Income related loans for

drought relief

RIRDC Publication No. 04/053

Repayment projections

A report for the Rural Industries Research & Development Corporation by

Simon Kelly, Bruce Chapman and Linda BotterillNational Centre for Social and Economic Modelling (NATSEM)

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Rural Industries Research and Development Corporation

© 2004 Rural Industries Research and Development CorporationAll rights reserved.

ISBN 0 642 58763 9ISSN 1440-6845

Income related loans for drought relief: Repayment projectionsRIRDC Project No. UCA-10ARIRDC Publication No. 04/053

This publication is copyright. However, RIRDC encourages wide dissemination of its research, providing the Corporation is clearly acknowledged. For any other enquiries concerning repro-duction contact the Publications Manager on phone 02 6272 3186.

In submitting this report the researchers have agreed to RIRDC publishing this material in its edited form.

Researcher Contact Details:Dr Simon KellyPrincipal Research FellowNational Centre for Social and Economic ModellingUniversity of Canberra170 Haydon Drive Bruce ACT 2617 Australia

Phone : +61 2 6201 2788Email: simonk@natsem.canberra.edu.au Web: www.natsem.canberra.edu.au

RIRDC Contact DetailsRural Industries Research and Development CorporationLevel 1, AMA House42 Macquarie StreetBARTON ACT 2600PO Box 4776KINGSTON ACT 2604

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Published in April 2004Designed and set by RIRDC Publications UnitPrinted by Union Offset Printing.

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ForewordThe Australian Government recently announced a review of the National Drought Policy. The Terms of Reference include consideration of the possible adoption of “income contingent loans” as a possible reform to the financing of drought relief. An income contingent loan involves the provision of financial resources to appropriate agencies with the understanding that some proportion of the outlay will be repaid only when and if the future economic circumstances of the debtor are propitious. That is, unlike usual mortgage-type loans, an income contingent arrangement explicitly takes into account capacity to repay and, in so doing, minimises the risks of default for both creditors and debtors.

The conceptual basis and advantages of such schemes are now well under-stood, and several applications of the principle have been operating successfully in a number of economic policy areas in different countries; perhaps the best known of which is Australia’s Higher Education Contribution Scheme. However, the implementation of income related loans for drought relief raises a number of practical challenges specific to agriculture. One of the most critical of these concerns are the processes and likely outcomes associated with the collection of repayments, which is the subject of our inquiry.

This paper examines the timing and impact of loan repayments on farm busi-nesses when repaid as a fixed proportion of future gross revenue, the measure considered most appropriate to be used as the basis of collection. The implica-tions for both the Commonwealth budget and the repayment burdens of a range of farm circumstances are illustrated for a variety of policy parameters, including different repayment rates, loan levels and rates of interest. While there is a wide breadth of projected outcomes for both the budget and for farms differing mark-edly with respect to revenue, it is potentially the case that a viable scheme could be designed that places acceptable repayment responsibilities on farms without incurring huge budgetary costs.

Most of our publications are available for viewing, downloading or purchasing online through our website:

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Simon HearnManaging DirectorRural Industries Research and Development Corporation

Author notesDr Simon Kelly is a Principal Research Fellow in the National Centre for Social and Economic Modelling at the University of Canberra.

Professor Bruce Chapman is from the Economics Program in the Research School of Social Sciences at the Australian National University.

Dr Linda Botterill is Post Doctoral Fellow at the National Europe Centre at the Australian National University.

AcknowledgmentsThis research was funded by the Rural Industries Research and Development Corporation. RIRDC does not necessarily agree with the content and is not responsible for any errors.

General caveatNATSEM research findings are generally based on estimated characteristics of the population. Such estimates are usually derived from the application of mi-crosimulation modelling techniques to microdata based on sample surveys.

These estimates may be different from the actual characteristics of the popula-tion because of sampling and nonsampling errors in the microdata and because of the assumptions underlying the modelling techniques.

