warren hall - dairy markets the direct payment per hundredweight for various usda reduction goals...
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MARKET ADMINISTRATOR
NEW YORK - NEW JERSEY MILK MARKETING AREA 205 EAST 42ND STREET. NEW YORK, NEW YORK 10017
212 - 557-0330
Cornell University Dept . of Agricultural Economics Attn: Dr. Andrew Novakovic Warren Hall Ithaca, NY 14853
Dear Dr. Novakovic:
February 18, 1983
The enclosed staff paper was developed while this office was researching the effect of the two 50¢ deductions and refund program.
This paper is being sent to you in case the ideas might prove to be helpful in the course of your studies.
If there are any comments or questions, please direct them to Robert Wellington of this office.
Enclosure
Very truly yours,
Thomas A. Wilson Market Administrator
MARKET ADMINISTRATOR
NEW YORK - NEW JERSEY MILK MARKETING AREA 205 EAST 42ND STREET. NEW YORK, NEW YORK 10017
212 - 557-0330
AN ANALYSIS OF THE IMPACT OF REFUNDABLE ASSESSMENTS
ON PRODUCERS' INCENTIVES TO DECREASE MILK PRODUCTION
February 1983
Staff Paper 83-4
The United States Department of Agriculture (USDA) is preparing to
implement the assessments authorized by the 1982 Omnibus Budget
Reconciliation Act. To date, two alternate methods for reducing the cost
of the dairy support program have been considered: 1) reducing the support
price and 2) instituting a direct payment plan by which farmers would
receive payments for not producing milk.
Two of the three plans, collecting the assessments or lowering the
current support price, will lower the price dairy farmers receive.
However, price reductions alone do not provide an adequate incentive to
reduce milk production immediately. Hany producers respond by increasing
production to maintain a sufficient income to meet payments on fixed assets
such as the farmstead, barn and silos. Although these increases are
limited by the capacity of existing assets, farmers could increase
production and maintain that higher volume for a period of time. When the
assets deteriorated, many dairy farmers would be forced out of business.
While this would eventually lead to a decline in milk production, it would
also cause major disruptions to the dairy industry and to rural
communities. Therefore, the U.S. government and the dairy industry cannot
be certain that either the USDA assessment program or a lower support price
would reduce support program costs in the near future. If farmers
increased production, the revenue collected from the assessments or the
lower unit support price paid by the Commodity Credit Corporation (CCC)
could be more than offset by increased purchases.
2
The other proposal under consideration is a government-funded direct
payment to the farmer for reducing milk production from a selected base
level. Unquestionably, this program offers a substantial incentive to
curtail excess production; however, it would be costly to the government.
Although the proposed $10.00 per hundredweight payment is lower than the
$17.00 cost of purchasing and storing the current excess production, 1/
government expenditures would still be unacceptably high.
Although the 1982 Budget Reconcilation Act does not explicitly provide
for "direct payments" to farmers for reducing milk production, refunding
the second 50<: assessment can be viewed as a direct payment for not
2/ producing milk to those producers who qualify for a refund. - The funds
for these payments would be generated by the assessments themselves.
Direct Payments
The implicit payment for not producing milk which would be made to
producers who qualified for a refund can be calculated as follows:
A P
D = G - A
where: PD
is the direct payment per hundredweight
A is the refundable assessment per hundredweight
G is the USDA "goal" (percentage reduction from base production)
(A mathematical proof of this formula is given in Appendix T.)
1/ Estimated CCC purchase, transportation and storage costs, cited in The Dairy Marketing Letter (ed. Jerry Dwyer) of January 21, 1983.
2/ The 1982 Omnibus Budget Reconcilation Act states that farmers must reduce "marketings" to receive refunds. For the sake of simplicity, in this presentation "production" and "marketings" are assumed to be equivalent.
Table 1. Direct Payment for Selected Levels of USDA Production Reduction Goals
Direct Payment USDA Goal SOc;: refundable (percent) ($/cwt.)
