1 **COST -**  **BENEFIT ASSESSMENT** Date: July 1 8 , 20 14 Agency : USDA/FSA Contact: Milton Madison

Dairy and Sweeteners Analy sis Group Economic and Polic y Analy sis Staff Farm Service Agency United States Department of Agriculture Washington, D.C. 20250 Phone: 202 - 69 0 - 0050 I. TI TL E Mar gin Protection Program

– Dairy and Dairy

Product Donation Program . II. EXECUTIVE SUMMARY Section 1401 - 10 , Title I , of the Agricultural Act of 20 14 ( Public L aw 113 - 79 , the 20 14 F arm B ill ) directs the Secretary of Agriculture to establish and administer the Margin Protection Program - Dairy (MPP - D airy) for dairy o perations that provid es catastrophic coverage for various “margin” levels, where the dairy production “margin” is defined as the difference between the all - milk price and f eed cost. Coverage at the $4 per hundredweight (cwt) margin level for all participating operations will cost a $100 annual administrative fee . T here are option s for producers to buy higher coverage for margins up to $8 per cwt at incremental premium increases. Pay ments under MPP - D airy are made to participating operations when actual dairy margins are less than the coverage level selected by the dairy operation during program sign - up. Section 1431 of the 2014 Farm Bill direct s the Secretary to establish the Dairy Product Donation Program (DPDP) to address low margins for dairy operations by us ing Commodity

Credit Corporation ( CCC ) fund s to purchase dairy products for public and private nonprofit organizations that feed low - income people. Purchases are only made during periods of low margins. Both programs are set to expire on December 31, 2018. U.S. Department of Agriculture (USDA) projections as of early 2014 indicate that, over the upcoming 10 - ye ar period, MPP - D airy pay ments will be triggered very infrequentl y and DPDP purchases will not be triggered at all . Continued strong export markets are expected to support domestic milk prices as production expands . Declining feed costs are expected to keep annual average margins above $10 per cwt through 2019 even as milk prices d ecline from recent record highs . Increasing feed prices in the second ha lf of the projection period , 2020 - 2024 , bring annual average margins below $10 per cwt , but they remain above the $8 maximum coverage level for MPP - D airy through 202 4 .2

When fluctuations in feed costs and milk prices around the mean estimates are considered in a stochastic model, ne t cumulative expenditures (after fee and premium costs) through 2018 for MPP - D airy and DPDP are projected to be $389 million. During low margin years for the dairy industry (See Figure 1) , program expend itures could reach $4 to $ 6 billion if nearl y all dairy operations participate and bu y coverage at $8 per cwt for 90 percent of their milk production . F ee and premium income w ould be $1.75 billion (see T able 2 ) . The CCC is p ublish ing a final rule to implement the new MPP - D airy and DPDP through regulations that would be specified in Title 7, Part 1430 of the Code of Federal Regulations (7 CFR Part 1430). This document provides the cost - benefit assessment of the final rule. Figure 1. MPP - Dairy

Margin s

Source Data: NASS Quick Stats II. NEED FOR ACTION Low margins (the revenue per cwt from milk sales over the cost of feed to produce t hat milk ) have consistent ly

concerned producer s for many y ears, and low dairy prices, high production costs, and oversupply have been issues as recently as 2013. T o address these concerns, MPP - Dairy

and DPDP focus on directly supporting producer margins, rather than indirectly

supporting producer profitability by supporting prices for dairy products ( i.e. nonfat dried milk, cheese, butter) or incomes. MPP - Dairy was established, in part, based on recommendations from the 17 - member Dairy Industry Advisory Committee $ per cw t3

established by

the Secretary

of Agriculture in 2009 . The committee p rovide d advice on way s to improve dairy

farm profitability

and reduce milk price volatility . Both MPP - Dairy

and DPDP are funded through the CCC. T here is no limit on how much may be spent under either program to support dairy producer operation s and prov ide dairy products to low income individuals. MPP - D airy and DPDP were developed by Congress to replace and improve the Milk In come Loss Contract Program (MILC), the Dairy Product Price Support Program (DPPSP) , and the Dairy

