TITLE I

COMMODITY PROGRAMS

**SUMMARY OF COMMODITY TITLE REFORM**

***Recommendations In Brief***

Reform farm policy to make it more market-oriented, more predictable,
less market distorting and better able to withstand challenge.

***Problem***

Loan deficiency payments and counter-cyclical payments are designed to
provide producers a safety net. However, under the 2002 farm bill, loan
deficiency and counter-cyclical payments were largest during years of
record-breaking harvests and record farm income. Yet in these same
years, natural disasters that caused complete crop loss often left some
producers with little safety net whatsoever. John from Kansas described
during a USDA Farm Bill Forum how he ended up with no support under the
current system. He said, "We didn\'t raise anything because of the
drought. Prices went up and we didn\'t get any payment. We didn\'t have
anything to sell." The current price-based programs tend to
"under-compensate when yields decline and over-compensate when yields
increase."

Additionally, these payments are being scrutinized by some trading
partners who believe they are trade-distorting. In fact, some farm bill
programs have already been found noncompliant with international
obligations. Further, the U.S. classification of some payments as
non-trade distorting ("green box") is being questioned. With the
expiration of the peace clause in the Uruguay Round Agreement, under
which domestic support measures were generally, but not fully, protected
from challenge, international competitors have already begun to
challenge other U.S. commodity programs.

The 2002 farm bill set loan rates at fixed levels significantly above
market prices year after year for many crops. Some claim that these high
loan rates encourage farmers to plant more of these crops - further
increasing supply and thus decreasing prices. These payments can also
encourage attempts to produce crops in environmentally-sensitive,
drought-prone lands. Furthermore, farmers can take advantage of
short-term market events (such as an export terminal closing due to a
hurricane) to lock-in artificially high loan deficiency payments, while
actually selling the commodity later at prices well above the loan rate.
This allows the market price received, combined with the loan deficiency
payment, to far exceed the intended loan rate protection.

Payment limits and the Adjusted Gross Income cap have affected few
producers. Only nine percent of all farms collect 54 percent of all
government commodity payments. The complexity of the law allows
virtually unlimited payments to the nation's largest and most wealthy
farms. During Farm Bill Forums, producers spoke often about these
wealthier farms inflating cash rental rates and outbidding their
neighbors for farm real estate. The nation's tax policy coupled with
these unlimited government payments have contributed to the surge in
high land values and high rental rates. As a result, it is more
difficult for beginning farmers to get started and for small-l and
medium-sized farmers to compete.

During USDA Farm Bill Forums, opinions varied about the commodity title,
but many were calling for a change from business as usual. For example,
Jeremy from South Dakota wrote, "Subsidies drive up prices all along the
production chain, from land to equipment to labor prices...Let free
market principles determine the price of a combine, not commodity
subsidies." And Mary, from Vermont wrote, "Congress needs to enact (and
USDA needs to implement) effective payment limitations on the commodity
program so that mega farms are not allowed to drive their neighbors off
the land and raise land rental/sale values beyond reachable limits for
beginning farmers."

***Recommended Solution***

The Administration is recommending reforms to Title I -- entitled
"Commodity Programs." Following is a list of the major components of the
commodity title package.

1.  Establish market-based loan rates at 85 percent of the 5-year
    Olympic average with maximum loan rates as established in the
    House-passed version of the 2002 farm bill. (For further
    information, see the proposal entitled "Revise Marketing Assistance
    Loans" on pages 9 -- 11.)

2.  Replace the current daily posted county prices (PCPs) used for
    determining loan deficiency payment (LDP) rates and repayment rates
    for marketing assistance loans with a monthly PCP for each crop.
    Revise requirements for establishing a producer's LDP and loan
    repayment rate to be based on the month that beneficial interest is
    lost. (For further information, see the proposal entitled "Revise
    Posted County Prices for the Marketing Assistance Loan Program" on
    pages 12 -- 13.)

3.  Increase overall direct payments and to provide additional income
    support in the 2010-2012 crop years. Continue direct payment acres
    at 85 percent of base acres, and do not update program payment bases
    and yields. This proposal would pay farmers an additional \$5.5
    billion over ten years. (For further information, see the proposal
    entitled "Increase Direct Payments" on pages 14 -- 15.)

4.  Further increase the direct payments to beginning farmers during
    their first five years of operation. These enhanced direct payments
    will invest \$250 million in the next generation of production
    agriculture over ten years. (For further information, see the
    proposal entitled "Increase Direct Payments for Beginning Farmers"
    on pages 16 -- 17.)

5.  Create a counter-cyclical program that is more responsive to actual
    conditions by replacing current price-based payments with
    revenue-based payments for program crops. (For further information,
    see the proposal entitled "Revenue-Based Counter-Cyclical Payment"
    on pages 18 -- 20.)

6.  Reform farm program payment limits, eligibility requirements, and
    attribution to reduce payments going to larger and higher income
    producers, increasing overall equity in farm programs. (For further
    information, see the proposal entitled "Strengthen Payment and
    Eligibility Limits" on pages 21 -- 23.)

7.  Eliminate commodity program payments for all newly purchased land
    benefiting from a 1031 tax exchange. (For further information, see
    the proposal entitled "Section 1031 Exchanges" on pages 24 -- 25.)

8.  Continue to support the price of milk at \$9.90 per cwt, and
    re-authorize and revise the Milk Income Loss Contract Program
    (MILC). MILC payments would be based on a reduced and historical
    payment rate, instead of actual, milk sales. These proposals are
    estimated to add \$793 million in additional dairy payments over a
    ten year period. (For further information, see the proposal entitled
    "Revise Dairy Counter-Cyclical Payments and Continue Price Support
    Program for Milk" on pages 26 -- 27.)

9.  Revise the sugar program to operate at no net cost to taxpayers by
    balancing supply and demand for sugar through domestic marketing
    allotments and the tariff rate quota on sugar imports. (For further
    information, see the proposal entitled "Sugar Policy" on pages 28 --
    29.)

10. In addition to the action already taken by the Congress to repeal
    Step 2 of the cotton program, repeal Steps 1 and 3 of the upland
    cotton competitiveness provision. Eliminate the competitiveness
    provisions for extra-long staple (ELS) cotton. (For further
    information, see the proposal entitled "Repeal Special Cotton
    Competitiveness Provisions" on pages 30 -- 31.)

11. Allow planting flexibility of fruits, vegetables, and wild rice on
    base acres. (For further information, see the proposal entitled
    "Remove Planting Flexibility Limitations" on pages 32 -- 33.)

12. Reduce or eliminate crop bases when an entire farm or a portion of a
    farm is sold for non-agricultural uses. (For further information,
    see the proposal entitled "Retire Crop Bases When Cropland Is Sold
    for Non-Agricultural Uses" on pages 34 -- 35.)

13. Offer program crop producers a "conservation enhanced payment
    option" that enables them to elect to receive an enhanced,
    guaranteed direct payment if they agree to meet certain conservation
    requirements and forgo marketing assistance loan program benefits
    and counter-cyclical program payments. This new program is expected
    to pay farmers an additional \$50 million over the next ten years.
    (For further information, see the proposal entitled "Conservation
    Enhanced Payment Option" on pages 36 -- 37.)

14. Update Section 1601(e) of the 2002 farm bill entitled "Adjustment
    Authority Related to the Uruguay Round Compliance" to allow USDA to
    adjust certain payments to meet current and future WTO commitments.
    (For further information, see the proposal entitled "Continuing WTO
    Compliance" on pages 38 -- 39.)

**REVISE marketing Assistance loans**

***Recommendation In Brief***

Establish market-based loan rates at 85 percent of the 5-year Olympic
average with maximum loan rates as established in the House-passed
version of the 2002 farm bill.

***Problem***

Loan rates guarantee farmers a "safety net" per unit of covered
commodities. However, producers have used marketing strategies to
receive large loan deficiency payments at harvest even when they sell
their crop later in the year at market prices well above the safety net
price. This unintended consequence allows some producers to lock in
lucrative payments from the government, even when they actually sell
their commodity at levels well above the safety net price prescribed in
the 2002 farm bill.

Under the 2002 farm bill, loan rates are fixed for the 2002-2007 crops.
As a result, loan rates for some commodities have been established at
levels well above market prices year after year. Most claim these fixed
loan rates create incentives for producers to plant one crop over
another simply because relative loan rates may not reflect the trends in
market prices. Most also claim a loan rate in excess of the market price
for a crop encourages producers to plant more acreage to that crop,
subsequently lowering the crop's market price and increasing marketing
assistance loan outlays even further.

The benefits of the marketing assistance loan program are considered
trade distorting and count against the product-specific domestic support
under the Aggregate Measurement of Support (AMS) calculation under World
Trade Organization (WTO) guidelines.

During USDA's Farm Bill Forums, producers repeatedly called for greater
protection from trade challenges. Rusty in Georgia said, "If we're going
to play in this free trade game and continue to support our farmers,
then we need to trade-proof our programs." Others discussed unintended
consequences of some support programs. Jessica of Arkansas said, "Due to
these price supports, one of the unintended consequences...has been the
artificially inflated cost of land which could cause young farmers to be
discouraged from going into the farming business."

