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Something for Nothing?

Direct Payments and Title I Farm Programs
Bruce A. Babcock

The United States spends over $5 billion per year supporting the farm sector through Farm Bill programs, most of which are inefficient. For a farm program to be efficient, it should not induce farmers to change their production decisions (allocation test), should be targeted at farm financial stress (farm safety-net test), and should not duplicate what the private sector can provide (private-market provision test). This paper uses these three criteria to determine the efficiency of Title I farm programs. Some of the conclusions include:

1) Direct payments do not create a financial safety net and should be eliminated: When price levels are high, there is little impact on the probability that farmers will lose money; when price levels are low, there is a larger impact on that probability. As an alternative to direct payments, no payment could be made when prices are high, and double payments could be made when prices are low. By making direct payments countercyclical with respect to revenue, the safety-net efficiency can be improved.

2) Countercyclical payments (CCPs) duplicate what the private market provides and should be eliminated: When market prices are expected to be above or below CCP triggers, the private market can provide risk protection through put options on futures contracts. When prices are expected to be lower than trigger prices, options tend to be more expensive, but CCPs provide little expected financial assistance when prices are high and much assistance when prices are low. The CCP program is thus inefficient for farmers who have a high probability of loss when prices are high.

3) Marketing loans can influence farmers’ planting decisions and should be eliminated or replaced: If marketing loans are to remain, they should be replaced with a recourse loan program whereby farmers have to pay back marketing loans with interest. Currently, farmers are overcompensated in bumper crop years and undercompensated in short crop years. This creates a direct incentive to increase production when expected prices are below the loan rate.

4) The Average Crop Revenue Election (ACRE) program should provide coverage against yield drops at the county level: The current system, which bases guarantees on state revenue, creates a yield basis risk. County coverage reduces moral-hazard issues associated with individual yield coverage. Payments could be triggered when county yields fall below a certain percentage of expected county yields.

5) An alternative to CCP and marketing loans is county revenue coverage: This would transform ACRE from county yield coverage into county revenue coverage. The justification for turning yield coverage into revenue coverage during low price periods is that it satisfies the need to aid the farming sector when prices are low.

Current farm programs are not an efficient use of taxpayer money because they duplicate price protection that the private sector can provide and they make payments when the farm sector is highly profitable.

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