5 9.50
6 7.83
7 6.64
8 5.75
9 5.06
10 4.50
10.3 4.35
11 4.05
12 3.67
13 3.35
14 3.07
15 2.83
20 2.00
25 1. 50
3
4
The direct payment per hundredweight for various USDA reduction goals
can be seen in Table 1. The Secretary of Agriculture recently proposed
that a 10.3 percent reduction in production from a 1981-1982 base level
would be required to qualify for a refund of SOc;:. However, pro rata
(partial) refund s will not be made for partial volume reductions from
base production. In other words, a producer must produce at or below his
target volume--his base marketings less the USDA goal--to receive a SOc;:
refund. With a 10.3 percent goal, the direct payment would be only $4.35
per hundredweight; this would give farmers little incentive to reduce
production for a number of reasons.
First, a farmer must curtail at least 10.3% of his milk production to
receive a payment of $4.35 for each hundredweight he no longer produced.
On the other hand, if a farmer continued to produce that milk and was paid
approximately $13.00 per hundredweight, was assessed $1.00 and incurred
variable production costs of about $7.00, that would leave $5.00 available
3/ to meet fixed expenses. Therefore, producers do not have an incentive
to reduce production if the implicit direct payment for curtailed
production is only $4.35.
Second, the USDA's current implementation plan only offers an "all or
nothing" refund. Because no pro rata refunds would be made, producers
cannot be certain that they will receive any payment for curtailing
p r oduction. Farmers who attempt to qualify for a refund and reduce
3/ The national all-milk price averaged $13.54 per hundredweight for 1982; therefore, for illustration we have assumed that the price farmers received net of standard deductions for hauling, cooperative and ADA dues, and the like would be approximately $13.00. Similarly, variable costs range from $5.00 to $10.00 per hundredweight but $7.00 was assumed for this illustration.
5
production will not receive any direct payment for not producing that milk
if they do not reach the USDA goal. Few producers would be likely to
attempt to qualify because of this risk. However, the 1982 Omnibus Budget
Reconcilation Act explicitly allows the Secretary to make partial refunds
for partial volume reductions from the base level. If the USDA
implementation proposal were amended to allow pro rata refunds, the
uncertainty about receiving a direct payment would be eliminated.
Partial Refunds. If partial refunds were given for partial volume
reductions from base marketings, a producer would still receive a refund of
his entire assessment if his production is below his base level by at least
the entire USDA goal set by the Secretary (i.e., at or below his target
volume) . However, if a farmer's actual production exceeds his target
volume, but is less than his base, he would receive no refund for
production above his target volume, but he would receive a partial refund
on his target volume. The partial refund would be based upon his actual
reduction from the base as a proportion of the USDA goal. In other words,
if the Secretary requires a 10% reduction but the producer reduces
production only 6% below his base, 60% percent (6% divided by 10%) of the
assessment on his target volume would be refunded. The refunds paid on
target volume implicitly translate to a direct payment for each
· hundredweight below base volume that is no longer produced. However, even
though the payment would be guaranteed, the $4.35 per hundredweight payment
discussed above is not a large enough incentive. (The formula given
previously would be used to calculate the direct payment implied by either
partial or lIall or nothing ll refunds.)
If the direct payment were more than $5.00, producers would be more
likely to reduce production. The direct payment could be incr e ased in
6
various ways: 1) by augmenting the producer-generated assessment refunds
with additional government funds; 2) by reducing the USDA goal (see Table
1); 3) by increasing the refundable portion of the assessment; or 4) by
using a combination of these means. Because the government would be averse
to increasing its expenditures and because a 10.3% reduction goal is
consistent with the level of overproduction, the least costly and most
practical alternative would be to refund the entire $1.00 assessment on a
pro rata basis.
As shown in Table 2, refunding the entire assessment increases the (
implicit direct payment. At the USDA goal of 10.3%, the direct payment
would be $8.71 per hundredweight. With the opportunity to receive an $8.71
direct payment for not producing milk, the producer has significantly more
incentive to curtail production.
Contribution of Excess Production to Income
From another point of view, the current assessment program also
provides a disincentive to continuing to produce milk in excess of the
target volume. With production in excess of target volume, a producer
loses the refundable assessment. Therefore, an alternative approach would
be to calculate the contribution to income from each hundredweight a farmer
produces in excess of his target volume and determine whether or not he has
any incentive to continue producing that milk.