***Recommended Solution***

To minimize these market distortions and unintended consequences, the
Administration recommends a more market-based solution for determining
loan rates. All loan rates for commodity crops would be set at the
lesser of:

1.  85 percent of the 5-year Olympic average (average of last five years
    price excluding the high year and the low year).

2.  The loan rate levels established in the House-passed version of the
    2002 farm bill (no loan rates were set for pulse crops, thus, the
    loan rates in current law are used to establish a maximum loan rate
    level for these three commodities).

+----------------+-------+-------------+--------------+--------------+
| **Commodity**  | **Un  | **Current** | **Average of | **Proposed   |
|                | its** |             | Proposed     | Maximum**    |
|                |       |             | Loan Rates   |              |
|                |       |             | over**       |              |
|                |       |             |              |              |
|                |       |             | **2008-2012  |              |
|                |       |             | 1/**         |              |
+----------------+-------+-------------+--------------+--------------+
| Wheat          | \     | 2.75        | 2.58         | 2.58         |
|                | $\\bu |             |              |              |
+----------------+-------+-------------+--------------+--------------+
| Corn           | \     | 1.95        | 1.89         | 1.89         |
|                | $\\bu |             |              |              |
+----------------+-------+-------------+--------------+--------------+
| Sorghum        | \     | 1.95        | 1.89         | 1.89         |
|                | $\\bu |             |              |              |
+----------------+-------+-------------+--------------+--------------+
| Barley         | \     | 1.85        | 1.70         | 1.70         |
|                | $\\bu |             |              |              |
+----------------+-------+-------------+--------------+--------------+
| Oats           | \     | 1.33        | 1.21         | 1.21         |
|                | $\\bu |             |              |              |
+----------------+-------+-------------+--------------+--------------+
| Upland Cotton  | \$    | 0.52        | 0.4570       | 0.5192       |
|                | \\lb. |             |              |              |
+----------------+-------+-------------+--------------+--------------+
| ELS Cotton     | \     | 0.7977      | 0.7965       | 0.7965       |
|                | $\\lb |             |              |              |
+----------------+-------+-------------+--------------+--------------+
| Rice           | \$    | 6.50        | 6.50         | 6.50         |
|                | \\cwt |             |              |              |
+----------------+-------+-------------+--------------+--------------+
| Soybeans       | \     | 5.00        | 4.92         | 4.92         |
|                | $\\bu |             |              |              |
+----------------+-------+-------------+--------------+--------------+
| Other Oilseeds | \     | 0.093       | 0.087        | 0.087        |
|                | $\\lb |             |              |              |
+----------------+-------+-------------+--------------+--------------+
| Peanuts        | \$    | 355         | 336          | 350          |
|                | \\ton |             |              |              |
+----------------+-------+-------------+--------------+--------------+
| Dry Peas       | \$    | 6.22        | 5.08         | 6.22         |
|                | \\cwt |             |              |              |
+----------------+-------+-------------+--------------+--------------+
| Lentils        | \$    | 11.72       | 10.45        | 11.72        |
|                | \\cwt |             |              |              |
+----------------+-------+-------------+--------------+--------------+
| Small          | \$    | 7.43        | 7.43         | 7.43         |
| Chickpeas      | \\cwt |             |              |              |
+----------------+-------+-------------+--------------+--------------+
| Graded Wool    | \     | 1.00        | 0.55         | 1.00         |
|                | $\\lb |             |              |              |
+----------------+-------+-------------+--------------+--------------+
| Nongraded Wool | \     | 0.40        | 0.22         | 0.40         |
|                | $\\lb |             |              |              |
+----------------+-------+-------------+--------------+--------------+
| Mohair         | \$\\b | 4.20        | 1.92         | 4.20         |
+----------------+-------+-------------+--------------+--------------+
| Honey          | \     | 0.60        | 0.60         | 0.60         |
|                | $\\lb |             |              |              |
+----------------+-------+-------------+--------------+--------------+

1/ Proposed loan rates are calculated for each year, 2008-2012, using
actual and projected market prices and then averaged over the 5-year
period.

***Background***

Marketing assistance loans are made by the Commodity Credit Corporation
(CCC) to eligible producers on eligible commodities. They provide
interim financing to facilitate the orderly distribution of commodities
throughout the marketing year. Instead of selling immediately at
harvest, the marketing loan program allows a producer who grows an
eligible crop to store the production and pledge the crop as collateral.
The loan proceeds help the producer to maintain financial stability
without having to sell the harvested crop at the time of year when
prices tend to be lowest. Later, when market conditions may be more
favorable, a producer can sell the crop and repay the loan.
Alternatively, the producer may forgo the loan and receive a loan
deficiency payment at any time up to the loan availability deadline.
Loan proceeds are based on loan rates set by statute and the quantity of
eligible commodity pledged.

Recently, a WTO panel on cotton ruled that Step 2 payments, cotton
marketing loans, and cotton counter-cyclical payments together
contributed to price suppression in world cotton markets. The United
States vigorously defended the programs, but as a result of the adverse
ruling, terminated the Step 2 program on August 1, 2006. Brazil has
requested permission from the WTO to retaliate against the United
States, charging that the two remaining U.S. programs --- marketing
loans and counter-cyclical payments --- continue to suppress world
cotton prices. As a result a panel has been established to rule on
Brazil's claims. Preliminary rulings on compliance are expected in 2007.

**REVISE POSTED COUNTY PRICES FOR THE MARKETING ASSISTANCE LOAN
PROGRAM**

***Recommendation In Brief***

Replace the current daily posted county prices (PCPs) used for
determining loan deficiency payment (LDP) rates and repayment rates for
marketing assistance loans with a monthly PCP for each crop. Revise
requirements for establishing a producer's LDP and loan repayment rate
to be based on the month that beneficial interest is lost.

***Problem***

The current system of using PCPs to determine LDPs and permit loan
repayment has enabled producers to receive financing early in the
harvest season, avoid forfeitures, and allow commodities to be marketed
in response to demand. However, the PCP system suffers from a series of
problems. First, calculating 80,000 PCPs daily is a massive undertaking
and leads to errors. Because PCPs are designed to reflect local market
prices, lack of information on local market conditions can lead to PCPs
that do not reflect local conditions and to PCPs that have unwarranted
differences from one county to the next. Second, an unusual short-term
event may cause a short-term decline in market prices, triggering a
large volume of LDP requests at a high LDP rate that may not reflect the
longer-term or underlying market conditions. This leads to excessive
costs of the marketing loan program. Third, producers may take advantage
of short-term price depressions to obtain an LDP and then market the
crop later in the year, with the resulting market price plus LDP greatly
exceeding the loan rate. In this case, the producer receives total
compensation much greater than intended by the loan program.

The unintended levels of compensation were noted in several USDA Farm
Bill Forum comments. Ellen from North Dakota said, "As the program
exists right now there are in fact no limits on commodity payments that
can be received, especially with respect to marketing loan gains."

***Recommended Solution***

The Administration recommends replacing the daily PCP with a monthly
PCP. The monthly PCP would be an average of five daily PCPs on pre-set
days during the previous month, excluding the high and low daily PCP.
This new system would apply to all covered commodities except upland
cotton, rice, wool, mohair, and honey. A producer who elects to forgo a
marketing assistance loan and receive an LDP during any month would
receive the LDP rate in effect on the day the producer loses beneficial
interest in the commodity. The LDP rate would be the difference between
the applicable loan rate and the monthly PCP. For a producer who elects
to take out a marketing assistance loan, the loan repayment rate would
be the loan rate plus interest, unless the producer loses beneficial
interest immediately upon repayment of the loan. In that case, the loan
would be repaid at the PCP in effect for the month if the PCP is less
than the loan rate plus interest. If the loan is carried to maturity,
the loan repayment rate would be the PCP in effect during the month the
loan matures or during the last month of the commodity marketing year,
whichever is earlier. For those producers who do not lose beneficial
interest (silage producers, farmer-feeders, etc.), USDA would establish
a payment rate for these producers based on the average of the monthly
PCPs during the first three months of the marketing year.

***Background***

Producers may receive a nonrecourse marketing assistance loan for
eligible commodities. They may settle their outstanding loan during the
loan period by repaying the loan or, upon maturity, by forfeiting the
commodity pledged as collateral for the loan to the Commodity Credit
Corporation (CCC). A producer may repay the loan at the loan repayment
rate which is the applicable county loan rate, plus accrued interest and
other charges (per bushel or cwt) or the announced loan repayment rate
for the respective commodity. Announced loan repayment rates, or PCPs,
are established and available each day based upon the previous day's
market prices at appropriate U.S. terminal markets, adjusted to reflect
quality and location, for grains and soybeans. Each day, some 80,000
PCPs are announced by USDA. In addition, a producer eligible to obtain a
marketing assistance loan may agree to forgo the loan and receive an
LDP. The LDP rate equals the amount by which the county loan rate
exceeds the announced loan repayment rate for the commodity.