Export Incentive Program (DEIP) , previous safety net programs for dairy farmers . MPP - Dairy

compensates producers when the difference between milk prices and feed prices fall below a certain level . P roduction coverage is not as limited as under MILC and can now be protected at the $4 p er cwt margin level for a small fixed fee . Greater protection is available at higher premium rates , which a llow s more protection for large dairy

operations . In addition, producers pay a lower premium for margin protection on the first 4 million pounds (equivalent to the production of a 185 cow herd) of milk production base covered under MPP - Dairy , which benefit s small producers. Incontrast, MI LC limited production eligibility coverage to 2.985 million pounds of milk, equivalent to the production of a 140 cow herd, which meant that large operations received MILC pay ments on a very

small share of their production. DPDP will support dairy

product prices when CCC mak es purchases of commercially available packages of dairy products for distribution by public and private nonprofit organizations that work to feed low income populations . This program is designed to remove dairy

products from the commercial market by providing the purchases to populations that otherwise have limited access to dairy products. These purchases should improve dairy

product prices and improve margins for dairy operations while supplying low income groups with needed food. Unlike the DPPSP program , which purchased and stored bulk dairy

produc ts until market prices improved or were reprocessed for donation , the DPDP is expected to cause less market distortion since products will be purchased but not be stored by

CCC . Savings in reprocessing costs are also expected to be an efficiency advantage to the government relative to DPPSP . The DEIP , established to help offset the competitive disadvantage of domestic dairy products due to European Union subsidies paid to export e rs that aided their export sales, has been inactive for most of the last decade as U.S. dairy products have become more competitive in world markets. DEIP was repealed by the 2014 Farm Bill (Section 1423), as was the DPPSP (Section 1421). IV . ADDITIONAL DETAILS ON MPP - D AIRY MPP - D airy suppo rts producer margins, not milk prices, and is designed to address both catastrophic conditions of low milk prices and/ or high feed costs th at re s ult in prolonged periods of low margins. MPP - Dairy provides margin protection at $4 per cwt f or an annual4

admi nistr ative fee of $100 . The “margin” is the difference between the price of one hundred pounds of milk and the price of the feed needed to produce that milk. For example, if the price of milk is $20 a cwt and the cost for soy bean meal, corn, and hay need ed to produce that milk is $12 a cwt, the margin is $8 a cwt. For $100, producers will be able to protect the margin on 90 percent of the ir milk produc tion bas e, which is based on their production history . In the first year of MPP - Dairy , a production bas e will be established for the dairy

operation at the highest level of annual milk production during calendar year 2011, 2012, or 2013. In subsequent y ears, annual adjustments to the producer’s production history will be made based on the national average growth in overall U.S. milk production as estimated by USDA. As required b y the 2014 Farm Bill and specified in the rule, producers will be able to buy additional “buy

up” margin protection coverage in 50 - cent increments, for margins beginning at $4 margin per cwt through $8 per cwt . There is no premium on the $4 per cwt coverage (bey ond the $100 administrative fee); however, dairy producers can purchase a higher coverage b y paying annual premiums, which will guarantee higher margin protection coverage. 1 For these bu y - up levels of coverage, p roducers will also be able to protect from 25 percent up to 90 percent (in 5 - percent increments) of their production history . The pri ce per cwt for the premiums is specified i n the 2014 Farm Bill and in the rule. USDA will calculate the margin using the all - milk price minus the average feed cost, as specified in the 2014 Farm Bill. Pay ments will be made to producers based on the percentage of their production history that they have chosen to protect (25 - 90 percent ) and the level of margin coverage they have selected ($4 to $8 per cwt ). Pay ments are made when margins fall below $4 per cwt (or below the selected level of coverage if a producer has selected a margin level above $4 per cwt ) for two consecutive statuto rily - paired months. The MPP - Dairy pay ment will be calculated by multiplying the difference between the coverage level threshold selected b y the dairy operation and the average actual dairy production margin for the applicable 2 - month period by the coverag e percentage (25 - 90 percent of production) selected b y the participating dairy operation and multiplying the result by the annual production history of the dairy

operation divided by

6 (to obtain the two - month production history). Benefits triggered under MPP - Dairy are not subject to average a d justed gross i ncome (AGI) limitations that apply to other FSA and CCC programs. An y increase in participation in MPP - D airy for large producers compared to MILC program participation due to AGI limits is likely to be offset by reduced participation by

small producers 1 For a 700 cow

dairy producing 15 million pounds of milk per year, selecting $7 per cw t coverage for 90 percent of their production base w ould cost $110 ,000 . Coverage at the $8 per cw t level would cost nearly $150 ,000 .5

