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Backgrounder #1524 on Agriculture

March 8, 2002

Farm Policy: An Agenda for Reform

By

Now that the U.S. Senate has passed its version of the farm bill, House and Senate conferees will soon begin meeting to resolve relatively minor differences between the two versions. Both the House and Senate bills represent a dramatic departure from the "freedom to farm" concept that was incorporated in the 1996 farm bill,1 and both bills signal a return to federal control over agriculture production. In addition, while both versions would increase farm subsidies by $73 billion over the next 10 years, the Senate bill front-loads more than 60 percent of the increase in the first five years. The Bush Administration has expressed its general reservations about the policy direction embodied in this legislation but has not threatened a veto.

President George W. Bush should send a message to Congress that it must step away from a myopic focus on government support and control in the agriculture industry and instead explore new ideas--particularly those that utilize private-sector solutions that are already available. In the long run, farmers stand to benefit far more from this approach than they do from a continuation of nanny-state programs and government micromanagement.

KEEPING REFORM ON TRACK

Although the 1996 farm bill failed to eliminate the archaic permanent farm law, it implied that the seven-year transition period from 1996 to 2002 would lead to the eventual termination of agricultural subsidies, which have been both counterproductive and harmful to agricultural trade. Former House Agriculture Committee Chairman Robert F. Smith (R-OR), speaking in opposition to an amendment to reform the sugar program in 1997, argued that the amendment was unnecessary because the sugar program was slated to end along with all other farm programs.

Neither the sugar program nor the gamut of other flawed subsidy programs, however, came to an end. The succession of emergency bailouts within the past few years provided ample warning that it would not be easy to keep agriculture policy on the track to free-market reforms.

It is important for policymakers to recognize that the long-term interests of U.S. agriculture are best served by eliminating the federal government's involvement in the industry--both support and regulation. It is equally important, if not more important, that America's farmers finally recognize that until they end their dependence on the federal government, they will remain vulnerable to efforts to re-regulate U.S. agriculture production and will never be fully able to take advantage of the limitless opportunities provided by the constantly growing global marketplace.

Rather than looking to the taxpayers to rescue them every time agricultural commodity prices drop or bad weather damages their crops, farmers should be independent. They constitute a sector of the U.S. economy that, on a continuing basis, refuses to take the responsibility to manage its own risk. If America's farmers took just half the money that is used to lobby Congress or to support political campaigns in an effort to maintain government support and instead devoted those resources to developing risk-management programs, they could be freed from dependence on Washington.

Action by the government to set time limits on how long individuals can continue to receive welfare payments should be echoed in the arena of agriculture. Many of today's farmers who depend on government subsidies represent a fourth generation living off the federal dole, and most of them are financially better off than the vast majority of Americans. It is long past time for them to be weaned from the largess of the federal government and to experience pride in their ability to stand on their own two feet.

WHAT'S AT STAKE IN THE REPEAL OF FREEDOM TO FARM

President Bush should ask for a farm bill that will put an end to counterproductive, dependency-producing agricultural programs once and for all. As is evidenced by the experience of the six years following the passage of the 1996 farm bill, it is not easy to make either farmers or Congress adhere to a phaseout transition period for subsidies. There is no evidence that farmers have used the transition period as a time to prepare for a future without government support; rather, they have used it to lobby for maintaining, or increasing, government payments.

It is time for America's farmers to take responsibility for managing their own risk. If the policies of the farm bills passed by the Senate and the House are preserved, however, U.S. agricultural policy will be headed in exactly the wrong direction. If policymakers revert to the failed pattern of government-managed agriculture, the U.S. farm economy will experience a critical setback.

RECOMMENDATIONS FOR BUILDING ON FREEDOM TO FARM

Rather than going backwards to New Deal-era government control, policymakers should build on the reforms that were initiated by the 1996 farm bill and expand the freedom of America's farmers. To this end, the following steps should be taken to reform agriculture policy in the United States.