Establishing the LDP rate or the loan repayment rate on the date the
producer loses beneficial interest in the commodity would enable the
producer to receive the price support provided by the loan rate while
limiting excessive LDPs and marketing loan gains. A producer has
beneficial interest in the commodity if all of the following remain with
the producer: control of the commodity, risk of loss, and title to the
commodity.

The following chart is an example of daily versus monthly PCPs:

![](media/image1.wmf){width="5.834722222222222in"
height="4.363194444444445in"}

**iNCREASE Direct payments**

***Recommendation in Brief***

Increase overall direct payments and to provide additional income
support in the 2010-2012 crop years. Continue direct payment acres at 85
percent of base acres, and do not update program payment bases and
yields. This proposal would pay farmers an additional \$5.5 billion over
ten years.

***Problem***

While program crop prices are generally expected to remain firm or
increase over the next few years, upland cotton is an exception. The
combination of increases in upland cotton yields per acre and declining
U.S. upland cotton textile production is expected to limit price gains
and result in substantial cotton program expenditures, compared to other
commodities.

The 2002 farm bill permitted producers to update their program crop base
acres and yields. For the purposes of World Trade Organization
obligations, updating bases and yields for direct payments would connect
them more closely to current production and could jeopardize their
"green box" status, causing these payments to be categorized as trade
distorting "amber box" assistance.

***Recommended Solution***

The Administration proposes increased direct payment rates. In addition,
the Administration proposes increased direct payment rates for
commodities other than upland cotton in the 2010-2012 crop years to
reduce the risk of weaker markets, with this increase totaling \$1
billion over the three years.

The chart below shows direct payment rates for 2007 under current law
compared to USDA's proposed direct payment rates for 2008-2017 crop
years:

+----------------------+-----------+-----------------+----------------+
| Crop                 | Current   | USDA Proposal   | USDA Proposal  |
|                      | Law       |                 |                |
|                      |           | 2008-2009 and   | 2010-2012      |
|                      | 2007      | 2013-2017       |                |
+----------------------+-----------+-----------------+----------------+
| Corn (\$/bu)         | 0.28      | 0.28            | 0.30           |
+----------------------+-----------+-----------------+----------------+
| Sorghum (\$/bu)      | 0.35      | 0.35            | 0.37           |
+----------------------+-----------+-----------------+----------------+
| Barley (\$/bu)       | 0.24      | 0.25            | 0.26           |
+----------------------+-----------+-----------------+----------------+
| Oats (\$/bu)         | 0.02      | 0.02            | 0.03           |
+----------------------+-----------+-----------------+----------------+
| Wheat (\$/bu)        | 0.52      | 0.52            | 0.56           |
+----------------------+-----------+-----------------+----------------+
| Soybeans (\$/bu)     | 0.44      | 0.47            | 0.50           |
+----------------------+-----------+-----------------+----------------+
| Rice (\$/cwt)        | 2.35      | 2.35            | 2.52           |
+----------------------+-----------+-----------------+----------------+
| Upland Cotton        | 6.67      | 11.08           | 11.08          |
| (cents/lb)           |           |                 |                |
+----------------------+-----------+-----------------+----------------+
| Peanuts (\$/ton)     | 36.00     | 36.00           | 38.61          |
+----------------------+-----------+-----------------+----------------+
| Other Oilseeds       | 0.80      | 0.80            | 0.857          |
| (\$/cwt)             |           |                 |                |
+----------------------+-----------+-----------------+----------------+

Additionally, to avoid jeopardizing the status of direct payments as
non-trade distorting "green box" support, direct payment base acres and
yields should not be updated. Payment acres should continue at 85
percent of base acres.

USDA Farm Bill Forums brought forth a diversity of opinions about direct
payments. Many producers commented on the benefits of direct payments in
the world trade arena. Brian from Minnesota wrote, "I support continuing
decoupled payments based upon cropping history rather than current
plantings."

***Background***

The Direct Payment Program (part of the Direct and Counter-Cyclical
Program, or DCP) provides payments to eligible producers on farms
enrolled in DCP during the 2002-2007 crop years. Direct payments are
computed using the base acres and payment yields established for each
farm and are available for barley, corn, grain sorghum, oats, other
oilseeds (canola, crambe, flaxseed, mustard seed, rapeseed, safflower,
sesame, sunflower seed), peanuts, rice, soybeans, upland cotton, and
wheat.

For each commodity, the direct payment for each crop year equals 85
percent of the farm's base acreage *multiplied by* the farm's direct
payment yield *multiplied by* the direct payment rate. Direct payments
are not based on producers' current production choices, but instead are
tied to historical, fixed acreages and yields. Because direct payments
provide no incentive to increase production of any particular crop, the
payments support farm income without affecting producers' current
production decisions.

For the purposes of reporting payments to the WTO, subsidies are
classified into "boxes" that are given the colors green, blue, and
amber.

Domestic support measures considered to distort production and trade
fall into the "amber" box. These include measures linked to current
production and prices. The U.S. amber box limit for product-specific
support is \$19.1 billion per year.

The "blue box" contains conditions designed to reduce distortion. Any
support that would normally be in the amber box, but also requires
farmers to limit production, can be placed in the blue box. There are
currently no limits on spending on "blue box" subsidies.

"Green box" programs include farmer support that is not related to
current production levels or prices. Examples include direct payments
and qualifying research, environmental protection and rural development
programs. "Green box" subsidies are therefore allowed without limits.

The 2002 farm bill permitted producers to update their program crop base
acres and permitted updating of payment yields for counter-cyclical
payments, if bases were updated. Payment yields for direct payments were
not allowed to be updated.

**INCREASE Direct Payment for**

**beginning farmers**

***Recommendation in Brief***

Further increase the direct payments to beginning farmers during their
first five years of operation. These enhanced direct payments will
invest \$250 million in the next generation of production agriculture
over ten years.

***Problem***

Beginning farmers and ranchers face barriers to entering production
agriculture. Farming is a high-cost business and a significant
percentage of these costs must be invested up-front as a new producer is
getting started. Land values and rental rates in the major program crop
regions have significantly increased. National average farmland values
have increased 65 percent in the past five years, from \$1,150 per acre
in 2001 to \$1,900 per acre in 2006. Average cropland rental rates
increased from \$71 per acre in 2001 to \$79 per acre in 2006, or 11
percent over the same period.

The amount and cost of equipment, including planting, cultivation and
harvest machinery, exemplifies the financial barriers to entering
production agriculture. The price of a representative front-wheel-assist
250 horsepower tractor ranges from \$180,000 to \$200,000. Harvest
equipment may be even more expensive, with a standard combine often
costing more than \$200,000. Lease costs are substantial as well.

This issue was raised repeatedly during USDA's Farm Bill Forums.
Comments made by Cameron, of Ohio, represent the comments of many
stakeholders. He said, "It is almost impossible for a young person to
get started in farming. The current program does not do enough to help
the younger farmer get established but almost hurts him because of the
competition from larger established farmers and the government payments
they receive."

***Recommended Solution***

To better prepare beginning farmers to face the initial financial
burdens associated with entering production agriculture, the
Administration recommends that beginning farmers receive an increased
direct payment rate. The direct payment rate for beginning farmers
should be determined by multiplying the covered commodity direct payment
rate by 1.20. After the initial five years, the producer would no longer
be eligible for a higher direct payment rate.

Vince, from Montana, is among the producers who strongly encouraged the
department to expand support for beginning farmers. Vince specifically
lauded direct payments. He wrote, "Because I am a beginning farmer, I
was able to acquire a FSA guarantee on my farm\'s land loan. It is the
direct payment in the current farm program that provides the stability I
require for my budget and cash flow projections...When projecting my
next year\'s budget, the direct payment is the only number I have been
able to guarantee as fixed income. Without it, my land payment would be
at risk."

***Background***

The Direct Payment Program (part of the Direct and Counter Cyclical
Program, or DCP) provides payments to eligible producers on farms
enrolled for the 2002 through 2007 crop years. Direct payments are
computed using the payment rates in statute and the base acres and
payment yields established for each farm. Direct payments are available
for barley, corn, grain sorghum, oats, and other oilseeds (canola,
crambe, flax, mustard, rapeseed, safflower, sesame and sunflower seeds),
peanuts, rice, soybeans, upland cotton, and wheat.

For each commodity, the direct payment for each crop year equals 85
percent of the farm's base acreage *multiplied by* the farm's direct
payment yield *multiplied by* the direct payment rate. Direct payments
are not based on producers' current production choices, but instead are
tied to historical, fixed acreages and yields. Because direct payments
provide no incentive to increase production of any particular crop, the
payments support farm income without affecting producers' current
production decisions.

**REVENUE-BASED COUNTER-CYCLICAL PAYMENT**

***Recommendations In Brief***

Create a counter-cyclical program that is more responsive to actual
conditions by replacing current price-based payments with revenue-based
payments for program crops.