The microdata do not contain any information that enables identification of the individuals or families to which they refer.

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v

ContentsForeword iiiAuthor notes ivAcknowledgments ivGeneral caveat iv

1. Background 1 1.1 Similarities and differences between drought loans and HECS 2 1.1.1 The debtor and the collection mechanism 2 1.1.2 Repayment threshold 2 1.1.3 On what basis is the debt collected? 3 2.1 The data 4 2.1.1 Definitions of industries 4

2. Data and Method 4 2.2 Explanation of the ‘up-down’ and ‘down-up’ categories in the model 5 2.3 Rates of repayment 6 2.4 The amount of the loan 6

3. Income related loans in operation 7 3.1 The time stream of total repayments 7 3.1.1 One-off loan of $50,0001 7 3.1.2 Two consecutive loans of $50,000 8 3.2 Distributions of loan repayments by farm revenues 8 3.2.1 One-off loan of $50,000 8 3.2.2 Two consecutive loans of $50,000 10 3.3 Illustrating the benefits of an income related loan: the up-down case 11

4. Conclusion 13

5. Appendix 14 5.1 Income related loans: the effect of subsidies 14 5.2 Repayments without subsidy 14 5.3 Subsidy greater than the real rate of interest 16

6. References 18

1

1. Background

In October 2003, the Australian Government announced a review of the Nation-al Drought Policy. The Terms of Reference for the review announced by Minis-ter Truss included consideration of “income contingent loans for drought relief” (Truss 2003). The proposal for an income related loans approach to drought relief discussed in this paper is based on work by Botterill and Chapman (2002). They argue that the circumstances of a drought-affected farmer are not dissimi-lar to those of a university student in that both farmers and students require ac-cess to capital to overcome short-term imperatives (persisting through drought or accessing university). However, both face potential impediments in access-ing commercial finance.

It has been proposed that an income related loans (IRL) system has the poten-tial to provide an effective and equitable system of allowing farmers access to capital during periods of adversity, while placing an obligation on recipients to repay these funds if and when their future circumstances allow. An IRL involves the provision of financial resources to agencies with the understanding that some proportion of the outlay will be repaid only when and if the future eco-nomic circumstances of the debtor are propitious. That is, unlike usual mort-gage-type loans, an income related arrangement explicitly takes into account capacity to repay and, in so doing, minimises the risks of default for both credi-tors and debtors.

Botterill and Chapman suggest the following possible advantages of the IRL ap-proach compared with existing arrangements:

• the approach is less regressive—part substitution of a grant for a loan will promote a lower burden on average tax payers, many of whom will be less well-off over their lifetimes than the farmers being assisted

• because some (perhaps a significant proportion) of the funds will be repaid, governments will be able to afford to support a greater number of farmers

• the approach builds on the National Drought Policy's principles of self-reli-ance and risk management.

However, these possible benefits of the application of an IRL to drought relief do not necessarily mean that such an alternative policy approach would be an improvement over existing arrangements. As with all policy, implementa-tion and administrative efficiency are critical. For example, suggesting a HECS

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mechanism in countries without sophisticated tax collection mechanisms is not a useful exercise, a point explained in Chapman and Nicholls (2003).

In this paper, we examine what this debt repayment instrument might mean for the levels and time streams of repayment from the perspective of both farm businesses and the Commonwealth Budget. To this end the following presents simulations of what the use of gross farm receipts might mean for repayments of various forms of a drought IRL. Of critical importance is that we are able to distinguish the effects of loan repayments for farm businesses that differ sig-nificantly with respect to both the distribution of gross revenue at any point in time, and for changes in revenue over time.

1.1 Similarities and differences between drought loans and HECSThere are several significant differences between the operation of income related loans for students and IRLs for farmers. The major distinctions become clear in the following discussion and explanation on how an IRL could work for drought relief.