unwilling to pay

the $100 administrative fee. Producers must have milk marketings at the time of program sign - up but there is no production limit for eligibility , although premiums are higher for production over 4 million pounds per year. In general, all U.S. dairy producers are eligible to participate in MPP - D airy ; however, producers enrolling in the MPP - D airy cannot re ceive benefits under the Risk Management Agency (RMA) Li vestock Gross Margin for Dairy (LGM - D airy) program. LGM - D airy is most beneficial when margins are falling, but it provides little benefit once margins have reached a low point and stabilize d . LGM - D a iry has about 500 active policies currently . T he largest LGM - D airy participation was in 2011 , when 1,224 policies were active. By contrast , over 35,000 operations participated in the MILC program in 2013. V. ADDITIONAL DETAILS ON DPDP DPDP is intended to remove dairy products from the commercial market to improve margins for milk producers. As specified in the 2014 Farm Bill, the products cannot be stored by USDA, but must be immediately distributed to public and private nonprofit organizations that provi de food to low income individuals. The Secretary is required to operate DPDP within 120 day s after the MPP - Dairy becomes operational. USDA has made the discretionary

decision to implement DPDP at the same time as MPP - D airy . Purchases must begin when the milk producer margin, as measured under MPP - D airy , fall s below $4 per cwt for the 2 prior months. Purchases continue until the margin recovers to above $4 per cwt , or for 3 months , whichever is shorter . Purchases terminate after 3 months even if mar gins are still below $4 per cwt, but can be activated again after a new 2 prior month period of margins are below $4 per cwt. The purchases also terminate if domestic cheddar cheese or nonfat dry milk prices exceed world prices by certain percentages spec ified in the 2014 Farm Bill . As specified in the 2014 Farm Bill , public and private nonprofit organizations will be consulted as to what dairy products they require for their feeding programs. USDA will make purchases of required items at market prices u sing CCC funds. Steps will be taken to ensure that the dairy

products reach the intended recipients and that offsets of commercial sales are minimized using existing USDA Food and Nutrition Service ( FNS ) procedures and regulations . Resale of donated dairy products is prohibited. FNS regulations in 7 CFR 250.13(d)(1) provide that d onated foods “ be distributed only to recipient agencies and individual recipients eligible to receive them ” under applicable program regulations . FNS regulations in 7 CFR 250.13(a)(1)(ii) provide that donated foods “not be sold, exchanged or otherwise disposed of without the approval of the Department.” Any losses of donated foods resulting from improper distribution or use will be subject to the requirements of 7 CF R part 250 and the instruction and guidance provided in FNS Instruction 410 - 1 , Rev 2 “ Claims for L osses of Donated Foods and Related Administrative Losses

—Procedures for the State Distributing Agency , ” and in FNS Instruction 420 - 1 , “ Managing Agency

Debts .”6

V I . IMPACTS

– COSTS , BENEFITS AND TRANSFERS Based on the FY 2015 President’s Budget Midsession Review (MSR) , gross program expenditures (non - stochastic) would average $ 1.8 million per y ear for the life of the MPP D airy and DPDP programs. Under this sce nario, if the MPP - D in 2015 were to have a similar participation rate as MIL C in 2013, about 75 percent of the expected 4 3 ,000 licensed dairy

operations would participate at the minimum coverage level at $4 per cwt and their administrative fees would generate $3. 1 million per y ear . Those administrative fees alone would more than offset program costs ( see Table 1, 2015 MSR Scenario) . Table 1 . Estimated Transfers ($ millions) and Underlying Inputs

When stochastic modeling is used (i.e. variation s around milk and feed ingredient price means are a ssum ed) , higher program expenditures are generated . 2 ( See Table 1) Past 2 Variation around the mean all - milk price and feed ingredient prices w as calculated for the previous 10 years. This variation was then applied, after adjusting for the increase in means to keep the variance and mean values Base FY 2015 FY 2016 FY 2017 FY 2018 Total FY 15 - 18 Annual Average Licensed Dairy Operations 45,082 43,730 42,418 41,145 39,911 Milk Production Base (Billion lbs) 202 207 213 220 224 Scenario Using (2015 MSR) USDA Gross MPP - D + DPDP Outlays - 2.0 2.0 3.0 7.0 1.8 USDA MPP - D Income 3.3 3.2 3.1 3.0 13 3.1 USDA Net MPP - D + DPDP Expenditures (3) (1) (1) 0 (6) (1.4) Stochastic Scenario: USDA MPP - D Outlays 100 175 175 185 635 159 USDA MPP - D Income 87 91 93 95 366 92 USDA Net MPP - D Expenditures 13 84 82 90 269 67 USDA DPDP Outlays 30 30 30 30 120 30 USDA Net MPP - D + DPDP Expenditures 43 114 112 120 389 977