***Problem***

Current price-based counter-cyclical payments are based on fixed program
payment yields and acreages. Thus when market prices drop below the
level that triggers a counter-cyclical payment, payments are made
regardless of the level of yields. By failing to take into account
actual production per acre, current counter-cyclical payments tend to
under-compensate producers when yields decline and over-compensate
producers when yields increase.

During USDA Farm Bill Forums, the idea of counter-cyclical payments
based on revenue was repeatedly echoed. Ernie from Nebraska said, "Too
often our farm policy focus is only on prices. The focus, we feel,
should really be on revenue which takes into account both prices and
yields... \[The current farm bill\] tends to overcompensate when it
should not and under-compensate when more assistance is needed." John
from Kansas said, "We didn\'t raise anything because of a drought. The
prices went up and we didn\'t get any payment; we didn\'t have anything
to sell. A target revenue program would fix that.\"

In 2004-2005, historically high yields for corn and cotton drove
supplies up and consequently prices down, triggering counter-cyclical
payments for both crops. While prices were down, bushels and pounds sold
by farmers were up, yielding unexpectedly high market revenues.
Nonetheless, the counter-cyclical payment formula under the 2002 farm
bill paid additional money to producers who were already experiencing
above average revenues. Conversely, if a farmer is experiencing a
drought and yields are low, commodity prices are often above the
counter-cyclical price trigger. If producers have few or no commodities
to sell at the high price, their farm revenue suffers, yet because the
market price is above the counter-cyclical price trigger producers
receive no payments. In cases such as these, unexpected market
conditions yield unintended consequences.

***Recommended Solution***

Replace the current price-based counter-cyclical payment program for a
commodity with revenue-based counter-cyclical payments for that
commodity. The revenue-based payment for a commodity would be triggered
when the actual national revenue per acre for the commodity is less than
the national target revenue per acre.

The national target revenue per acre for the commodity would equal the
2002 farm bill's target price minus the 2002 farm bill's direct payment
rate multiplied by the national average yield for the commodity during
the 2002-2006 crop years, excluding the high and the low years. The
national actual revenue per acre for a commodity would equal the
national average yield for the commodity times the higher of: (1) the
season-average market price and (2) the loan rate for the commodity.

If a payment is triggered, the national revenue-based payment per acre
would be converted to a payment rate for producers by dividing the
national revenue payment per acre by the U.S. average payment yield per
base acre under the 2002 farm bill countercyclical payment program. An
individual producer's revenue-based counter-cyclical payments would be
determined by multiplying the national average payment rate for the
commodity times 85 percent of the producer's base acres times the
producer's program payment yield under the 2002 farm bill
countercyclical payment program.

Base acres and program payment yields would remain fixed over the life
of the 2007 farm bill. The national yield for determining target revenue
would remain fixed over the life of the 2007 farm bill and would equal
the average yield for the 2002-2006 crops, excluding the high and the
low year.

***Background***

Price-based counter-cyclical payments established under the 2002 farm
bill are triggered when the effective price for a covered commodity
falls below the target price for the commodity. The effective price is
the sum of: (1) the higher of the season-average market price or the
national average loan rate for the commodity and (2) the direct payment
rate for the commodity. Since current counter-cyclical payments are not
directly tied to actual yields, they may over-or-under compensate
producers for annual fluctuations in market revenue. For example, when
yields are above trend, causing market prices to decline, current
counter-cyclical payments can over-compensate producers since higher
yields offset some revenue lost from lower market prices. The opposite
occurs when yields are below trend. In this situation, lower production
can cause market prices to increase and counter-cyclical payments to
decline -- even to zero. However, because revenue per acre may change
only slightly or even decrease as a result of declining yields per acre,
revenue-based payments would be more responsive to actual conditions.

The following page provides examples of how the program would operate in
a hypothetical year for corn.

  ------------------ ----------------- ------------------ -----------------
  **U.S. Data**      **Current         **U.S. Data**      **Recommended
                     Price-Based**                        Revenue-Based**

  **Target Price**   \$2.63/bu.        **Target Price**   \$2.63/bu.

  **Direct Payment** \$0.28/bu.        **Direct Payment** \$0.28/bu.

  **Price            \$2.35/bu.        **Difference**     \$2.35/bu.
  Guarantee**                                             

  **Program Yield    114.3 bu./ac.     **Olympic Average  146.4 bu./ac.
  (bu./ac.)**                          Yield              
                                       (2002-2006)**      

                                       **Target Revenue** 344.04
  ------------------ ----------------- ------------------ -----------------

**Price-Based Versus Revenue-Based Payments: Price and Revenue
Guarantees**

**Price-Based Versus Revenue-Based Payments: Payment Calculation**

**Example \# 1---Higher Yield, Lower Price**

+-----------------------------------+-----------------+---------------+
| **U.S. Data**                     | **Assume Actual |               |
|                                   | Pr              |               |
|                                   | ice=\$2.00/bu.; |               |
|                                   | Yie             |               |
|                                   | ld=170.0/bu.;** |               |
|                                   |                 |               |
|                                   | **Revenue       |               |
|                                   | =\$340.00/ac.** |               |
+-----------------------------------+-----------------+---------------+
|                                   | **Price-Based** | **Re          |
|                                   |                 | venue-Based** |
+-----------------------------------+-----------------+---------------+
| **Price-Based Payment Rate Per    | \$0.35          | \--           |
| Bushel (1)**                      |                 |               |
+-----------------------------------+-----------------+---------------+
| **Program Yield**                 | 114.3 (bu./ac.) | 114.3         |
|                                   |                 | (bu./ac.)     |
+-----------------------------------+-----------------+---------------+
|                                   |                 |               |
+-----------------------------------+-----------------+---------------+
| **Revenue-Based Payment Per Acre  | \--             | \$4.04        |
| (2)**                             |                 |               |
+-----------------------------------+-----------------+---------------+
| **Payment Rate Per Bushel (3)**   | \--             | \$0.035       |
+-----------------------------------+-----------------+---------------+

\(1\) \$0.035 = \$2.35 - \$2.00

\(2\) \$4.04 = \$344.04 - \$340.00

\(3\) \$0.035 = \$4.04/114.3

**Price-Based Versus Revenue-Based Payments: Payment Calculation**

**Example \# 2---Lower Yield, Higher Price**

+-----------------------------------+-----------------+---------------+
| **U.S. Data**                     | **Assume Actual |               |
|                                   | Pr              |               |
|                                   | ice=\$2.30/bu.; |               |
|                                   | Yie             |               |
|                                   | ld=130.0/ac.;** |               |
|                                   |                 |               |
|                                   | **Revenue       |               |
|                                   | \$299.00/ac.**  |               |
+-----------------------------------+-----------------+---------------+
|                                   | **Price-Based** | **Re          |
|                                   |                 | venue-Based** |
+-----------------------------------+-----------------+---------------+
| **Price-Based Payment Rate Per    | \$0.05          | \--           |
| Bushel (1)**                      |                 |               |
+-----------------------------------+-----------------+---------------+
| **Program Yield**                 | 114.3 bu./ac.   | 114.3 bu./ac. |
+-----------------------------------+-----------------+---------------+
|                                   |                 |               |
+-----------------------------------+-----------------+---------------+
| **Revenue-Based Payment Per Acre  | \--             | \$45.04       |
| (2)**                             |                 |               |
+-----------------------------------+-----------------+---------------+
| **Payment Rate Per Bushel (3)**   | \--             | \$0.394       |
+-----------------------------------+-----------------+---------------+

\(1\) \$0.05 = \$2.35 - \$2.30

\(2\) \$45.04 = \$344.04 - \$299.00

\(3\) \$0.394 = \$45.04/114.3

**STRENGTHEN PAYMENT AND ELIGIBILITY LIMITS**

***Recommendation in Brief***

Reform farm program payment limits, eligibility requirements, and
attribution to reduce payments going to larger and higher income
producers, increasing overall equity in farm programs.

***Problem***

Farm program payments account for a sizeable share of farm income for
producers of program crops. Generally, the effect of payment limits has
been limited because producers have been able to use various legal and
regulatory provisions to avoid being restricted by these limits. The
Commission on the Application of Payment Limitations for Agriculture
authorized in the 2002 farm bill found the "limits on marketing loan
benefits are not effective, only a small percentage of program crop
producers reach the current limits on direct and counter-cyclical
payments, and many of the largest farms have either restructured or are
likely to do so to lessen the extent to which the limits reduce
payments."

With only limited constraints on payments, a substantial portion of
payments go to large, high income producers. In 2005, commercial farms
(defined as a farm with sales of \$250,000 or more, where the principal
occupation of the operator is farming) accounted for nine percent of all
farms but received 54 percent of all government payments, averaging
\$54,100 per farm. These farms had average household incomes of
\$200,000. Farms where the principal occupation of the operator was
farming and with sales up to \$250,000 (intermediate farms) accounted
for 23 percent of farms and received 27 percent of all payments,
averaging \$8,700 per farm. These farms had average household incomes of
\$68,000. The U.S. average household income was \$63,344 in 2005. These
data indicate most payments go to farm households that have large
incomes compared with other farms and with U.S. average household
income. Moreover, these large payments are likely to provide a means and
incentive for the "big to get bigger" and outbid their neighbors in
purchasing and renting farmland.