To simplify this approach, the "all or nothing" refund qualification
for a SOC refund is assumed temporarily. Therefore, only producers whose
actual volume is at or below target volume will receive a refund. The
first hundredweight in excess of target volume causes the farmer's income
to decline substantially. Assuming a $12.50 net pay price (i.e., net of
both standard deductions and the SOC non-refundable assessment) and a
Table 2. Direct Payment for Selected Levels of USDA Reduction Goals
Direct Payments USDA Goal 50¢ refundable $1.00 refundable (percent) ($ / cwt.)
5 9.50 19.00
6 7.83 15.66
7 6.64 13.29
8 5.75 11.50
9 5.06 10.11
10 4.50 9.00
10.3 4.35 8.71
11 4.05 8.09
12 3.67 7.33
13 3.35 6.69
14 3.07 6.14
15 2.83 5.67
20 2.00 4.00
25 1. 50 3.00
7
8
target volume of 500,000 pounds, the first excess hundredweight decreases
income by $2,488. That is, the farmer earns $12.00 for the first excess
hundredweight but loses 50C per hundredweight on the 5,000 others--$2,500.
Although the second excess hundredweight would also earn $12.00 without a
further decline in income, the cost of losing the refundable SOC on the
entire target volume should not be allocated only to the first excess
hundredweight. Ra ther, the loss should be "borne" by all of the excess
milk. The per hundredweight contribution to income from the excess
production is, therefore, calculated as the change in total income divided
by the production in excess of the target volume.
Sample calculations for selected levels of actual production are shown
in the top portion of Table 3. It can be seen that the contribution
to income is negative when the farmer's actual production volume is less
than 20,000 pounds above his target volume.
The bot tom half of Table 3 shows the contribution to income if the
entire $1.00 assessment is refundable. In this case, the net uniform price
(before assessments) is $13.00, but it is clear that the farmer has less
incentive to continue excess production with a $1.00 refundable assessment
than with a 50C refund. For example, if actual production is 550,000
pounds, the producer is 10% above his target volume. 4/
With a 50C
refund program, excess production contributes $7.00 per hundredweight to
the farmer's income; this probably compensates him for feed costs and makes
him indifferent to a choice between reducing or maintaining his production.
However, if the entire $1.00 is refundable, the contribution to income is
only $2.00 per hundredweight which would not cover feed costs; therefore,
he would prefer to reduce production if he indeed qualified for a refund.
4/ With 10% excess volume, a producer would be near the base level implied by the USDA 10.3% goal.
Table 3: Calculation of Contribution From Excess Production
Net Lost Production Pay Refundable
a/ Price Total Excess Contribution
Level Price Assessment Received Income Production to Income lbs. $7cwt. $ lbs. $ $/cwt.
Target Volume 500,000 12.50 0.00 12.50 62,500
Actual Volumes 510,000 12.50 0.50 12.00 61,200 10,000 -1,300 -13.00
520,000 12.50 0.50 12.00 62,400 20,000 100 .50
530,000 12.50 0.50 12.00 63,600 30,000 +1,100 + 3.67
540,000 12.50 0.50 12.00 64,800 40,000 +2,300 + 5.75
550,000 12.50 0.50 12.00 66,000 50,000 +3,500 + 7.00
-----------------------------------------------------------------------------------------------------------------
Target Volume 500,000 13.00 0.00 13.00 65,000
Actual Volumes 510,000 13.00 1. 00 12.00 61,200 10,000 -3,800 -38.00
520,000 13.00 1. 00 12.00 62,400 20,000 -2,600 -13.00
530,000 13.00 1. 00 12.00 63,600 30,000 -1,400 - 4.67
540,000 13.00 1. 00 12.00 64,800 40,000 200 .50
550,000 13.00 1. 00 12.00 66,000 50,000 +1,000 + 2.00
a/ No partial refunds allowed.
10
The contribution to income of production in excess of target volume as
shown in Table 3 would vary with the assumed price paid to the producer,
his assumed target volume and his assumed actual production. However, if
the excess production is expressed as a percentage of target volume,
the general formula for calculating contribution to income from excess
production would be:
where:
c = P - A - ~
C is the per hundredweight contribution to income of production in excess of target volume
P is the net price paid to the producer (net of standard deductions and non-refundable assessment).
A is the refundable assessment
R is excess volume as a percentage target volume.
(The mathematical proof of this formula is given in Appendix II.)
The contribution per hundredweight for selected pay prices and excess
production percentages is given in Tables 4 and 5. A graphic
representation which assumes a $1.00 refundable assessment, a $13.00 pay
price and various levels of excess production is shown in Figure 1.
