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Price Supports

Raising Price Supports Could Drive Up Government Spending and Distort Planting Decisions

Friday, June 14, 2013

Price Supports

Raising Price Supports Could Drive Up Government Spending and Distort Planting Decisions

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The House and Senate versions of the pending farm bill are supposed to save $47 billion by repealing three subsidy programs: direct payments, counter-cyclical payments and the average crop revenue election. But both bills would then use almost three-quarters of those savings – about $35 billion – to fund a suite of new farm income support programs designed to put a higher floor under crop prices or guarantee average revenues from crop sales.

The House’s “Price Loss Coverage” (PLC) program in particular is essentially a far more generous version of the program the bill repeals. It would:

  • Increase the probability of large government outlays that would erase the predicted savings. If, for example, crop prices were 15 percent lower than expected, this study estimates that PLC would cost $2 billion a year more than current programs.
  • Potentially distort producers’ decisions of which crops to plant and how many acres of each.
  • Threaten trade agreements that have helped U.S. growers expand their exports.

How the House Proposal Would Work

The Price Loss Coverage proposal follows the basic formula of all farm subsidy programs that trigger payments to producers when market prices fall below a guaranteed level.

(Guaranteed price – market price) X (payment yield*) X (payment acres**) = payment to farmer
* a pre-set number of bushels or pounds per acre assigned by USDA for each farmer’s crop
** a pre-set number of acres of each crop assigned by USDA

PLC, however, would make three important changes to the current subsidy program. It would:

  • Guarantee a higher price (called the target price under the current program and the reference price under PLC).
  • Allow a farmer to increase payment yield above the levels in the current program
  • ŸTie payments to a percentage of a farmer’s actual planted acreage (payment acres are currently limited to a set percentage of the acres planted with subsidized crops in the past).

Taken together, these changes increase the risk of big government outlays and retreat from the reforms made to farm subsidy programs since the 1996 farm bill.

Price Loss Coverage Risks Big Government Payouts

The cost of PLC depends on whether actual crop prices fall below the guaranteed prices. This report analyzes two scenarios:

  1. actual prices are close to the baseline prices used in USDA’s most recent long-term projections and the Congressional Budget Office’s (CBO) cost estimates,
  2. actual prices are 15 percent lower than those baseline prices.

The closer the price fl oor to actual market prices, the greater the probability that payments will be triggered by even small changes in market prices, and PLC dramatically raises the price fl oor for most program crops (Figure E-1). Currently, the guaranteed prices (red bars) for corn and soybeans are set by law at less than 50 percent of the average market prices between 2008 and 2012; the guaranteed wheat price is less than 60 percent of its average market price. The House proposal (green bars) would raise the price fl oor to 85 percent of the USDA 2014 to 2018 projected average market price for corn, 79 percent for soybeans and 96 percent for wheat. The already very high prices guaranteed for cotton would increase to 99 percent of projected average market prices and peanuts would actually exceed projected market prices by 8 percent. The price fl oor for rice would rise from just over 56 percent to 91 percent of its projected average market price.

Guaranteeing higher prices increases both the likelihood that payments will be triggered and the size of the resulting payments.

Table E-1 (below) compares the percentage increase in the price guarantee to the concomitant increase in the maximum payment per bushel or per pound that could be triggered under the PLC proposal, compared to the current counter-cyclical program (CCP). Maximum payments for soybeans are fi ve times higher, for corn and rice three times higher, and for wheat almost twice as high as under the current program. Already very high maximum payments for cotton and peanuts would rise by 30 percent and 80 percent, respectively.

Setting price floors so high relative to actual market prices means that even under the baseline price scenario, PLC payments could be larger than the payouts farmers currently receive from the direct payment program the House would repeal. PLC payments would exceed current direct payments 31 percent of the time for peanuts, 28 percent of the time for wheat and soybeans, 23 percent of the time for corn, 17 percent of the time for cotton and 4 percent of the time for rice. If crop prices fall 15 percent below baseline prices, the potential for PLC payments to exceed current direct payments rises dramatically, ranging from 5.8 percent of the time for rice to 51 percent of the time for peanuts.

Even under the baseline price scenario, estimated PLC payments per acre would exceed current direct payments per acre for peanuts, equal direct payments for wheat and be well above two-thirds of direct payments for corn and cotton. PLC payments would far exceed current direct payments for all crops except cotton if prices dipped below 15 percent of the baseline.

PLC payments would total $1.9 billion a year less than current direct and counter-cyclical payments over the next five years if prices hew to the levels projected by CBO. If actual prices fall by as little as 15 percent below the projected prices, the cost of PLC would balloon to $6.9 billion a year, 140 percent more than under the baseline price scenario and 40 percent more than under current programs.

PLC Distorts Markets and Trade

The 1996 farm bill made a much-heralded advance in farm policy by decoupling farm subsidies from farmers’ production decisions. Farmers could decide which crops and how many acres to plant based on price signals from the market, rather than on the level of government support. Farmers, in other words, would no longer farm the government, instead of the market.

The House’s PLC proposal marks a troubling retreat from that important farm policy reform. The higher price floor and payments tied to actual acres in production recouples farm income support to farmers’ production decisions. Farmers will once again have incentives to farm the government as well as the market.

Because the United States is the largest exporter of several subsidized crops, PLC could have significant effects on global prices, production and trade and erode the much sought-after gains in export markets that U.S. producers have enjoyed under current trade agreements.

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