The problem was highlighted in the comments offered during many Farm
Bill Forums. Kristina from Virginia said, "Farm bill policies are
supposed to preserve family farms, but they disproportionately channel
money to big agribusiness." Steve from Georgia said, "These people
drawing these multiple payments are in competition against us... They...
keep getting bigger every year. The number of farmers drops every year.
There\'s going to be fewer and fewer farmers, and there won\'t be such a
thing as a family farm."

***Recommended Solution***

The Administration proposes increasing the effectiveness of farm bill
payment limits and helping assure equity among farmers.

1.  Decrease the Adjusted Gross Income (AGI) eligibility cap for all
    farm commodity program payments from the current \$2.5 million to
    \$200,000 annually. Continue current law AGI requirements and
    payment limits on all conservation title payments.

2.  Repeal the current provision in law that waives the AGI cap if 75
    percent or more of the AGI is derived from farming, ranching, or
    forestry activities. Thus, if a producer has an annual adjusted
    gross income of \$200,000 or more, regardless of the source of the
    income, the producer would not be eligible for commodity program
    payments.

3.  Replace the three entity rule with direct attribution of payments,
    so that all payments are attributed to natural persons directly and
    through entities that are determined to be actively engaged in
    agriculture.

4.  Maintain the effective overall payment limit of \$360,000 but adjust
    the separate payment limits on specific types of payments -- from
    \$80,000 to \$110,000 for direct payments, from \$130,000 to
    \$110,000 for counter-cyclical payments, and from \$150,000 to
    \$140,000 for marketing loan gains.

5.  Repeal honey, peanut, wool, and mohair program-specific payment
    limits (i.e., establish one comprehensive payment limit per person
    for all commodity program payments including dairy, not one limit
    for one set of commodity payments and another limit for other
    commodity payments).

6.  Issue new rules that strengthen the now difficult-to-measure
    requirements for the active management contribution to the operation
    that enables individuals or entities to qualify for commodity
    program payments without contributing labor to the operation.
    Landowners who contribute land to an operation and receive rent in
    the form of a share of production of a program commodity produced on
    the land would continue to be considered actively engaged in
    agriculture and eligible for program payments.

7.  Issue rules to institute new procedures to validate producer AGI and
    eligibility for payments to help ensure no erroneous payments are
    made.

8.  Establish a de minimis level on the issuance of direct and
    countercyclical payments. To achieve efficiencies in the
    distribution of payments, no payment of \$10.00 or less would be
    issued under the direct and countercyclical payment programs. In
    2004, USDA made direct payments of \$10.00 or less to 27,809
    producers. These payments totaled \$93,711.

Comments submitted during USDA's Farm Bill Forums offered varying
opinions about payment limits. Some spoke passionately about the need
for greater equity in distribution. Janet from North Dakota said, "We
ask that changes be made in our agricultural support system which will
do more than use family farmers as the poster children for ag spending.
Put a cap on subsidies and close the loopholes which allow an unfair
advantage to a few." Paul from Minnesota said, "You need to do something
about a more equitable distribution so that the dollars are not going
just to the largest farmers."

Internal Revenue Service (IRS) data for 2004 indicate that 97.7 percent
of all American tax filers have an AGI under \$200,000 and only one half
of one percent of all Americans have an AGI over \$500,000. Compared to
the \$2.5 million AGI cap in current law, less than .0007 percent of all
American tax filers have an AGI of over \$2.5 million. Put another way,
less than seven in every 10,000 American families have an AGI over \$2.5
million. Looking at farmers specifically, 2003 IRS data indicate that
approximately two million tax filers submitted a Schedule F -- reporting
a profit or loss from farming. Of these, only 71,800 --- 3.6 percent ---
reported AGI of \$200,000 or more. This data also indicates that 4.5
percent of farm program payments (including Conservation Reserve Program
Payments) went to the 3.6 percent of Schedule F filers with AGI of
\$200,000 or more.

***Background***

A limitation on the total annual payments that a \"person\" may receive
under certain commodity programs has been in effect since enactment of
the Agricultural Act of 1970. Subsequent farm legislation continued
payment limitation requirements and added other income limitations. Most
notably, the 2002 farm bill added a \$2.5 million AGI limitation with
respect to these programs. An individual or entity is not eligible for
farm program and other payments if the individual's or entity's average
AGI exceeds \$2.5 million for the three tax years immediately preceding
the applicable crop, program, or fiscal year. AGI for an individual
filing a separate tax return is the amount reported as "adjusted gross
income" on the Federal tax return for the individual for the applicable
tax year, which includes wages, salaries, dividend and interest income,
capital gains, net farm income (gross farm income minus farm expenses
including depreciation) and other sources of income. Similar definitions
apply to individuals filing joint returns, corporations, partnerships,
trusts, etc. However, an individual or entity is considered eligible to
receive farm program payments regardless of the level of AGI if 75
percent or more of the average AGI is derived from farming, ranching, or
forestry operations. Reducing the AGI cap and repealing the 75 percent
exception would reduce the number of high income households receiving
farm income support.

Eliminating the three entity rule would allow transparent identification
of payments to individuals and would reduce the incentive to create
business organizations for reasons other than risk or business
considerations.

**section 1031 exchanges**

***Recommendation In Brief***

Eliminate commodity program payments for all newly purchased land
benefiting from a 1031 tax exchange.

***Problem***

While many farmers are reporting significant economic hardship, land
values have continued to climb. Average farm real estate value increased
over 90 percent from \$974 per acre in 1998 to \$1,900 per acre in 2006.
During that same period, the average value of cropland increased almost
80 percent to an average \$2,390 per acre.

![](media/image2.wmf){width="5.059722222222222in"
height="3.438888888888889in"}

High land values continue to be a barrier for new farmers who are
seeking to enter production agriculture. These high land values are also
problematic for small and socially disadvantaged farmers who are seeking
to expand their operations.

A reoccurring theme at USDA Farm Bill Forums centered on how individuals
near urban areas sold their land and moved to more remote areas where
they outbid local farmers for farmland, simply to take advantage of the
1031 tax exchange. For example, Troy, a 26-year-old college graduate in
agribusiness from Utah said, "It has always been my dream to be able to
someday own my own farm. Currently, I am unable to do so due to the
giant barrier of entry which is land values....This is mainly due to
speculation of real estate and 1031 exchanges." Ronald from Minnesota
caused a round of applause when he stated "it\'s the 1031 tax exchange
that\'s killing the young farmer." And Len from Wisconsin added, "The
1031 is just driving our land rents and land prices to where the average
producer, even big producers can\'t compete."

***Recommended Solution***

To help rectify this situation, USDA proposes to eliminate eligibility
for direct payments, counter-cyclical payments and marketing loan
benefits on land purchased after the date of enactment of the 2007 farm
bill through a 1031 exchange. This policy change will help mitigate an
unintended consequence of the tax code by allowing the market, not the
tax code, to drive land purchases and prices.

***Background***

Section 1031 of the U.S. Internal Revenue Code allows investors to defer
capital gains taxes on the exchange of like-kind properties. Like-kind
(tax-deferred) exchanges, or "1031 tax deferments," can affect rural
farmland values. Under "1031 tax deferments," landowners selling land at
a profit can defer taxes on that profit by using the proceeds to acquire
similar property for business or investment purposes. These taxes can be
significant because urban expansion has caused a rapid increase in
nearby agricultural land values. As farmers, ranchers, and others sell
land, usually for nonfarm use, in these urban-affected areas, they may
acquire farmland in more rural locations to avoid taxes.

Agricultural land value reflects the future value of agricultural
production from that land (measured in current dollars), but also
includes factors such as urban development pressures and recreational
uses. Agricultural land values rose sharply in the 1970s and early
1980s, declined rapidly between 1982 and 1987, and have risen steadily
since 1987.

![](media/image3.wmf){width="5.076388888888889in" height="3.45in"}

**rEVISE DAIRY Counter-cyclical Payments and continue Price support
PROGRAM for milk**

***Recommendation In Brief***

Continue to support the price of milk at \$9.90 per hundredweight (cwt),
and re-authorize and revise the Milk Income Loss Contract Program
(MILC). MILC payments would be based on a reduced and historical payment
rate, instead of actual milk sales. These proposals are estimated to add
\$793 million in additional dairy payments over a ten-year period.

***Problem***

Operation of the milk price support program has helped to provide
stability to producers' milk prices. Counter-cyclical payments to dairy
producers are triggered under the MILC program when the Class I price in
Boston in any month falls below \$16.94 per cwt. The MILC program is not
consistent with the other farm bill counter-cyclical programs that
require payments to be based on historical production levels and an 85
percent payment rate.