Table 5 and Figure 1 show that the producer faces the risk of being
caught in an extremely adverse income position if he reduces production,
bu t fails to reach the USDA goal (i. e., his target volume). That risk
\.;Tould be eliminated if the "all or nothing" qualification \.;Tere dropped and
producers received partial refunds for partial declines from the base
level.
If pro rata refunds are made for partial reductions from the base
level, the contribution per hundredweight from excess production is the
same for all production up to the base. However, the level of that
contribution varies with the price received, the amount of the refundable
II
Table 4. Per Hundredweight Contribution to Income From Milk Marketed in Excess of Target Volume for Selected Milk Prices and
Percentages of Excess Production
Note: Assumes SOC Non-refundable Assessment and SOC Refundable Assessment "Allor nothing" Refund Qualification, 10% USDA Goal
Price Received Less Standard Deductions ($ / cwt.) 12.50 13.00 13.50 14.00 14.50 15.00
Less Non-Refundable Assessment of 50C/cwt. 12.00 12.50 13.00 13.50 14.00 14.50
Percentage Over Target
Volume Contribution To Income At Above Prices ($/ cwt.)
1 -38.50 -38.00 -37.50 -37.00 -36.50 -36.00
2 -13.50 -13.00 -12.50 -12.00 -11. 50 -11. 00
3 - 5.17 - 4.67 - 4.17 - 3.67 - 3.17 - 2.67
4 - 1.00 .50 0.00 .50 1. 00 1. 50
5 1. 50 2.00 2.50 3.00 3.50 4.00
6 3. 17 3.67 4. 17 4.67 5. 17 5.67
7 4.36 4.86 5.36 5.86 6.36 6.86
8 5.25 5.75 6.25 6.75 7.25 7.75
9 6.19 6.44 7. 19 7.44 8.19 8.44
10 6.50 7.00 7.50 8.00 8.50 9.00
11 6.95 7.45 7.95 8.45 8.95 9.45
12 7.33 7.83 8.33 8.83 9.33 9.83
13 7.65 8.15 8.65 9.15 9.65 10.15
14 7.93 8.43 8.93 9.43 9.93 10.43
15 8.17 8.67 9. 17 9.67 10.17 10.67
20 9.00 9.50 10.00 10.50 11.00 11. 50
25 9.50 10.00 10.50 11. 00 11. 50 12.00
30 9.83 10.33 10.83 11.33 11.83 12.33
12
Table 5. Per Hundredweight Contribution to Income From Milk Marketed in Excess of Target Volume for Selected Milk Prices and
Percentages of Excess Production
Note: Assumes $1. 00 Refundable Assessment with an 11AII or Nothing11
Refund Qualification, 10% USDA Goal
Percentage Over Target
Volume
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
20
25
30
Price Received Less Standard Deductions ($/cwt.) 12.50 13.00 13.50 14.00 14.50 15.00
Contribution To Income At Above Prices ($/cwt.)
-88.50 -88.00 -87.50 -87.00 -86.50 -86.00
-38.50 -38.00 -37.50 -37.00 -26.50 -36.00
-21.83 -21. 33 -20.83 -20.33 -19.83 -19.33
-13.50 -13.00 -12.50 -12.00 -11.50 -11. 00
- 8.50 - 8.00 - 7.50 - 7.00 - 6.50 - 6.00
- 5.17 - 4.67 - 4.17 - 3.67 - 3.17 - 2.67
- 2.79 - 2.29 - 1. 79 - 1. 29 .79 .29
- 1.00 .50 0.00 + .50 + 1.00 + 1.50
.39 .89 1. 39 1. 89 2.39 2.89
1. 50 2.00 2.50 3.00 3.50 4.00
2.41 2.91 3.41 3.91 4.41 4.91
3.17 3.67 4. 17 4.67 5.17 5.67
3.81 4.31 4.81 5.31 5.81 6.31
4.36 4.86 5.36 5.86 6.36 6.86
4.83 5.33 5.83 6.33 6.83 7.33
6.50 7.00 7.50 8.00 8.50 9.00
7.50 8.00 8.50 9.00 9.50 10.00
8.17 8.67 9.17 9.67 10.17 10.67
Figure 1. Per Hundredweight Contribution to Income from Milk Production., .