1.1.1 The debtor and the collection mechanismIn order for the scheme to work successfully it is important to identify the appropriate debtor, specifically, should it be the farmer or the farm business? Second, what is the appropriate collection mechanism? These matters are discussed, and we believe resolved, in Botterill, Chapman and Egan (2004), in which it is suggested that an IRL should be a debt of the farm business and collected through the use of the Business Activity Statement. This approach addresses a number of possible avoidance issues such as inter-generational transfer and sale of the farm business (Botterill et al 2004). It is also potentially administratively simple.

1.1.2 Repayment thresholdThe suggested scheme could include a threshold below which no repayments of the IRL debt would be required, which is the way in which HECS operates. However, there are several reasons why it might be preferable not to have a repayment-free threshold for a farm business IRL. The most important of these is that farm receipts reflect to an important extent farm size. This means that if repayments were not required for revenue below a certain level the policy might excuse all repayments from small farm units (even in periods in which a significant proportion of small establishments are not experiencing economic hardship). Since an IRL requires contributions when debtors have the capac-ity to pay, a threshold would nullify to some extent this advantage of the IRL. It would also have an unfortunate behavioural characteristic of systematically

3

encouraging the participation in the scheme of those farms expecting to have relatively low gross revenue in the longer term, thus undermining the prospect for the government of high levels of collection.

Setting a threshold below which farms do not need to make payments against the debt also complicates the administration of the scheme in terms of the tim-ing of payments. At a flat rate of repayment, farmers with ‘lumpy’ incomes will not overpay their loans in high income periods. The introduction of a threshold means that potential overpayment becomes a possibility, raising the issue of the frequency and timing of drought loan repayments.

1.1.3 On what basis is the debt collected?A third issue of implementation, which is also critical for the effective opera-tion of an IRL for drought relief, is the appropriate income, revenue or profit reference for the collection of the debt. There are several possible options with respect to the measurement of the capacity of a farm business to pay an IRL. One would be the farm’s taxable income. However, taxable farm income is not a useful measure of a farmer’s actual income situation. In order to obtain an accu-rate picture of a farm’s economic situation, the collection mechanism cannot be based on a measure which allows for a range of deductions, even occasionally resulting in negative income for tax purposes (see Botterill and Chapman 2002).

A second option involves the use of the farm’s gross receipts. As discussed in Botterill et al (2004) this would have the advantages of not being subject to minimisation through a range of behaviours, and of the information being already available to the Tax Office as an integral part of the farm’s Business Activity Statements.

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2. Data and Method

2.1 The dataABARE provided historical data by industry and state for this project. The time series gross farm receipts data used in the modelling are an aggregation of information from two annual surveys—the Australian Agricultural and Grazing Industries Survey (AAGIS) and the Australian Dairy Industry Survey (ADIS) (for farms with revenues in excess of $22,500 per year). These provide time-series coverage of six farming industries—wheat and other crops, mixed livestock-crops, sheep, beef, sheep-beef and diary—from 1989 to 2002. The data have been arranged in quintiles, and nominal receipts have been adjusted to 2000-01 dollars with the use of the Consumer Price Index.

To approximate actual drought conditions, the modelling used 1994 as the first year. Thus revenue figures from years 1995 through 2002 were used for years 1-8 and data from years 1989-1993 were used for years 9-13. To allow simulations over a longer period the years 14-25 are repeats of years 0-11.

2.1.1 Definitions of industriesThe industry definitions used in the two surveys are based on the Australian and New Zealand Standard Industrial Classifications (ANZSIC). These classifications are in line with an international standard that is applied comprehensively across Australia, permitting comparisons between industries, both within Australia and internationally. Farms assigned to a particular ANZSIC class have a high propor-tion of their total output characterised by that class.