Under the 2002 farm bill, authority for the MILC program expired on
September 30, 2005. The Deficit Reduction Act of 2005 extended the MILC
program authorizing payments through August 31, 2007, but no payments
are authorized thereafter. Because the MILC program expires prior to
expiration of the 2002 farm bill, the MILC program is not part of the
2007 farm bill baseline spending for FY 2008-2017. Thus, a continuation
of the program in the 2007 farm bill would cause farm bill program
spending to exceed baseline spending.

During USDA's Farm Bill Forums, dairy farmers from throughout the
country let their views be known. For example, Ed from Wisconsin said,
"We see the MILC program as an important supplement to the milk price
support program, which is also an important part of the dairy income
safety net. However, the milk price support program, by itself in its
current form, is an insufficient safety net for dairy producers." And
Calvin from Florida added, "We support the continuation of this
relatively low cost safety net for dairy farmers...With the large
investment required of dairy operations and the time frame required to
enter dairy farming it is imperative that a floor be kept on dairy
prices to maintain an adequate milk supply. The dairy price support
program is a win-win for producers, processors, and consumers."

***Recommended Solution***

The Administration proposes to maintain the milk price support program
and extend the MILC program. Under the proposed MILC program, dairy
producers would continue to be eligible to receive a payment if the
Class I price in Boston in any month falls below \$16.94 per cwt. For FY
2008, the proposed payment rate would remain at the current rate of 34
percent of the difference between \$16.94 per cwt and the Class I price
in Boston. For subsequent years, the payment rate would be phased down
to 31 percent in FY 2009, 28 percent in FY 2010, 25 percent in FY 2011,
22 percent in FY 2012, and 20 percent in FY 2013-2017.

MILC payments would be based on 85 percent of the 3-year average of milk
marketed during fiscal years 2004-06. Payments would be subject to the
current quantity-based limit on milk marketed eligible for MILC payments
of 2.4 million pounds per year. This policy change would make the MILC
program consistent with the other farm bill counter-cyclical programs
that are calculated on historical production bases. MILC payments would
also count towards a producer's overall counter-cyclical payment limit
of \$110,000 annually, helping to limit payments to producers with
multiple dairy operations. The new adjusted gross income eligibility cap
of \$200,000 annually would also apply to MILC payments.

***Background***

The Milk Price Support Program (MPSP) supports the price of milk
produced in the 48 contiguous states through the purchase of cheese,
butter, and nonfat dry milk (NDM). The current milk price support rate
is \$9.90 per cwt. for milk testing 3.67 percent butterfat (milk fat).
Under the MPSP, farmers are not paid directly but are supported through
Federal purchases of dairy products. Purchases vary from year to year
depending on the dairy market supply and demand situation and the
support rate.

In recent years, the average price received for milk has been well above
the support price and only very small amounts of nonfat dry milk, butter
and cheese have been removed from the market to support the price of
milk. Current projections suggest that the farm-level price of milk will
continue to remain considerably above the support price and purchases
under the milk price support program will remain small.

Besides MPSP, the MILC program is also available to dairy producers.
MILC program payments are made on a monthly basis when the Class I milk
price in Boston falls below the benchmark price of \$16.94 per cwt. A
maximum of 2.4 million pounds of milk marketed by an operation are
eligible for MILC payments per fiscal year. MILC program payment rates
are currently determined by multiplying 34 percent of the difference
between \$16.94 and the Boston Class I price for the month. By statute,
no payments are authorized under the MILC program after August 31, 2007.

**SUGAR POLICY**

***Recommendation In Brief***

Revise the sugar program to operate at no net cost to taxpayers by
balancing supply and demand for sugar through domestic marketing
allotments and the tariff rate quota (TRQ) on sugar imports.

***Problem***

The sugar program is a nonrecourse loan program that supports the price
of raw cane sugar at 18 cents per pound and refined beet sugar at 22.9
cents per pound. The 2002 farm bill requires the Secretary of
Agriculture to establish domestic allotments that result in no
forfeitures of sugar to the Commodity Credit Corporation (CCC) under the
sugar price support program. However, the 2002 farm bill suspends the
requirement when sugar imports for human consumption are expected to
exceed 1.532 million short tons, and the imports would lead to a
reduction in the overall allotment quantity. The current program limits
imports of raw and refined sugar through a TRQ. Under the World Trade
Organization (WTO), the United States is subject to minimum access
requirements consistent with U.S. obligations.

Because of increased sugar imports expected from Mexico, which, under
the NAFTA agreement, is not subject to the TRQ, USDA's current long-term
projections indicate imports in excess of 1.532 million short tons,
triggering the suspension of domestic marketing allotments during FY
2008-2017. As a result, U.S. sugar supplies are projected to exceed
domestic use, and domestic sugar placed under nonrecourse loans would be
forfeited to the Commodity Credit Corporation. USDA's projected outlays
under the sugar price support program are \$1.4 billion during FY
2008-2017.

***Recommended Solution***

The Administration recommends continuing the sugar price support program
but eliminating the provision which requires the Secretary of
Agriculture to suspend marketing allotments when sugar imports are
projected to exceed 1.532 million short tons. Domestic marketing
allotments for sugarcane and sugar beets could be reduced, as needed, to
balance sugar supply and demand and prevent price support forfeitures.
The sugar program could then continue to be operated at no net cost to
taxpayers as it traditionally has in the past.

USDA heard divergent views on U.S. sugar policy. For example, Stephen,
from Hawaii wrote, "We strongly urge that a no-cost U.S. sugar policy be
retained in the next farm bill." While Stephen, from California,
suggested, "A good start would be the end of ridiculous sugar price
supports, benefiting the few at the expense of many \-- not only all
U.S. consumers, who pay artificially high prices for sugar products, but
poor cane growers in other nations, who can\'t compete with our
artificially priced products."

***Background***

The objective of the Administration's proposal would be to continue to
maintain domestic sugar prices near historical levels while eliminating
the Federal cost of the sugar price support program. On January 1, 2008,
full implementation of NAFTA eliminates all customs duties for sweetener
trade between Mexico and the United States. Relative costs of
production, transportation, and other market factors will determine
where sugar crops are grown and processed in the United States and
Mexico following elimination of customs duties on sweeteners trade
between the two countries. If price supports for raw and refined sugar
remain at current levels, U.S. prices would likely attract imports from
Mexico. Depending on the volume of imports from Mexico, sugar prices
could drop below the forfeiture level resulting in U.S. sugar program
costs. USDA currently projects sugar program costs of \$1.4 billion
during FY 2008-2017, an average of \$140 million per year, due to
anticipated forfeitures. Under the proposal, the domestic marketing
allotment program would be available to reduce domestic sugar supplies
and support sugar prices for producers when imports exceed 1.532 million
short tons.

Sugar imports from Mexico were 784,000 tons in FY 2006 and are projected
at 330,000 tons for FY 2007. Prior to FY 2006, over-quota
tariffs restricted imports to about 25,000 tons per year.

The over-quota tariff is currently \$0.015 per pound, and drops to zero
on January 1, 2008.

**REPEAL Special Cotton**

**Competitiveness Provisions**

***Recommendation In Brief***

In addition to the action already taken by the Congress to repeal Step 2
of the cotton program, repeal Steps 1 and 3 of the upland cotton
competitiveness provision. Eliminate the competitiveness provisions for
extra-long staple (ELS) cotton.

***Problem***

In the cotton dispute brought by Brazil, the World Trade Organization
(WTO) ruled that Step 2 payments for cotton users and exporters under
the 2002 farm bill were prohibited subsidies contingent on exports or on
the use of domestic over imported cotton. Congress subsequently repealed
the Step 2 payment provisions. Step 2 was part of a set of three
competitiveness provisions in the 2002 farm bill. The other two
provisions \-- a discretionary adjustment in the loan repayment rate and
a special import quota \-- have seldom been used, have increased program
costs when used, and have had little meaning in the absence of Step 2.

The ELS cotton program includes a payment to domestic users and
exporters that is analogous to the upland cotton Step 2 program.

***Recommended Solution***

Repeal Step 1, the discretionary adjustment in the loan repayment rate,
and Step 3, the special import quota for upland cotton. Congress has
already eliminated the Step 2 program for upland cotton. Steps 1 and 3
remain in law and should be repealed. Repeal the ELS competitiveness
payment which is analogous to the Step 2 payment for upland cotton.

***Background***

The upland cotton program is comprised of a non-recourse marketing
assistance loan and a 3-step competitiveness provision. The non-recourse
marketing loan allows a producer to:

1.  Place cotton under loan for up to 9 months,

2.  Receive some money up front, which can be used to pay production
    expenses, and

3.  Wait for an advantageous move in prices to market the cotton.

If subsequent prices do not allow the producer to repay the loan and
receive a higher price, then at the end of the 9-month loan the producer
can forfeit the cotton as payment in full for the loan. If the producer
elects to repay the loan prior to maturity, the producer may repay the
loan, at the lower of:

1.  The loan rate, plus applicable storage and interest, or

2.  An alternative repayment rate, called the adjusted world price
    (AWP), announced each Thursday.

Step 1 of the 3-step competitiveness provision for upland cotton is a
discretionary adjustment to the AWP. The Secretary may, when certain
conditions are met, reduce the AWP by an amount not to exceed the
difference between the A-Index and the lowest U.S. quotation in Northern
Europe (USNE). The decision concerning the discretionary Step 1
adjustment is based upon several factors including the likelihood of
achieving the prevailing export forecast, and the likelihood of
forfeiture of loan collateral in the absence of the adjustment. The
discretionary reduction has seldom been used, and when used, it
increases the cost of the cotton program.