$/ewt.
13 .010-------
8 .00
6.00
4 .00
2.0 -
I .,
" ,
Assuming an "Allor Hothing" Refund
Production Qobr-~~----r-----r--~L--r--~-~-~--~~---T-~ ___ _
-2.00
-4.00-
-6.00
-8.00
-10.00
-12.00
-14.00
-16.00
-18.00-
-20.00
Target . Level
Base Level
15% 20 % 25%
13
assessment and the USDA goal. The contribution formula becomes: 5/
A CF = P - G
where: CF
is the per hundredweight contribution to income
P is the net price paid to the producer
A is the refundable assessment
G is the USDA goal
(A mathematical proof of the above formula is given in Appendix II.)
14
Table 6 shows the per hundredweight contribution to income assuming a
reduction goal of 10% and a $1.00 partially refundable assessment, for
selected pay prices and actual production levels. Figure 2 is a graphical
depiction of the contribution to income for the $13.00 net pay price shown
in Table 6. As mentioned above, with a pro rata refund of the entire $1.00
assessment, the contribution to income is constant for all excess
production between the target and base levels. At an assumed pay price of
$13.00, continuing to produce milk in excess of the target volume
contributes only $2.00 per hundredweight to the producer's income. Feed
costs alone are higher than $2.00 per hundredweight, therefore producers
would have a significant disincentive for continuing to produce milk in
excess of the target volume.
Methods To Increase Producers' Incentives
Any program designed to reduce the excessive cost of the dairy support
program will be successful only if producers respond to it by reducing milk
production; therefore, producers must have an adequate incentive to
participate in the plan. The incentive to reduce production provided by
the assessment refund program has been presented from two viewpoints:
5/ For actual production levels in excess of the base level, the previous formula still applies.
15
Table 6. Per Hundredweight Contribution to Income From Milk Marketed in Excess of Target Volume for Selected Milk Prices and
Percentages of Excess Production
Note: Assumes $1.00 Refundable Assessment and Partial Refunds for Partial Production Declines, 10% USDA Goal
Percentage Over Target
Volume
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
20
25
30
Price Received Less Standard Deductions ($/cwt.) 12.50 13.00 13.50 14.00 14.50 15.00
Contribution To Income At Above Prices ($/cwt.)
1. 50 2.00 2.50 3.00 3.50 4.00
1. 50 2.00 2.50 3.00 3.50 4.00
1. 50 2.00 2.50 3.00 3.50 4.00
1. 50 2.00 2.50 3.00 3.50 4.00
1. 50 2.00 2.50 3.00 3.50 4.00
1. 50 2.00 2.50 3.00 3.50 4.00
1. 50 2.00 2.50 3.00 3.50 4.00
1. 50 2.00 2.50 3.00 3.50 4.00
1. 50 2.00 2.50 3.00 3.50 4.00
1. 50 2.00 2.50 3.00 3.50 4.00
2.41 2.91 3.41 3.91 4.41 4.91
3.17 3.67 4.17 4.67 5.17 5.67
3.81 4.31 4.81 5.31 5.81 6.31
4.36 4.86 5.36 5.86 6.36 6.86
4.83 5.33 5.83 6.33 6.83 7.33
6.50 7.00 7.50 8.00 8.50 9.00
7.50 8.00 8.50 9.00 9.50 10.00
8.17 8.67 9.17 9.67 10.17 10.67
16
Figure 2. Per Hundredweight Contribution to Income from Milk Production, Assuming a Partial Refund tor Partial Production Decline
S/ewt.
6.00
4.00
I
2.0 - I
Production 0.06
5% 10% 15% 20% 25%
Target Base -2.00 Level Level
-4,.00
17
1) as a producer-funded direct payment for milk not produced below the
base level and 2) as the contribution to income from milk still produced
above the target level. In either case, the risk inherent in the currently
proposed "all or nothing" refund qualification will discourage producers
from even attempting to qualify for the refunds, in spite of the incentive
level provided by the refunds. If we, therefore, assume that pro rata
refunds will be made, we can re-examine the formulas to discover the
. factors which could increase a producer's incentive to participate. The
two formulas are:
1) Implicit Direct Payment
where: PD
is the direct payment per hundredweight
A is the refundable assessment
G is the USDA "goal"
2) Contribution to Income
where: in addition to the above,
CF
is the per hundredweight contribution to income
P is the net price paid to producers.