The five broad-acre industries covered in AAGIS are:

1. wheat and other crops industry (ANZSIC Class 121)—farms engaged mainly in growing cereal grains, coarse grains, oilseeds and/or pulses

2. mixed livestock-crops industry (ANZSIC Class 122)—farms engaged mainly in running sheep or beef cattle and growing cereal grains, coarse grains, oilseeds and/or pulses

3. sheep industry (ANZSIC Class 124)—farms engaged mainly in running sheep

4. beef industry (ANZSIC Class 125)—farms engaged mainly in running beef cattle

5. sheep-beef industry (ANZSIC Class 123)—farms engaged mainly in running both sheep and beef cattle.

5

As well, ADIS covers farms in:

6. Dairy industry (ANZSIC Class 130)—farms engaged mainly in dairying.

While it is possible to illustrate the differences in repayments between these industries and by State, what follows presents aggregate results only. Thus the annual revenue figures used are weighted averages of Australian farms in the above six industry areas.

2.2 Explanation of the ‘up-down’ and ‘down-up’ categories in the modelSince the simulations by quintile cover different periods of time, an implication of using this method only is that we would be assuming that farms that begin in a particular revenue quintile remain there for the entire period of the loan receipt and its repayment. However this is unlikely to be true since a proportion of farms will experience economic gains and losses resulting in their relative wellbeing changing over time. To illustrate the significance or otherwise of this dynamic, we have simulated the loan repayment experience for a hypothetical category of farms which traverse the relative revenue positions of the distribu-tion.

Specifically we assume that the so-called ‘up-down’ category is one in which a farm starts in the bottom half of the lowest quintile and each year its revenue position improves until it ends up at the top of the distribution. After this, the process is reversed. This means that a farm goes through around two and a half cycles of the distribution over our time period. In most of the figures following, we use also the so-called ‘down-up’ category, which is the mirror image of the ‘up-down’ case.

Figure 1 shows the revenue of the hypothetical up-down farm simulated over the time period modelled, illustrating the potentially important role played with respect to the dynamics of income change. For comparison, the figure also in-cludes the revenue levels for a median farm in which it is assumed that the farm does not change category over the period. It is quite clear that the ‘up-down’ category captures an extremely large potential variance of farm revenues, with the highest revenue being around 15 times higher than the lowest. These simu-lations of the hypothetical dynamic can thus be seen to represent very large hypothetical changes in a farm’s position, which we consider to be an important advantage of our method.

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$0

$100

$200

$300

$400

$500

$600

$700

$800

1994 1996 1998 2000 2002 1990 1992 1994 1996 1998 2000 2002 1990 1992

)s000'$( stpi eceR hsa

C latoT egarevA

Median Up-Down

Figure 1: Gross revenue for ‘up-down’ and median revenue categoriesData source: NATSEM

2.3 Rates of repaymentThere is an important reason for an IRL involving a collection base of gross revenue to have relatively low repayment rates. Essentially this is that the use of gross revenue as an indication of a farm’s economic welfare is very approximate only, there being circumstances in which higher receipts do not necessarily mean commensurate improvements in contemporary economic circumstances. Accordingly, because it is sensible not to impose too great a repayment burden, we have used a maximum repayment rate of 5 per cent per annum only of gross revenue. For comparative purposes we illustrate in addition the implications of a much lower rate of 2 per cent. The parameter chosen would be a matter for policy-makers.

2.4 The amount of the loanThe level of the loan chosen to illustrate repayment experiences is somewhat arbitrary for illustrative purposes. We have chosen to focus in the main on $50,000 per farm but also consider a doubling to $100,000. These orders of magnitude fit roughly with the experience of the current grants-based ap-proach to drought relief.

It is of interest that the simulations impose the same loan amount per farm by quintile, irrespective of the expected gross revenue level of farms. However, if higher revenue farms are more likely to borrow relatively high amounts, the simulations will systematically understate repayments, thus exaggerating the likely costs to the budget. This issue is considered further below.