Step 2 of the 3-step competitiveness provision, now repealed, was
designed to ensure that U.S. upland cotton could be readily marketed in
both the domestic and international market. Step 2 operated when U.S.
upland cotton prices were above world prices for a certain period and
provided a subsidy to domestic users and exporters in the amount of the
difference between the U.S. and world prices.

Step 3 of the 3-step competitiveness provision allows for the opening of
a special additional import quota for upland cotton. These quotas permit
importation of cotton above that permitted under existing quotas. Step 3
import quotas are triggered when U.S. cotton prices quoted in Northern
Europe exceed world prices in Northern Europe for a specified period by
more than the Step 2 payment rate. When the Step 2 provision was
adopted, there was concern that it could result in exports of domestic
supplies and lower prices to foreign buyers. The provision was enacted
to provide domestic textile mills access to foreign cotton should U.S.
prices rise and supplies tighten due to Step 2. Without Step 2, there is
no basis for Step 3.

The ELS program provides payments that are analogous to the Step 2
payments. When U.S. ELS cotton prices are above world prices for a
certain period, a payment is made to domestic users and exporters in the
amount of the difference between the U.S. and world prices.

**REMOVE Planting Flexibility Limitations**

***Recommendation in Brief***

Allow planting flexibility of fruits, vegetables, and wild rice on base
acres.

***Problem***

Under World Trade Organization (WTO) rules, direct payments can be
classified as non-trade-distorting or "green box" support if, among
other conditions, they are not "related to, or based on, the type or
volume of \[current\] production" by the recipient. In the Brazil cotton
case, the WTO ruled that direct payments provided under the 2002 farm
bill could not be classified as "green box" support, because of the
limitations on planting flexibility that currently prohibit the planting
of fruits, vegetables, and wild rice on base acres eligible for
payments. The WTO reasoned that because direct payments are conditioned
on the recipients' avoiding production of certain crops after the base
period, they are related to current production and thus do not meet the
criteria for decoupled income support as defined in the WTO Agreement on
Agriculture.

Although the WTO rulings and recommendations in the cotton dispute were
limited to particular claims made by Brazil in that case, the reasoning
in *Cotton* would suggest that it is desirable to remove the planting
flexibility limitations.

***Recommended Solution***

To ensure that direct payments will be considered to be non-trade
distorting green box assistance, the Administration proposes that the
provision of the 2002 farm bill that limits planting flexibility on base
acres to exclude fruits, vegetables, and wild rice, should be
eliminated.

***Background***

The 2002 farm bill contained a provision limiting planting flexibility
to exclude the planting of fruits, vegetables, and wild rice on base
acres. Base acres are used to calculate direct and counter-cyclical
payments.

U.S. commodity programs, from their inception in the 1930s to the
present day, have had some form of acreage or production controls as a
component of agricultural policy. These production and acreage control
programs have served two purposes. Primarily, they were an attempt to
balance supply and demand. The secondary purpose was to reduce
government payments and limit the amount of acreage eligible for
payment.

In the United States, interest in more market-oriented programs and
global trade liberalization under multilateral trade agreements have
prompted policy makers to design and implement less distorting
government programs. Beginning with the 1985 farm bill, acreage
limitations have gradually been eliminated and replaced by increased
planting flexibility for farmers.

The 1996 farm bill provided producers with broad planting flexibility.
Producers no longer were required to plant within restrictive and rigid
Government regulations. They no longer had to produce a specific crop to
receive program benefits and could make planting decisions based on
market signals and what was in their best economic interest. The 1996
farm bill singled out fruits and vegetables as the exception to planting
flexibility.

The 2002 farm bill continued the exception and added wild rice. Planting
fruits, vegetables (other than lentils, mung beans, and dry peas), or
wild rice on base acres makes the producer ineligible for direct and
counter-cyclical payments. Exceptions include regions with a history of
double cropping fruits, vegetables, and wild rice with commodities
eligible for direct and counter-cyclical payments, farms with a history
of planting fruits, vegetables, and wild rice (with an acre for acre
reduction in payments), and producers with a history of planting fruits,
vegetables, and wild rice (with an acre for acre reduction in payments).

**retire crop bases when cropland IS sold for non-agricultural uses**

***Recommendation In Brief***

Reduce or eliminate crop bases when an entire farm or a portion of a
farm is sold for non-agricultural uses.

***Problem***

There are several situations in which a farmer may sell an entire farm
or a portion of a farm with no reduction in crop acreage bases and no
reduction in direct and counter-cyclical payments. For instance, a
farmer with two farms may sell one of the farms for non-agricultural
uses and transfer the crop bases from the farm being sold to the
remaining farm. In this instance, the crop bases on the farm being sold
may be assigned to the farm being retained if the sum of the crop bases
on the two farms is less than total cropland on the farm that is being
retained. If a farmer sells a portion of an existing farm, the crop
bases on the farm are not reduced unless the sum of the crop acreage
bases on the farm exceeds the total cropland on the farm following the
sale. In these situations, a producer could sell a major portion or an
entire farm for non-agricultural uses with no reduction in direct and
counter-cyclical payments. This could permit a producer to continue to
receive the same level of direct and counter-cyclical payments even
though the remaining cropland on the farm was significantly reduced.
Additionally, the retention of crop acreage bases may contribute to the
inflation of farmland values, making it harder for beginning and limited
resource farmers to purchase land.

***Recommended Solution***

The Administration proposes to permanently reduce crop acreage bases in
proportion to the decline in cropland when a portion of an existing farm
is sold for non-agricultural uses. This recommendation also would
prohibit reassignment of crop acreage bases to another farm or farms
when an entire farm is sold. This proposal is modeled after the
mechanism that proportionally reduces program crop base acres when a
portion of a farm is enrolled in the Conservation Reserve Program.

Consider a farm with 100 acres of cropland and 60 acres of crop base.
Under current law, if that farmer sells 20 acres to development of a
subdivision and 20 acres to build a golf course, the farmer would retain
the same amount of direct and counter-cyclical payments as before the
sale. Under the Administration's proposal, that same farmer would see a
proportional reduction in their base acres and a subsequent reduction in
direct and counter-cyclical payments. Thus, in this case, the farmer
started with 60 base acres and sold 40 percent of the farm to
non-agricultural use; the farmer would receive a 40 percent reduction in
base (60 acres multiplied by 40 percent equals a 24 acre reduction) and
a proportional reduction in direct and counter-cyclical payments of 40
percent.

***Background***

Under the 2002 Farm Bill, direct and counter-cyclical payments for
program crops are determined by multiplying a prescribed payment rate by
payment production. Payment production for a program crop equals 85
percent of a farm's base acres times the farm's program yield.
Therefore, the amount of direct and counter-cyclical payments a producer
is eligible to receive is directly tied to the program crop base acres
on the producer's farming operations. Program crop base acres are
determined by land's previous planting history.

**CONSERVATION ENHANCED PAYMENT OPTION**

***Recommendation In Brief***

Offer program crop producers a "conservation enhanced payment option"
that enables them to elect to receive an enhanced, guaranteed direct
payment if they agree to meet certain conservation requirements and
forgo marketing assistance loan program benefits and counter-cyclical
program payments. This new program is expected to pay farmers an
additional \$50 million over the next ten years.

***Problem***

Farm programs may provide incentives for some producers to grow crops
even on drought-prone, marginal lands. Intensive production of program
crops on marginal lands is counter to natural resource conservation
goals. Moreover, a fixed, direct "green" payment, if properly
constructed, would meet World Trade Organization (WTO) rules for
non-trade distorting support that is exempt from WTO disciplines. Such
incentives must be completely decoupled from current production and
prices and must have clearly defined eligibility criteria in order to
qualify under WTO rules as "green box" decoupled income support.

***Recommended Solution***

The Administration proposes to offer producers with program crop base
acreage a "conservation enhanced payment option" that would allow
producers to receive an enhanced direct payment in place of marketing
assistance loan program benefits and counter-cyclical payments. The
annual direct payment level for farmers choosing this option would be
their regular direct payment provided under provisions of the 2007 farm
bill plus ten percent of that payment for the duration of the 2007 farm
bill. The direct payment limit for farmers choosing this option would be
increased by ten percent as well from \$110,000 to \$121,000 annually.

Producers who choose this option would be required to adopt conservation
and environmental practices equivalent to the Progressive Tier (for more
information on the Progressive Tier, see proposal entitled "Conservation
Security Program" on pages 46-48) requirements under the Conservation
Security Program (CSP). Producers would not be required to produce
agricultural commodities to receive the direct payment.