These formulas have two common variables which affect their values:
the USDA reduction goal (G) and the amount of the refundable assessment
(A) .
The lower the USDA reduction percentage is, the greater is the
incentive to reduce production. If the USDA selected a 10% goal, the
farmer would have a smaller target volume and, therefore, a larger required
production decrease for a full refund than if 8% were selected. However,
as the goal declines, the per hundredweight contribution to income from
excess production also declines but the direct payment for not producing
increases; this increases the incentive not to produce. Although this
18
suggests that the USDA should choose a smaller goal to increase the
incentive, a low goal might not reduce the current level of CCC
expenditures sufficiently. In other words, a lower goal would induce more
producer participation, but the higher target level production would
continue to generate an unacceptably high surplus. The Secretary of
Agriculture, therefore, does not have much flexibility and should choose a
fairly high percentage.
The second variable affecting a producer's incentive to reduce
production is the amount of the refundable assessment. With the current
50<; refundable assessment, producers \.;rould be likely to continue excess
production because the direct payment associated with a 50<; refund is too
small and the contribution to income from excess production would cover
variable costs. As the amount of the refundable assessment increases,
producers' incentives to participate in order to obtain that larger refund
also increase. Under current legislation, the maximum assessment is $1.00
per hundredweight. If the entire $1.00 now mandated were refunded,
producers would receive an implicit direct payment of $8.71 per
hundredweight (or a $2.29 contribution from excess production) with the
USDA's proposed reduction goal of 10.3% (see Table 2)~ this would provide
an adequate . . 6/ lncentlve. - Although a refundable assessment in excess of
$1.00 would further increase a producer's incentive to reduce production,
it would also put an undue burden on him. A larger assessment would be
unfair both to those who do decrease production and to those who do not. A
larger assessment obviously has a larger negative impact on the revenue of
6/ Congressman James M. Jeffords of Vermont has proposed refunding 85<; per hundredweight and using the remaining 15¢ for promoting dairy product consumption. If 85<; were refunded the direct payment would be $7.40 and the contribution to income from excess volume would be $4.60 (with a 10.3 percent USDA goal).
19
producers who do not decrease produc tion. However, the larger assessment
also affects those producers who decrease production and obtain the larger
refund. All producers would be assessed but those who qualify would not
receive the refund until months later, significantly reducing cash flows.
Therefore, increasing the current assessment, without compensating for the
impact on cash for operations, does not appear to be advisable.
In addition to the two variables discussed above, the base marketing
period selected also affects the producer's incentives to participate. If
the current USDA goal of 10.3% is required, a producer might simply refer
to Table 6 to find the income contribution per hundredweight for actual
production at 10% above target volume. However, if the selected base
period is not recent (currently an average 1981-82 base is proposed rather
than 1982 itself), the producer may have increased production since the
base period. In October 1982, more than 37% of the farmers with deliveries
under the New York-New Jersey Milk Marketing Order had increased production
at least 10% above the average of their October 1980 and October 1981
levels. If production is 10% above the base level, it is approximately 20%
above target volume and the income contribution is $7.00 per hundredweight
rather than $2.00. In addition, a producer would not receive implicit
payments for curtailing production above the base level. Therefore, he has
less incentive to reduce production. Choosing a more recent base period
would also reduce the number of "new" producers (those who would not have
established a base during an older marketing period).
Summary of the Possible Incentives from an Assessment Program
The only permanent solution to excessive CCC expenditures is reducing
U.S. milk production. Milk price reductions alone, however, are not likely
to result in such a reduction. If both SOC producer assessments are made
20
refundable on a partial basis, the assessment program can offer sufficient
economic incentive to reduce milk production and can give farmers an
alternative to their present choices: increasing production to pay bills or
going out of business.
The economic incentive to reduce production could also be increased if
the refundable assessment is higher than $1.00. But, as has been
discussed, assessing farmers more than $1.00 would severely strain cash
flows. However, an increased refundable assessment would be more
acceptable to producers if it were accompanied by an increase in the
support price. Although an increase in the support price would seem to be
an anathema to consumers, handlers and the government, the combination of a
higher support price with a larger refundable assessment would offer
substantially higher incentives to decrease production and would reduce eee
expenditures more than either a $1.00 refundable or a SOc;.
non-refundable/SOc;. refundable assessment program. In addition, if both the
assessment and the support price were increased, U. S. consumers would be
assured of a stable and healthy dairy industry.