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3. Income related loans in operation

3.1 The time stream of total repayments3.1.1 One-off loan of $50,0001

Figure 2 illustrates the repayments to government of an income-related loan of $50,000 to all farms in Year 0. To demonstrate the differential impact on government receipts, it shows the amount that will have been repaid at annual rates of both 2 per cent and 5 per cent of farm revenue.

No real rate of interest is applied to the loan in this example so in net present value terms the estimated receipts to the government are overstated some-what. The rate of subsidy which could be applied to an income related loan is a matter for policy decision. The Appendix illustrates the impact of a real rate of interest on these repayment rates as well as the impact of a more generous subsidy (ie greater than the real rate of interest).

79.7%

58.7%

0%

25%

50%

75%

100%

0 5 10 15 20 25

d iaper la tot fo noitroporP 5%

2%

Figure 2: Proportion of one-off $50,000 loans repaid over time, 2 and 5 per cent repayment rates(Note: The percentages shown are the proportions of the amount lent that has been repaid after ten years)Data source: NATSEM

The data suggest that 10 years after repayments commence the government can expect to have received a significant proportion (nearly 60 per cent) of the amount lent at the low repayment rate of 2 per cent per year of gross revenue. At a relatively high repayment rate of 5 per cent per year of farm revenue, the government will have received around 80 per cent of the original amount lent.

1 All Figures show results with loan collections commencing in the first year in which the loan is taken up. Policy makers may choose instead to give farmers a year or more grace period after the loan is granted before requiring repayments to begin.

8

3.1.2 Two consecutive loans of $50,000Circumstances may arise in which government decides that farm businesses require access to an income related loan in a second year. Figure 3 illustrates the impact of two consecutive annual loans of $50,000 (a total of $100,000 per farm) on the repayments to government. In this example, the government will be repaid about 45 per cent of the money lent by year 10 at a repayment rate of 2 per cent per year, and 65 per cent of outlays at a rate of 5 per cent per year. Again, the caveat concerning the role of interest rate subsidies applies, and this is dealt with further in the Appendix.

65.0%

46.0%

0%

25%

50%

75%

100%

0 5 10 15 20 25

diaper lat ot fo noitroporP 5%

2%

Figure 3: Proportion of two consecutive $50,000 loans repaid over time, 2 and 5 per cent repayment rates(Note: The percentages shown are the proportions of the amount lent that has been repaid after ten years)Data source: NATSEM

3.2 Distributions of loan repayments by farm revenuesIncome related loans are by definition tied to capacity to pay, meaning that farms with different levels of gross revenue will necessarily take varying peri-ods of time to repay the loan. This issue is important for policy debate since it promotes assessments of the differences between farms in repayments of an income related loan scheme. This section illustrates the length of time taken for different revenue categories of farms to repay loans.

3.2.1 One-off loan of $50,000In a first illustration, we consider repayment simulations for a one-off loan of $50,000. Figure 4 illustrates outcomes for a rate of 2 per cent per year of farm revenue, and Figure 5 shows results for a repayment rate of 5 per cent. In both cases the repayment time is shown for the lowest quintile, the ‘up-down’ and ‘down-up’ categories, the median quintile and the top quintile.

9

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Q1 Median Q5 Up-Down Down-Up

The data from Figure 4 suggest that the highest revenue farms (Q5) repay the loan in under six years, and the lowest revenue farms will have repaid about 40 per cent of the loan after 25 years. The median farm repays the loan in full in 17 years. Up-down and down-up respectively repay the loan in 11 and 15 years.

Figure 4: Amount of one-off $50,000 loan repaid over time by farm revenue, 2 per cent repayment ratesData source: NATSEM

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Q1 Median Q5 Up-Down Down-Up

Figure 5: Amount of one-off $50,000 loan repaid over time by farm revenue, 5 per cent repayment ratesData source: NATSEM

10

From Figure 5, the relatively high rate of repayment rate results in the highest revenue farms (Q5) repaying the loan in just over two years and the farms with the lowest revenue repaying the loan in full in 25 years. The median farm re-pays the loan in seven years, and up-down and down-up respectively take three and eight years to repay in full.