fluctuations in milk prices, feed costs and margins can b e seen in Figure 1. Under this scenario, i t is assumed that 75 percent of dairy operations participate in MPP - Dairy , similar to the Milk Income L oss Contract Program (MILC) participation rate, and half of total dairy

operations buy

supplemental coverage (that is, above the $4 per hundredweight (cwt) margin level) and those buying higher coverage insure half of their eligible milk production base. The participation rates were based on discussions with University dairy specialists from Illinois, Michigan, Minnesota, New York, Ohio and Wisconsin. Preliminary

survey results released b y the University of Minnesota indicate that between 60 percent and 75 percent of dairy operations may participate in MPP - Dairy and between 42 percent and 53 percent of total pro ducers may buy coverage above $4 per cwt. The 2014 Farm Bill repeals the MIL C program effective September 1, 2014 or upon implementation of the MPP - Dairy program, whichever is earlier. ( MPP - D airy premiums for 2014 and 2015 are discounted b y 25 percent for the first 4 million pounds of base.) Stochastic MPP - D airy program cost projections range between $100 and $ 185 million per ye ar , while premiums and fees paid by dairy operators range between $87 million and $95 million over the life of the MPP - Dairy (20 15 - 2018). Net transfers to dairy operations are expected to match the average net MPP - Dairy payout of about $67 million per year or almost $270 million for the four ye ars of the program. Meanwhile, USDA purchases of milk products under the DPDP for distri bution to low - income food recipients is expected to cost an average $30 million per year , with the program expected to trigger once every three ye ars, for the time period of the program. Food aid recipient benefits are expected to equal the DPDP outlay s of $30 million per y ear or $120 million for the total program. N et program expenditure s for MPP - D and DPDP range from approximately $ 43 million to $120 million per y ear or $389 million through 2018 . The expected transfers projected with the non - stochastic approach and shown above we re calculated using an assumption of conditions used for the 2015 President’s Budget, which reflects a very

attractive margin period for dairy operations. If the program had been in effect for a year such as 2012 , costs would have been much different (recall Figure 1) . In that ye ar, f

eed costs were high and milk prices were low. If no producers had bought supplemental coverage , and 75 percent of operations participated in the program at the mi nimum ($4 per cwt) coverage level , expenditures for a ye ar such as 2012 would have been $350 million (see T able 2 , line 3 ) and fees paid by dairy operations would have been about $4 million . Under 2012 conditions, i f 2 5 percent of operations participate in the program at the minimum ($4 per cwt) coverage level , and half of the dairy operations bought coverage at the $6 per hundredweight level and covered half of their milk production base , expenditures would have gone up to $ 79 0 million in that y ear, whi le fees and premiums paid by dairy operations would have been about $50 million (see Table 2 , line 4) . proportional, to the projected all - milk prices and feed ingredient prices for the MPP - Dairy program period.8

As a worst case scenario , if all operations had signed up for the program at the $8 per cwt coverage level in 2012 and covered 90 percent of their milk production base , expenditures for that year could have reached $4. 6 billion , with about $1.75 billion paid in fees and premiums by

dairy operations (see Table 2 , line 5) . If the program had been in effect during 2009 , expenditures would have been eve n higher , as can be seen in the T able 2 below in lines 6 through 8 . T able 2 - Examples of MPP - D airy Expenditures, Fees and Premiums Under Various Assumptions , Using Historic Data Estimated MPP - Dairy cost per ye ar $ million Fees and