If the support price were increased by SOc;. per hundredweight and the
refundable assessment were raised to $1.25, the net impact on farmers who
did not reduce production would be a price reduction ranging from 7sc;. to
$1.00 per hundredweight (depending on how much of the support price
increase actually reached farmers). Farmers who decreased production,
however, would clearly benefit. With a 10% USDA goal, farmers who reduced
production to target levels would be refunded the entire $1.25 assessment
and would receive approximately SOc;. more for their actual production
volume (again, depending on the impact of the higher support price on pay
prices). If pay prices rose to $13.50 as a result of the increased support
21
price, the implicit direct payment for not producing would be $11.25 per
hundredweight.
The eee would benefit whether or not producers decrease production.
If they do decrease production, the eee would make fewer purchases. And if
producers do not decrease production, the eee would purchase products at
50C more per hundredweight. The eee is now purchasing approx imately 10%
of U. S. production; therefore, the additional cost would average 5C per
hundredweight of all U. S. production. However, under this program, the
assessment would rise by 25C on all U.S. production.
would have a net gain of 20C.
Therefore, the eee
A 50c increase in the support price would represent a 4% increase
since October 1980 (or an annual increase of less than 2%), which is a much
smaller increase in income than most U.S. workers have received during the
same period. Because raw milk costs are only approximately half of total
retail costs, a 4% increase in raw milk costs may result in only a 2%
increase in retail dairy product costs. Therefore, a 50c increase in
the support price should not be unacceptable to consumers, especially if it
contributes to a stable dairy industry and eliminates the excessive costs
in the price support program.
Impact on Price Support Program Net eosts
Viewing the 50c refundable assessment as a direct payment for milk
not produced does not change the impact of the current program on the eee.
And whether the farmer views the refund as a direct payment or views the
lack of a refund as lost income attributable to excess production, the
proposed assessments are currently allowed under the 1982 Act. Although
the pro rata refunds would result in more refunds actually being made than
"all or nothing" refunds, partial refunds are more likely to induce farmers
22
to reduce milk production. And the funds for pro rata refunds are still
generated by the producer assessments, not the U.S. treasury. In addition.
every hundredweight of milk that farmers do not produce would save the U.S.
treasury approximately $17.00.
eee net expenditures could be significantly lower with a $1.00 refund
plan than with the current SOC non-refundable/SOC refundable proposal.
There are three possible production responses to both plans: (1) neither
plan offers a sufficient incentive to reduce production; (2) both plans
provide a sufficient incentive; or (3) the $1.00 refund will be sufficient
incentive but the SOC/SOC plan will not.
If producers do not respond to either plan and do not reduce
production, the eee collects the $1.00 per hundredweight assessment on all
producer milk, none of which is refunded.
If producers respond to either plan and do reduce production, the
SOC/SOC plan would generate more revenue to offset support program costs,
because all producers would lose (and the ~ee would keep) the SOC
non-refundable assessment. In light of this. the non-refundable assessment
appears to be unfair to those producers who do decrease production and are
no longer contributing to program costs.
The third response is the one most likely to occur. As has been
shown, the SOC/SOC plan will not induce participation because it does not
offer an adequate incentive to decrease production. With a $1.00 refund,
however, the producer is much more likely to decrease produc tion. In
addition. if producers do not decrease production under the SOC/SOC plan.
total dairy price support program expenditures would initially decline by
$1.00 per hundredweight. Based on fiscal 1982 data. the assessment would
generate $1.4 billion for the eee. However, since program costs have been
23
$2.4 billion, net costs would be approximately $1.0 billion. If producers
respond to the 50~/50~ assessment by increasing production six percent or
more, any net saving would be eliminated and total program costs would
again exceed $2.0 billion. On the other hand, if producers decrease
production under a $1.00 refund plan, program costs would decline and the
excessive purchases could perhaps be eliminated in the long run.
Conclusion
Dairy farmers should be made aware of the impact of refundable
assessments on their income. Presenting the refunds as implicit direct
payments for not producing or as per hundredweight contributions to income
from continuing excess production are two methods of showing the impact.