  1. End permanent farm law. If it is determined that an additional period is needed in which farmers receive transition payments, make that period no longer than three years and ensure that it cannot be extended beyond that time. As long as a permanent structure exists for making payments to farmers, supporters of a centrally planned agriculture industry will use any slight downturn in commodity prices or land values as justification for returning to government controls. Ending permanent farm law would also eliminate marketing loans for wheat, feed grains, cotton, rice, and oilseeds, which have resulted in huge payments that have circumvented payment limitations and gone primarily to the wealthiest farmers.
  2. End the sugar and peanut programs. Provide a three-year phaseout of support prices, import quotas, and acreage allotments. Current support prices should be reduced incrementally throughout the three successive years so that U.S. prices for these commodities would approximate the world price by the end of the third year. No direct payments should be provided during the transition. Additionally, import quotas and acreage allotments should be reduced by approximately 33 percent annually, ultimately disappearing in the third year. Restrictions dictating eligible producers should be lifted so that any farmer would be allowed to produce these commodities.
  3. End the dairy program. The price support program, the archaic Milk Marketing Order System, and authorization for monopolistic dairy compacts such as the Northeast Interstate Dairy Compact should all be eliminated immediately. It is inappropriate for the federal government to determine winners and losers in the industry by putting dairy farmers in certain regions of the country at an unfair disadvantage. There should be no restrictions on where milk is sold or marketed, nor should the government any longer interfere with interstate commerce as it relates to dairy products. Milk marketing orders should no longer set various prices of milk for fluid, manufactured, or any other arbitrary category of products. Demand from domestic consumers and the international market should make those determinations.
  4. Eliminate or scale back the Conservation Reserve Program (CRP). The CRP should be phased out by prohibiting the U.S. Department of Agriculture (USDA) from renewing any expiring contracts or entering into any new contracts. Additionally, since millions of sustainable acres now enrolled in the program are lying idle, current CRP participants should be given the flexibility to remove non-environmentally sensitive land from the program prior to their contract expiration date and, in return, receive 33 percent of their contract payments.
  5. Phase out the federal crop insurance program. Since it is impossible to reform the federal crop insurance program to make it actuarially sound, the program should be phased out over a period of three years, during which the government crop insurance premium subsidy would be available for a declining percentage of each farmer's crop. This policy would allow for the development of private insurance programs, which have not been able to compete with programs that are subsidized by the federal government and rely on insurance premiums that are also heavily subsidized by taxpayers.
  6. Pursue an open global food economy. An open global food economy will provide America's farmers with the greatest opportunities for a prosperous and secure future. The federal government must open up world trading opportunities by negotiating trade agreements that remove trade barriers and allow greater market access abroad for U.S. food and agriculture products. Greater access to the international marketplace will allow U.S. farmers to take advantage of a continuing decrease in real cost of production per unit. The greater the volume of sales, the greater the profit to both the farm sector and the overall U.S. economy.

    In the appropriate international forums, particularly in the World Trade Organization (WTO), the U.S. government should aggressively pursue the elimination of export subsidies and all forms of agricultural protectionism--including tariffs, tariff-rate quotas, import quotas, and non-tariff barriers--to provide greater market access for all agricultural commodities throughout the world. All agricultural commodities and programs should be on the negotiating table, and the negotiations should be brought to a conclusion with a single undertaking that encompasses all sectors. The Senate should provide the President with trade promotion authority as soon as possible. Otherwise, no country will engage in serious talks with the United States to reduce high tariff and non-tariff barriers to U.S. farm exports.

By pursuing this reform agenda, the federal government would finally remove the obstacles to a truly free market for American agriculture. Once this is accomplished, the freedom to compete and innovate will allow the private sector to develop tools through which U.S. farmers can manage their risks and build their own safety nets.

A PRIVATE-SECTOR SAFETY NET

Rather than returning to supply controls or providing ad hoc emergency payments to U.S. farmers on a nearly annual basis, the federal government should help farmers to create their own safety net. There are a number of ways that farmers could manage their own risks with regard to both weather-related disasters and price drops. However, as long as the government provides no-cost or low-cost risk protection through disaster assistance, emergency bailouts, or subsidized crop insurance, there will be no incentive for farmers to manage their own risk or for the private sector to develop appropriate risk-management tools.

Farm programs began with the assumption that it is the government's responsibility to provide U.S. farmers with a safety net to protect them from low prices and weather-related risks. In other sectors of the U.S. economy, however, both businesses and individuals are expected to manage their own risks. Even in the case of devastating natural disasters such as earthquakes, hurricanes, and floods, the most generous governmental assistance that is offered is in the form of low-interest loans to rebuild damaged or destroyed homes or businesses or to replace lost inventories. Agriculture is the only sector of the economy in which it is expected that the federal government will provide a bailout in every time of crisis and will ensure that a designated threshold income level is achieved. In essence, for farmers, bailouts have become an entitlement.

In the 21st century, the only appropriate functions for the federal government in U.S. agriculture should be to defend the sector from unfair trading practices abroad, assure that U.S. farmers are guaranteed unfettered market access abroad, and facilitate the development of private-sector solutions to the decades-long quest for a safety net for America's farmers.

The federal government should take the first steps toward assuming its rightful role by removing regulatory roadblocks and anti-competitive obstacles that interfere with the ability of farmers or the private sector to develop sound risk-management strategies--including expanded use of futures and options markets--and allowing greater free-market competition in the development of risk-management strategies, such as crop revenue insurance, growth income assurance, and the existing crop insurance program.