***Background***

Under this recommendation, a producer with crop acreage base could elect
to enter a long-term contract covering the life of the 2007 farm bill to
forgo benefits of the marketing assistance loan and the counter-cyclical
payment programs. The contract would require the producer to meet the
conservation requirements of the Progressive Tier under the CSP. Under
the Progressive Tier, the producer must address water and soil quality
concerns to a sustainable level and agree to address a third resource
concern to a sustainable level by the end of the five-year contract.
Similar to other conservation compliance requirements, producers would
self-certify compliance with the Progressive Tier and would be subject
to audit.

The participating producer would receive an annual, fixed, direct
payment in lieu of marketing assistance loan program benefits and
counter-cyclical payments. In addition, the producer would continue to
receive the direct payment now provided under the 2002 farm bill. This
direct payment along with the new "conservation enhanced payment option"
direct payment would be subject to a payment limit of \$121,000
annually. The producer would also be subject to other payment limit
changes and adjusted gross income changes recommended for the 2007 farm
bill. \[See Title I recommendation entitled "Strengthen Payment and
Eligibility Limits" on pages 21-23.\]

Example conservation enhanced payment rates under this proposal will be
as follows (calculated as 1.1 times the proposed direct payment rates
and data are rounded):

+-------------------+---------+-------------+----------+--------------+
| **Commodity**     | **Pr    | **C         | **P      | **Co         |
|                   | oposed\ | onservation | roposed\ | nservation** |
|                   | Direct  | Enhanced**  | Direct   |              |
|                   | Payment |             | Payment  | **Enhanced** |
|                   | Rate**  | **Payment** | Rate**   |              |
|                   |         |             |          | **Payment**  |
|                   | **2008  | **Rate**    | **201    |              |
|                   | -2009** |             | 0-2012** | **Rate**     |
|                   |         | **          |          |              |
|                   | **2013  | 2008-2009** |          | *            |
|                   | -2017** |             |          | *2010-2012** |
|                   |         | **          |          |              |
|                   |         | 2013-2017** |          |              |
+-------------------+---------+-------------+----------+--------------+
| Barley (bu.)      | \$0.25  | \$0.28      | \$0.26   | \$0.29       |
+-------------------+---------+-------------+----------+--------------+
| Corn (bu)         | \$0.28  | \$0.31      | \$0.30   | \$0.33       |
+-------------------+---------+-------------+----------+--------------+
| Grain Sorghum     | \$0.35  | \$0.39      | \$0.37   | \$0.41       |
| (bu)              |         |             |          |              |
+-------------------+---------+-------------+----------+--------------+
| Oats (bu)         | \$0.02  | \$0.02      | \$0.03   | \$0.03       |
+-------------------+---------+-------------+----------+--------------+
| Other Oilseeds    | \$0.80  | \$0.88      | \$0.86   | \$0.95       |
| (cwt)             |         |             |          |              |
+-------------------+---------+-------------+----------+--------------+
| Peanuts (ton)     | \$36.00 | \$39.60     | \$38.61  | \$42.47      |
+-------------------+---------+-------------+----------+--------------+
| Rice (cwt)        | \$2.35  | \$2.59      | \$2.52   | \$2.77       |
+-------------------+---------+-------------+----------+--------------+
| Soybeans (bu)     | \$0.47  | \$0.52      | \$0.50   | \$0.55       |
+-------------------+---------+-------------+----------+--------------+
| Upland Cotton     | \$0.11  | \$0.12      | \$0.11   | \$0.12       |
| (lb)              |         |             |          |              |
+-------------------+---------+-------------+----------+--------------+
| Wheat (bu)        | \$0.52  | \$0.57      | \$0.56   | \$0.62       |
+-------------------+---------+-------------+----------+--------------+

For each commodity, the direct payment for each crop year equals 85
percent of the farm's base acreage *times* the farm's direct payment
yield *times* the direct payment rate.

To ensure that the payments are considered non-trade distorting under
WTO criteria, the payments should be structured to meet the criteria of
decoupled income support. The payments should be fixed and independent
of current production and price and the producer should not be required
to produce in order to receive the payment.

**continuing wto compliance**

***Recommendation In Brief***

Update Section 1601(e) of the 2002 farm bill entitled "Adjustment
Authority Related to the Uruguay Round Compliance" to allow USDA to
adjust certain payments to meet current and future World Trade
Organization (WTO) commitments.

***Problem***

The 2002 farm bill contains a \"circuit breaker\" provision that
provides the Secretary of Agriculture with the authority to adjust
expenditures under certain domestic support programs to ensure that
expenditures do not exceed total allowable domestic support limits under
the Uruguay Round Agreements. Section 1601(e) of the Act states:

> "If the Secretary determines that expenditures under subtitles A
> through E that are subject to the total allowable domestic support
> levels under the Uruguay Round Agreements \... will exceed such
> allowable levels for any applicable reporting period, *the Secretary
> shall*, to the maximum extent practicable, *make adjustments* in the
> amount of such expenditures during that period *to ensure that such
> expenditures do not exceed such allowable levels*.\" (emphasis added)

Under Title I, entitled \"Commodity Programs," Subtitles A through E
deal with direct and counter-cyclical payments for covered commodities,
marketing assistance loans and loan deficiency payments for loan
commodities and specific program payments for peanuts, sugar and dairy.

With the potential of a Doha agreement on the horizon, this statutory
provision, while a useful tool, has become outdated. Since the current
law provision is tied to the Uruguay Round Agreement, USDA would have no
mechanism to ensure compliance with a Doha agreement. The ultimate goal
is to replace the Uruguay Round Agreements with new agreements that open
markets and integrate the global economy through measures such as the
reduction or elimination of trade-distorting agricultural subsidies and
tariffs. Current law suffers from the defect of being tied directly to
the Uruguay Round Agreements, which we hope to supersede with Doha or
another such agreement.

***Recommended Solution***

Section 1601 of the 2002 farm bill should be repealed and the following
provision enacted:

Number range CHAPTER

"(e) *Adjustment Authority Related to World Trade Organization
Agreements Compliance*.

> \(1\) *Required Determination; Adjustment*. \-- If the Secretary
> determines that expenditures subject to the total allowable domestic
> support levels under the Uruguay Round Agreements, or any successor
> agreements, will exceed such allowable levels for any applicable
> reporting period, the Secretary shall, to the maximum extent
> practicable, make adjustments in the amount of such expenditures to
> ensure that such expenditures do not exceed allowable levels.
>
> \(2\) *Successor Agreements*. \-- For purposes of this subsection,
> "Uruguay Round Agreements" shall have the meaning prescribed by
> Section 2 of the Uruguay Round Agreements Act (19 U.S.C. 3501) and
> "successor agreements" shall refer to any future agreements concluded
> under the auspices of the World Trade Organization, duly approved by
> Congress, and determined by the President to be a successor agreement
> entered into force."

This proposed provision would permit the circuit breaker provision to be
available with respect to any future WTO agreement limits and would not
be confined solely to those applicable under the Uruguay Round
Agreements.

In addition, the current law circuit breaker ties both the determination
of allowable levels of domestic support and the expenditures that may be
adjusted solely to those expenditures under subtitles A through E of the
2002 farm bill. Other domestic support measures, however, may be
properly included in any calculation of total amber box support. The
proposed amendment would accommodate their inclusion for all aspects of
the circuit breaker determinations.

***Background***

In 1994, the member states of the WTO entered into a series of trade
agreements known as the Uruguay Round Agreements. With respect to
agriculture, the agreements sought to reduce subsidies and other
market-distorting practices. Since the Uruguay Round Agreements do not
themselves have the force of domestic law in the United States, Congress
enacted the Uruguay Round Agreements Act to implement the obligations
undertaken by the United States.

The agreements provided rules and disciplines for agricultural trade in
three principal areas: market access, export subsidies, and domestic
support measures. With respect to domestic support, each country agreed
to a maximum amount of trade-distorting domestic support it would
provide annually. The Uruguay Round Agreement on Agriculture established
criteria to differentiate among policies that distort trade ("amber box
measures"), policies that do not distort trade ("green box measures"),
and direct payments that meet certain production-limiting requirements
("blue box measures").

Under Uruguay Round Agreements, WTO members are required to limit their
annual expenditures on "amber box" measures. Each member nation has a
different amber box limit, calculated from a historical basis for that
country. With a significant exception for measures qualifying as *de
minimis* support, the annual limit for the United States is \$19.1
billion. Among U.S. programs, marketing loan gains, counter-cyclical
payments, the dairy support program, and sugar policy are examples of
"amber box" measures.

Recognizing that, under certain market conditions in a given year, U.S.
domestic support programs could result in expenditures greater than the
amount permitted under the Uruguay Round Agreements, Congress enacted
the so-called "circuit breaker" provision in the 2002 farm bill. This
provision provides the Secretary of Agriculture with the authority to
adjust expenditures under certain domestic support programs to ensure
that expenditures do not exceed total allowable domestic support limits.