Once again this example has an implicit subsidy equivalent to the real interest rate. The Appendix models the impact on different farm categories of income related loans without a subsidy and with a subsidy greater than the real interest rate at repayment rates of both 2 per cent and 5 per cent.

3.2.2 Two consecutive loans of $50,000The Figures following illustrate the amounts of unpaid loan obligations for dif-ferent revenue categories of farms in the circumstance in which they qualify for an additional loan of $50,000. Figure 6 assumes a repayment rate of 2 per cent per year of farm revenue and Figure 7 assumes a rate of 5 per cent.

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Q1 Median Up-Down Down-Up Q5

In this case the highest revenue farms (Q5) will repay the total loan ($100,000) in 9 years. The other revenue categories will take in excess of 25 years to repay.

Figure 6: Amount of two consecutive $50,000 loans repaid over time by farm revenue, 2 per cent repayment ratesData source: NATSEM

11

Figure 7: Amount of two consecutive $50,000 loans repaid over time by farm revenue, 5 per cent repayment ratesData source: NATSEM

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Q1 Median Up-Down Down-Up Q5

At the higher repayment rate of 5 per cent of farm revenue, the highest revenue farms will repay the total $100,000 loan in just four years. The ‘up-down’ farms will repay in nine years and the ‘down-up’ and median farms will repay the loan in 13-14 years. The lowest revenue farms (Q1) will take more than 25 years to repay the total loan.

3.3 Illustrating the benefits of an income related loan: the up-down caseAn interesting aspect of our exercises concerns the hypothetical simulations involving significant changes in a farm’s relative gross revenue position. The up-down case can be used to illustrate a benefit of income related loans associ-ated with capacity to pay and income smoothing compared with standard bank loans. Unlike income related loans, mortgage-type loans from banks require repayment irrespective of a debtor’s capacity to pay—the implications of which for a farm’s repayment contributions as a proportion of gross revenue are il-lustrated below.

In Figure 8 we have simulated a typical bank loan repayment schedule and compared this with the time stream of repayments for an income related loan for the up-down case, all with respect to proportions of gross revenue paid. The bank loan is for a principal of $50,000 at a real rate of interest of 4.5 per cent, with repayments to be finalised after 15 years. The income related loan is for a sum of $50,000, repaid at rates of both 2 and 5 per cent2. The resulting propor-tions paid of gross annual revenue are as follows.

2 For strict comparability the income related loan would also have a real rate of interest of 4.5 per cent per annum. However, this affects the length of time of the repayment and does not compromise the essential message concern-ing the relative variance in annual repayment as proportions of gross revenue.

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0%

2%

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8%

1 3 5 7 9 11 13 15Yrs after loan made

eunever mraf fo noitropo rP

Bank Loan over 15 yrs2% repayments5% repayments

Figure 8: Proportion of annual gross farm revenue required to repay IRL and bank loans for ‘up-down’

The data from Figure 8 show a very striking effect of the repayment conditions for an income related loan compared with a mortgage-type loan. By definition, the income related loan requires a fixed proportion of gross annual revenue to be repaid, so that this proportion cannot change over time. However, a typi-cal bank loan repayment schedule is associated with marked differences in the proportions of gross revenue a farm must use for repayments since there is no sensitivity of repayments with respect to capacity to repay. Thus, for example, if a farm experiences low levels of gross revenue (as does up-down at the begin-ning and end of the 15 year period), repayments to a bank can be as high as 7 per cent of revenue; for the income related scheme, repayments must always be 2 or 5 per cent. Bank loan repayments fall to as low as around 1 per cent of gross revenue in years in which the farm experiences the highest economic well being. The bottom line is that bank loan repayments do not have the obvious IRL benefit of revenue smoothing.

