The Economics of Farm Subsidies Fa 08

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What is a subsidy?

A subsidy is a type of financial assistance typically paid by the government to a business. Businesses receive subsidies in order to remain competitive with international markets and perhaps pay for more expensive upgrades that they otherwise would be unable to afford. It is important to understand the concepts behind subsidies because once in place, they tend to have long-lasting effects on the economy, the environment, and nearly all aspects of society (Steenblik). It is easy to see why farmers would benefit from subsidies since the growing seasons are never the same and they have nothing to fall back on if their crops fail. Also they provide food for millions of people and providing them with money in times of need is important for everyone. However there is at least one subsidy whose benefits to society are questionable and that is the subsidy provided to tobacco farmers.

How were tobacco crops subsidized?

Although they are not technically called subsidies, tobacco farmers did receive a form of “price support program” until 2004 (McCuen 2000). The program started after the Great Depression in order to protect farmers if their harvest did not meet a set price at the auction (McCuen 2000). This program was very helpful in keeping the farmers afloat in hard times.

The Price support program had two functions: it raised the price of tobacco by limiting the amount each farmer can sell and it guaranteed the farmers a certain price per pound through nonrecourse loans. (Womach, 2004) Farmers are limited to a national marketing quota that is based on the land they own and the quota limit is set so that the aggregate US supply is enough to meet domestic and export demand. In order to grow tobacco, a farmer must purchase or rent land that has a quota. (Womach, 2004) The Crop Insurance Program was started in the 1930s in response to the events of the Depression and the Dust Bowl (RMA, 2008). This program protected farmers from crop loss due to natural disasters or loss in revenue due to declining cost of commodities (RMA, 2008). Although still government regulated, private insurance companies are able to sell insurance deals to farmers (RMA, 2008).

The No-Net-Cost Tobacco Program was passed by Congress in 1982 in response to criticism of taxpayers for the government subsidizing the tobacco industry, which was also responsible for many health problems (Womach, 1998). This act requires that all tobacco programs must pay for themselves and take no taxpayer money. This is done through collecting interest in the loan program and also in a 1% tax on every pound of leaf marketed (Womach, 1998). This program generates more money than it uses and the extra money goes into the country’s general deficit reduction (Womach, 1998).

Why was the Tobacco Subsidy system changed?

Under the post Great Depression system, tobacco growth had declined 42% from 1.941 billion pounds to 1.121 billion pounds in 2001. The Tobacco subsidy system was changed because it did not promote competitive prices and instead protected the local national tobacco crops from international price pressures. So, local growers were not encouraged to achieve economies of scale or focus on more efficient crop raising practices. Thus in 2002, foreign tobacco was 40% of the cost of US tobacco. (Womach, 2003)

The irony of the subsidy

While the government was giving money to tobacco farmers, in 1998 they also passed a law forcing cigarette manufacturers to pay billions to help cover expenses for tobacco-related illnesses (McCuen 2000). The settlement requires tobacco companies to pay $246 billion over the next 25 years (Lauterstein 2008). Instead of providing funding to help these farmers transition to a crop that is less harmful to human health, the government is both helping and penalizing farmers for their production of tobacco (McCuen 2000). Interestingly, 50 percent of the settlement was allocated to tobacco farmers. Only 10 percent was set aside for anti-smoking efforts and the remaining 40 percent was distributed for roads, education, and other undetermined initiatives (Lauterstein 2008).

The change from price support program to buyout

In 2004, President Bush signed the Fair and Equitable Tobacco Reform Act that ended the price support program for tobacco farmers and established the Tobacco Transition Payment Program (Farm Service Agency, 2008). The payments from the program began in 2005 and will continue through 2014 and will go out to eligible tobacco quota holder and producers (Farm Service Agency 2008). The funds set aside for this program are equivalent to 25 years’ worth of future payments that will equal approximately $18.6 billion a year (Stokes 2007). Aside from this money, the start of the 2005 harvest of tobacco marked the beginning of no planting restrictions, no marketing cards, and no price-support loans (Lauterstein 2008).

Consequences of the buyout

Under the original price support program, tobacco farmers were restricted to plots of land that were seldom larger than 10 acres (Etter 2007). Once the buyout occurred in 2004, many of the older farmers simply took the money and completely stopped growing the crop (Etter 2007). A number of them turned to crops that required less time and effort such as strawberries (Etter 2007).