Futures Contracts.
One way to avoid price risk that is already available to most farmers is to trade futures contracts in private markets that operate without government subsidy. Under a futures contract, a farmer agrees to sell a set quantity of a certain commodity at a certain date in the future at a certain price. Farmers can use futures contracts to guard against the risk that prices will be lower when they are ready to bring their crops to market. At the present time, six futures exchanges in the United States offer contracts for dozens of farm commodities.2

Options Market.
Another risk-management strategy for price drops is the options market, in which the right to buy or sell a commodity at a set price is granted until the expiration of the contract. Options differ from futures in that the right to buy or sell is not an obligation: If prices do not move the way the option holder had hoped, he can simply let the option expire unexercised, though he would forfeit a premium to the option seller. The advantage of an option is that the farmer can protect against unfavorable price movements without giving up the prospect of windfall profits from favorable price moves. Options on agricultural commodities, however, are severely restricted by the Commodity Exchange Act and are allowed for only a few commodities, although options on futures contracts are available.3

In contrast to such risk-management techniques, America's farm policy (exhibited in the government's generous "emergency relief packages" throughout the past few years) has entailed a risk-management strategy in which taxpayers make up for any lost farm income, whether it is caused by weather-related disaster, low prices, or profits that were less than anticipated.

Crop Insurance.
The government's secondary risk-management strategy has been federally subsidized crop insurance. Although the crop insurance program began in 1938, it was not until 1980 that the first serious legislative effort was made to make the program viable enough to replace traditional emergency disaster assistance. However, farmers correctly assumed that the government would never withdraw benefits of disaster assistance, and this policy has undermined attempts to encourage greater participation in crop insurance as a risk-management tool. Since 1980, there have been a number of legislative attempts to make crop insurance more attractive in order to increase participation, but the only thing that has encouraged more farmers to use this means of risk management is a dramatic increase in the level of the government subsidy for crop insurance premiums.

Revenue Insurance.
At the present time, various revenue insurance programs are available in connection with federal crop insurance. While basic crop insurance protects against crop yield losses, these additional programs insure against deviations from a target level of revenue. In an environment in which heavily subsidized crop insurance is easily available, it is unlikely that private-sector initiatives to develop crop insurance plans would have any chance of success. Nor is it likely that farmers will demonstrate any interest in ideas such as crop revenue insurance or growth income assurance. This result is regrettable because, as Dr. Bruce Gardner explains, "a focus on crop insurance subsidizes farming in higher-risk areas or using higher-risk practices relative to lower-risk areas or practices."4

Farm Risk Savings Accounts.
Finally, if federal policy could move away from the assumption that it is the government's responsibility to protect farmers from all risk, it might be possible to encourage farmers to create their own safety net. Then there would be some possibility of encouraging farmers to use self-managed individual retirement account plans. Money saved in these accounts could be tax-free unless it was withdrawn in "bad" years.

CONCLUSION

There should be no turning back from the progress toward freeing America's farmers that began with the 1996 farm bill, but the Senate and House farm bills are not headed in this direction. The legislation includes "countercyclical payments," which are a reincarnation of the target price/deficiency payment scheme that was discarded in 1996. Inevitably, a return to such policies will result in a return to supply controls.

A return to supply control policies should be unthinkable; it will not help U.S. farmers in any situation, even at the most price-depressed times. Reverting to a failed 60-year-old agriculture policy will guarantee that U.S. farmers will not be able to take advantage of an export market that is steadily growing as a result of population growth and rising standards of living throughout the world.

Government subsidies and protections must end. They fail to provide a safety net for America's neediest farmers, and they have proved to be counterproductive. The federal government should enable farmers to develop sound risk-management strategies without creating regulatory roadblocks or anti-competitive interference. This policy would be an important step toward the creation of a truly effective safety net.

The most important role for (and, indeed, responsibility of) the federal government in promoting a healthy farm economy is to ensure that U.S. farmers are able to take advantage of opportunities in an expanding global marketplace that holds the potential for continuing increases in income and the creation of wealth throughout rural America. In other words, the federal government should get out of the way and allow American farmers to succeed and prosper.

John E. Frydenlund is Director of the Center for International Food and Agriculture Policy at Citizens Against Government Waste in Washington, D.C.


1. H.R. 2854, the Federal Agriculture Improvement and Reform Act of 1996, signed into law "with reservation" by President Bill Clinton on April 4, 1996.

2. Ralph M. Chite, "Managing Farm Risk in a New Policy Era," Congressional Research Service, CRS Report for Congress 97-572 , updated January 22, 1999.

3. Ibid.

4. Bruce L. Gardner, "The Federal Government's Role in 21st Century Agriculture," testimony presented to the Commission on 21st Century Production Agriculture, Washington, D.C., January 27, 2000.

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