The Figure also suggests that repayment rates as high as 5 per cent could impose higher annual burdens of repayments than bank loans at a similar level for some years, but this is not the case for the 2 per cent repayment rate. The latter sce-nario necessarily leads to a relatively high time period of repayment.

It is also worth recording that the majority of farms which might take advantage of an IRL are also likely to hold bank loans larger than an IRL. For example, ABARE found that the average farm business debt for All Broadacre Industry farms in 2001-02 was $195,740 and for Diary Industry farms it was $298,350 (ABARE 2003, Table F p 53 and Table F16 p 79). This suggests that the data of Figure 8 reflect that the likely burden of an IRL, compared with a bank loan, is fairly modest, although this is not an issue we have explored extensively.

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4. Conclusion

The simulations presented show a significant range of outcomes with respect to the time stream of repayments of an income related loan for drought relief. In some scenarios involving a 5 per cent annual repayment rate, a very significant proportion of loans is repaid in full in less than ten years, but this is not the case for the lower repayment rate of 2 per cent. This suggests that the appropriate repayment parameter would be at least 2 per cent of gross revenue per annum, in order to minimise the costs for the budget. The effects of different levels of subsidy (including a subsidy of approximately zero), shown in the Appendix, illustrate a wide range of outcomes which should be useful input for policy debate.

It should be emphasised that the simulations are for a defined set of param-eters, all of which should be subject to further variation in the interest of addi-tional information for policy debate. In particular we note the assumption that farms with low expected revenues are provided with loans of equivalent levels to farms with high expected revenues. Since members of the latter group are more likely to take higher loans, and repay quicker, to some extent this aspect of the exercise biases the result against finding relatively quick repayments. On the other hand it might be the case that farms with very high expected revenues would be less inclined to take advantage of the availability of an IRL suggesting a potential bias in the opposite direction.

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5. Appendix

5.1 Income related loans: the effect of subsidiesIncome related loans can be structured to provide a subsidy to farmers by vary-ing (or removing) the rate of interest to be applied to the loan and/or by requir-ing that farmers pay back less than the amount borrowed. This is a matter for policy decision.

If it is decided that a subsidy should be provided to drought-affected farmers, this can be achieved through imposing less than a real rate of interest on the debt and/or through the requirement that farmers only repay a portion of the amount borrowed. The former case was the basis for the modelling in the body of this paper. A more generous subsidy is the second example modelled below.

5.2 Repayments without subsidyAn income related loan (IRL) without a subsidy takes the form of the loan on av-erage being repaid in full including an effective real rate of interest on the debt which would result in an adjustment to principal of around 4 per cent above inflation per annum. The implication would be that there is no true financial cost to the Budget of operating the scheme.

One way in which this might be achieved would be the application of a sur-charge to the principal of the loan, but with no further adjustments beyond inflation. This is the way the Higher Education Contribution Scheme works and the benefits of such an approach are explained in Chapman (2003). The sur-charge would be chosen in lieu of a real rate of interest and in what follows we have assumed that this would be 25 per cent of the loan.

The impact of a surcharge on the time stream of total repayments is set out in Figure A1.

96.4%

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125%

0 5 10 15 20 25

diaper lat ot fo noitroporP 5%

2%

Figure A1: Pro-portion of one-off $50,000 loans with a 25 per cent surcharge repaid over time, 2 and 5 per cent repayment rates

(Note: The percent-ages shown are the proportions of the amount lent that has been repaid after ten years)Data source: NATSEM

15

The distribution of repayments by farm revenues with a 25 per cent surcharge is set out in Figures A2 and A3, modelling repayment rates of 2 per cent and 5 per cent respectively.