Within a year, total acreage of tobacco lots being farmed dropped 27% and the prices dropped from $1.98 to $1.64 per pound (Etter 2007). While these numbers originally worried the cigarette companies, dedicated tobacco farmers were able to pick up the slack. Since there was no longer a restriction on lot space, those who wanted to continue farming tobacco were able to expand, many up to twice the size of their original lot. Also, even though the price of tobacco was down, the farmers were making more money because they did not have to pay to rent a quota (Etter 2007). However, the larger fields require more work and many farmers are forced to hire foreign help which causes much controversy in many of the small farming towns (Etter 2007).

One of the ideas behind the buyout payments is that the money will serve to compensate the farmers for the unavoidable decrease in land value (Stokes 2007). The value is determined not only be what is grown on it, but also by the amount of government payments it receives (Stokes 2007). Without the subsidies the value of the land will decrease dramatically (Stokes 2007). Now, growers will have to sell their tobacco to individual companies instead of the government. As a result, in the post-buyout economy, growers will need to more carefully heed production and management practices such as chemicals and fertilizer application, disease control and market preparation to meet their customer company’s standards (Snell, 2007).

Should tobacco farmers have received aid in both the support and buyout programs?

The change from a free market to the subsidy program for the tobacco industry brought about a lot of implications for the market itself. The tobacco industries were no longer affected from international price pressures and were reduced to producing only the amount that was available in their quota. Tobacco farmers did need protection against cyclical farming problems and natural disasters, however the support program that was implemented did not encourage innovation since the government guaranteed a profit regardless of the harvest.

One argument against government supported tobacco subsidy is that it contradicts the concern of the government for tobacco related health problems. The No-Net-Cost Act addressed this issue to tax payers, but in 2004 the government initiated the new buy out program that would do away with the subsidies completely by 2014.

The buyout was necessary in order for the farmers to be able to switch to a competitive market. This switch has caused many of the tobacco farmers who held quotas to sell them to other tobacco farmers enabling the remaining tobacco farmers to produce enough to be competitive in the new market. Some of the original tobacco farmers have now sold their quotas and switched their crops to farm things other than tobacco. The buyout has served as the initial test to see how well farmers can survive without guaranteed money.

Thus far the buyout program has been a success because those who are remaining tobacco farmers have maintained a profit. However, the buyout will take a long time and be very expensive. This example demonstrates how costly it can be to change or get rid of an established subsidy program to switch to a self-sustaining agricultural system without governmental support. Only once the money from the buyout program runs out will we be able to tell if harvesting alone is enough to support the tobacco farmers.

References

Etter, Lauren. 2007. Nicotine buzz: U.S. farmers rediscover the allure of tobacco; end of subsidy system bring higher profits; lessons for Mr. Barbre. The Wall Street Journal. http://envoy.dickinson.edu:2075/pqdweb?vinst=PROD&fmt=3&startpage=-1&clientid=4534&vname=PQD&RQT=309&did=1337291711&scaling=FULL&vtype=PQD&rqt=309&cfc=1&TS=1227714760&clientId=4534

Joossens, Luk and Raw, Martin. Education and debate: Are tobacco subsidies a misuse of public funds? 1996. BMJ 1996;312:832-835 http://www.bmj.com/cgi/content/full/312/7034/832

McCuen, B. 2000. Is it time to end tobacco subsidies? http://www.speakout.com/activism/issue_briefs/1245b-1.html

Steenblik, R.P. A Subside Primer. Global Subsidies Initiative. http://www.globalsubsidies.org/subsidy-primer/ASubsidyPrimer.php

Stokes, B. 2007. Ending farm subsidies. National Journal. 39, 8: pp 41-42.

United States Department of Agriculture Farm Service Agency. 2008. Tobacco Transition Payment Program. http://www.fsa.usda.gov/FSA/webapp?area=home&subject=toba&topic=landing

Womach, Jasper. 2004. Tobacco Price Support: An overview of the program. CRS Report for Congress. http://cineonline.org/NLE/CRSreports/04Jun/95-129.pdf

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