In addition, dairy leaders, legislators and USDA officials should also be
made aware of the assessment plan's impact on farmers and on government
costs. An understanding of how the various components of an assessment
program affect a farmer's incentives to decrease production will help all
parties to formulate a program that will, in fact, solve the problem of
surplus supply.
APPENDIX 1
MATHEMATICAL PROOF OF THE DIRECT PAYMENT FORMULA WITH A REFUNDABLE ASSESSMENT PLAN
Note: This formula only holds when actual production is between target volume and base volume.
24
The direct payment per hundredweight is defined as the total value of
a producer's assessment refund divided by the number of hundredweight by
which actual production is below base volume (i.e., the number of
hundredweight no longer produced). Thus, the formula is:
~ A"'~xT
~)C B
where: PD
direct payment ($/cwt.)
A refundable assessment ($/cwt.)
~ percentage by which base production has been reduced
G USDA reduction goal (%)
T target volume (cwt.)
B base volume (cwt.)
That is, ~ G
is the proportion of the full assessment which will be
refunded, and A)(~ is the per hundredweight value of that refund. Since a G
refund will be made only on the target volume, the numerator represents the
total dollar value of the refund. The denominator, ~)C B, represents the
producer's volume reduction (i.e., the number of hundredweight he no longer
produced).
Note that target volume (T) can also be expressed as:
T or T
B- (B )( G) B (l-G)
If we substitute this expression for T into the original direct payment
formula, it becomes:
p = D
RB A~ G~BX(l-G)
RBXB
AXRBX B~ (I-G) - -----)(
G
The B and ~ terms cancel, leaving:
p = Al\.(l-G) D G
or p = A --' .. A D G
25
APPENDIX 2
MATHEMATICAL PROOF OF THE PER HUNDREDWEIGHT CONTRIBUTION TO INCOME FROM EXCESS PRODUCTION, UNDER TWO ASSUMPTIONS
26
The per hundredweight contribution to income that results from excess
production is defined as the change in total income due to production above
target volume divided by the number of hundredweight above target volume
that are actually produced.
Assumption 1: Producer will not receive a refund unless actual production
is at or below target volume--the "all or nothing" refund policy.
The formula is:
C=P_A_A~T R oX T
where: C contribution to income resulting from excess volume ($/cwt.)
P net uniform price less non-refundable assessment ($/cwt.)
A refundable assessment ($/cwt.)
T target volume (cwt.)
R percentage by which actual volume exceeds target volume
Each hundredweight above target volume earns the net uniform price less the
full assessment, but because he has excess production, the producer does
not qualify for any assessment refund on his target production. The last
term, A ~ T allocates the total value of the lost refund (A ~ T) to the R " T
actual production in excess of target volume (R ~ T).
Simplified, the formula is:
C P - A - ~
27
Assumption 2: A partial refund will be given if the producer's actual
production is above the target volume but lower than the base volume.
Under such a plan, the producer would lose a proportional amount of the
assessment refund on target volume. Therefore, the formula is:
where: CF
p
A
G
~ T
R
C F
G -RB P - A - A x G x T
R x T
contribution to income of excess volume ($/cwt.)
net uniform price less non-refundable assessment ($/cwt.)
refundable assessment ($/cwt.)
USDA reduction goal (%)
percentage by which base production has been reduced
target volume (cwt.)
percentage by which actual volume exceeds target volume
Again, the last term allocates the total value of the lost portion of the
refund (numerator) to the excess volume (denominator).
If B is defined as the base volume in hundredweight, we can express
actual production in two ways:
a) T (1 + R)
b) B(l - ~)
This creates the identity:
T(l + R) = B(l - RB)
Target volume (T) can also be expressed as:
T = EO - G)
(See Appendix I.)
28
Substituting for T and solving for (G - ~) in the identity:
B)((l-G) (l+R) BX(l-RB
)
(i-G) (l+R) l-RB
l+R-G-(RlCG) 1-RB
G-R+(RlC.G) RB
G-RB R-(RxG)
G-RB R"-(l-G)
If we substitute for (G - ~) in the contribution formula above and
simplify:
CF
AX R(l~G) . G . X
P - A -Rx T
A R(l-G)
>< G P - A -
R
Ax R(~ - 1) P - A -
R
1 P - A - A (G" - 1)
A P-A-C+A
P A G
T