Premiums per year $ million Assumptions 1. 2015 MSR 1.8 3. 1 7 5 % of operations cover at $4 level 2. Stochastic Estimates 100 to 185 87 to 95 25% of operations cover at $4 level , 50% cover > $4 per cwt on 50% of base 3. 2012 $4 per cwt coverage 350 4 7 5% of operations cover at $4 level 4. 2012 $6 per cwt coverage 790 50 25% of operations cover at $4 level , 50% cover $6 per cwt on 50% of base 5. 2012 $8 per cwt coverage 4,600 1,75 0 100% of operations cover $8 per cwt on 90% of base production 6. 2009 $4 per cwt coverage 565 5 7 5% of operations cover at $4 level 7. 2009 $6 per cwt coverage 1,200 50 25% of operations cover at $4 level , 50% cover $6 per cwt on 50% of base 8. 2009 $8 per cwt coverage 5,730 1,750 100% of operations cover $8 per cwt on 90% of base production The estimates in line 1 of Table 2 represent the assumptions used in the President’s budget . T he stochastic model is centered on those conditions , but it also include s the variability contributed by

y ears such as 2012 and 2009. This added variability results in the higher cost estimates seen in Table 2, line 2 compared to Table 2, line 1. Nearl y all of the impacts estimated in this analy sis are transfers between the federal government and dairy

farmers or from the federal government to low - income individuals.9

Although these transfers create incentives that very likel y change the way

society uses its resources, we lack data with which to estimate the resulting social costs or benefits. VII. AL TERNATIVES CONSIDERED AND ASSOCIATED IMPACTS The primary

alternative considered was the timing of producer signup relative to the start of the program ye ar. (The start of the program y ear is the start of the coverage period.) Options included holding signup at the beginning of the program ye ar, and either 6 months or 3 months in advance of the program ye ar. The first option -- choosing coverage while in the coverage period -- was viewed as akin to allowing a home owner to buy fire insurance while the house is on fire , a significant adverse selection issue . This option would allow dairy operations to sign - up for maximum coverage when low margins were projected and not sign - up at all if projections were for a high margin y ear. As a result, this option was not chosen because it would greatly increase program costs during low margin periods , and have an adverse effect on sign up in high - margin years, limit ing fee and premium income . While the second option

— enrolling 6 months in adv ance of the program year -- would allow plenty of time for producers to consider coverage levels, unpublished survey results obtained from John Newton (Universit y of Illinois) and Mark Stephenson (University of Wisconsin) indicate that producers are reluctant to sign up for coverage so far in advance of the covered period. If producers are not willing to participate in the program, it will not provide the desired safety net. The Newton/Stephenson s urvey results indicated that producers were comfortable with a 90 day advance signup, which would alleviate much of the adverse selection problem while not discouraging dairy operations from participating in the program. Regardless, expected margins over the 2014 - 2024 periods

—irrespective of the signup window

— are high enough that pay ments would be negligible. These issues will arise if markets move unexpectedly to a lower margin period. The adverse selection problem is discussed in the references at the end of the CBA. VIII. SUMMARY OF EXPECTED IMPACTS Allowing variation in milk prices and feed ingredient costs around their means in a stochastic model generates estimates of $100 to $185 million per y ear in MPP - D airy pay ments to dairy

operations, $30 million per y ear for DPDP purchases , and collection of $ 87 to $95 m illion per y ear in fees and premiums paid by dairy operations for program participation. For the four - year life of the MPP - D airy and DPDP progr am s , cumulative net expenditures through 2018 are expected to total $389 million . Cumulative net MPP - D airy pay m ents to dairy

producers are expected to total almost $ 270 million , while benefits to food aid recipients are expected to be about $30 million per y ear for a total of $120 million. Program pay

ments would be much larger if dairy operations face conditions similar to 2009 or 2012. In that situation , MPP - D airy pay ments could reach as high as $ 4 to 6 billion per ye ar , DPDP costs could be $100 to $200 million , with fees and premiums collect ed a s high a s $1.75 billion.10

References: Newton, J., C.S. Thraen, and M. Bozic. 2013a. “Actuariall y Fair or Foul? Asy mmetric In formation Problems in Dairy Margin Insurance . ” Paper presented at NCC - 134 Conference on Applied Commodity Price Anal ys is, Forecasting and Market Risk Management, St Louis , MO, April 22 - 23 , 20 13 .

--- . 2013b. “Whither Dairy Policy ? Evaluating Expected Government Outlay s and Distributional Impacts of Alternative 2013 Farm Bill Dairy Title Proposals.” Paper presented at AAEA Annual Meeting, Washington , D , C , August 4 - 6, 2013 .