Shallow-loss programs could leave taxpayers in deep trouble

Vincent H. Smith & Barry K. Goodwin American Enterprise Institute

Imagine what would have happened if, at the peak of the housing bubble in 2006, Congress had passed a law guaranteeing that all homeowners could sell their property at close to its record price for the next five years, regardless of market conditions. In the wake of the housing bust, many homeowners would have been ecstatic about the program, but it would clearly have been outrageously expensive and unfair for taxpayers.

Yet this is effectively what Congress is gearing up to do for farmers by expanding so-called shallow-loss programs. While promising to do away with about $5 billion a year in direct subsidies — which even many farm lobbies know are no longer politically viable — advocates of shallow-loss programs are pushing them as essential emergency relief that is needed to protect America’s food supply.

But shallow-loss programs are not really an essential safety net. They consist of a tangled web of distortions that could end up funneling even more than $5 billion a year to the agricultural sector that, for the most part, would end up in the hands of a relatively small group of wealthy farmers. A shallow-loss program would also generate serious moral hazard incentives, distort planting decisions and damage our trade relations, and it could leave taxpayers on the hook for more than $60 billion over the next five years. No other business lobby in America would dare to ask Congress to effectively guarantee — at public expense — that industry revenues will never fall below 90% of record levels. Yet the farm lobby calls it “reform.”

In a just-released study for the American Enterprise Institute that we co-authored with Bruce Babcock, we performed an extensive analysis of the costs that shallow-loss programs are likely to impose based on various market scenarios. If prices for major commodities like corn, wheat, soybeans and cotton remain at or close to their current near-record levels, then, depending on how the shallow-loss program is structured, taxpayer costs will be around $3 billion a year. However, if prices return to more normal levels, then the taxpayer costs of the shallow-loss program will soar well above the current $5 billion in outlays on direct payments. For example, the shallow-loss program currently being proposed by the Senate Agriculture Committee could cost taxpayers as much as $7.4 billion if crop prices return to their average levels over the past 15 years.

A closer look at the farm lobby’s rationale for shallow-loss programs demonstrates that the programs are a solution to a problem that does not exist. Advocates stress that legislation is needed to protect farmers from sudden drops in prices which, the lobbies claim, would immediately create such dire financial conditions that the agricultural sector would be eviscerated. Leaving aside the fact that all businesses must face market swings, the agricultural sector is, from a financial perspective, better positioned than almost any other sector of the economy to handle year-to-year variations in revenues and costs.

Consider the following facts: The current debt-to-asset ratio in the agricultural sector is less than 9 percent, and has been declining steadily over the past decade. And farms fail at a rate of less than one in 200 a year. Moreover, the USDA estimates that the agricultural sector is currently using only about one-third of its capacity to comfortably carry debt. Farms are exceptionally well positioned to handle market fluctuations and, moreover, most of them carry extensive heavily subsidized federal crop insurance protection against farm-specific losses (the federal government effectively pays about 70 percent of the total cost of each farm’s crop insurance policy).

Shallow-loss programs have been an explicit part of U.S. farm commodity subsidy policy since 2008. The 2008 Food Conservation and Energy Act introduced two such programs, the Average Crop Revenue Election (ACRE) program and the Supplemental Revenue Assistance Payments (SURE) disaster program.

Recently, three senators from the Northern Plains — Max Baucus (D-MT), Kent Conrad (D-ND) and John Hoeven (R-ND) — proposed their own commodity subsidy program in the form of a blend between ACRE and SURE in which payments would be triggered by farm-level yields in many cases.

This type of program is the most problematic variation on the shallow-loss theme from any economic efficiency, budgetary or trade-relations perspective. And farm lobbies are pushing hard to have exactly this type of program expanded.

Like the federal crop insurance program that currently accounts for the largest share of taxpayer outlays on agricultural programs (about $9 billion a year over the next 10 years, according to the CBO), the proposed shallow-loss programs contain features that could cause adverse consequences.

Under shallow-loss programs, revenue guarantees and support levels increase as prices and yields rise, regardless of the overall health of the farm economy. The taxpayer is therefore exposed to what could be budget-busting expenses if prices drop unexpectedly in the short term, even though those prices would themselves be relatively high. Shallow-loss programs have the potential to pay out large sums even though the loss is only on paper. It is indeed a strange policy that increases support levels in the face of rising crop prices and improving farm household incomes.

Another problem of shallow-loss programs is that, because they substantially reduce the negative financial consequences of risk-taking, they can encourage unwise and wasteful changes in farm management and crop production practices. As in other areas of economic activity, this moral hazard incentive will cause farmers to choose strategies that offer some prospect for above-average profits but relatively high probabilities for significant losses.

Why? Because, to the farmers, the losses do not matter anymore; they have become the taxpayer’s problem. Crop insurance programs in which indemnities are triggered by a farm’s yields have consistently been shown to have such effects. Shallow-loss programs based on a farm’s individual yields will simply make matters worse.

Finally, the fundamental structure of all of the proposed shallow-loss programs violates U.S. World Trade Organization (WTO) commitments to avoid introducing new “amber box” policies providing production incentives for crops, opening up the potential for numerous WTO trade complaints that the United States will find difficult to refute.

At a time when severe budget pressure is forcing legislators to consider cuts to food stamps, it does not seem appropriate to double down on wasteful farm subsidies that largely flow to wealthy households. Shallow-loss programs are not reforms; they are a big step backward. “Too big to fail” and “private gains, public losses” are Washington concepts that infected Wall Street and ended up costing Main Street. We shouldn’t extend those “privileges” to America’s heartland.

Vincent H. Smith is a professor of economics at Montana State University and a visiting scholar at the American Enterprise Institute. Barry K. Goodwin is the William Neil Reynolds Professor of Agricultural Economics at North Carolina State University. This essay is based on the recent AEI working paper and a part of the American Boondoggle: Fixing the 2012 Farm Bill project. Learn more at www.aei.org/americanboondoggle.