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Q1 Median Q5 Up-Down Down-Up

Figure A2: Amount of one-off $50,000 loan with a 25 per cent surcharge repaid over time by farm revenue, 2 per cent repayment ratesData source: NATSEM

With a surcharge of 25 per cent and a repayment rate of 2 per cent of revenue, the highest revenue farms (Q5) repay the IRL in six years, the down-up and the up-down repay in around 16 years while the median group repays in 21 years. The amount owed by Q1 farms is $42,700 at Year 25 under the two percent schedule. These repayment times compare with six years for Q5 and 17 years for the median in the absence of a surcharge (See Figure 4).

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Q1 Median Q5 Up-Down Down-Up

Figure A3: Amount of one-off $50,000 loan with a 25 per cent surcharge repaid over time by farm revenue, 5 per cent repayment ratesData source: NATSEM

16

At the higher repayment rate of 5 per cent, Q5 farms repay the loan in 3 years (compared with 2 years in the absence of a surcharge) and the lowest revenue farms still owe $13,000 after 25 years (compared with repaying the whole loan in 25 years in the absence of a surcharge). The up-down, down-up and median revenue farms repay the loan 2-3 years later than under the surcharge-free model.

5.3 Subsidy greater than the real rate of interestIt may be decided that the income related loans scheme should be subsidised by more than the real rate of interest. The following section models a discount of 25 per cent for farmers accessing the loan, ie farmers borrow $50,000 but are only required to repay $37,500 (and in addition have no real rate of interest on the debt).

63.0%

50.4%

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0 5 10 15 20 25

d ia pe r l atot fo no it ropor P 5%

2%

Figure A4: Proportion of one-off $50,000 loans with a 25 per cent surcharge repaid over time, 2 and 5 per cent repayment rates(Note: The percentages shown are the proportions of the amount lent that has been repaid after ten years)Data source: NATSEM

Figure A4 reflects the fact that a policy decision has been made not to require full repayment of the loan. Nevertheless, under the 5 per cent repayment option, almost two-thirds of government outlays have been repaid after ten years—half has been repaid with the repayments set at 2 per cent of gross revenue.

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0

25

50

0 5 10 15 20 25

)s000'$( gniw

O tm

A

Q1 Median Q5 Up-Down Down-Up

0

25

50

0 5 10 15 20 25

)s000'$( gniw

O tm

A

Q1 Median Q5 Up-Down Down-Up

Figure A5: Amount of one-off $50,000 loan with a 25 per cent discount repaid over time by farm revenue, 2 per cent repayment rateData source: NATSEM

At a 2 per cent repayment rate and with a 25 per cent discount, the highest revenue farms repay the loan in less than 5 years and the median farms repay in 13 years. The amount owed by Q1 farms is $17,700 at Year 25 under the two percent schedule.

Figure A6: Amount of one-off $50,000 loan with a 25 per cent discount repaid over time by farm revenue, 5 per cent repayment rateData source: NATSEM

The data of Figure A6 show that farms with the lowest gross revenue will take around 20 years to repay this loan. The farms with the highest gross revenue as well as the down-up group will take less than two years and the median about five years. The up-down scenario results in a repayment period of seven years.

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6. References

ABARE (2003) Australian Farm Surveys Report Canberra, November 2003

Botterill, Linda and Bruce Chapman (2002) “Developing Equitable and Afford-able Government Responses to Drought in Australia” Centre for Economic Policy Research Discussion Paper Discussion Paper No 455

Botterill, Linda, Bruce Chapman and Michael Egan (2004) “Income related loans for drought relief” Centre for Economic Policy Research Discussion Paper Dis-cussion Paper No 472

Chapman, Bruce (2003) “Income related loans for higher education: internation-al reforms” mimeo Canberra, Australian National University

Chapman, Bruce and J Nicholls (2003) “Implementation Issues for the adoption of income related loans in developing countries” mimeo Washington DC, World Bank

Truss, the Hon Warren MP (2003) Minister Truss announces drought review panel Media Release by Federal Minister for Agriculture, Fisheries and Forestry AFFA03/329WT Canberra, 9 November 2003