This is a formula that is to be expected, and that may garner the support of most farmers, in a time when prices for programs crops are relatively high and expected to remain that way. Much of the USDA's argument is based on the fact that direct payments should be more palatable to the WTO, especially if the removal of planting restrictions allows fixed payments to be considered "green box" payments, rather than "amber box."

by Tom Jackson