Dairy Provisions in the 2014 Farm Bill (P.L. 113-79)
Released: 2014-09-15T00:00:00

Introduction

After several years of growing producer discontent with the apparent ineffectiveness of the federal dairy price support program and growing concerns about rapidly escalating dairy feed costs, the U.S. dairy industry advocated for substantial changes in the nature of federal dairy support. As a result, the 2014 farm bill (the Agricultural Act of 2014; P.L. 113-79 ), which was signed into law on February 7, 2014, makes significant changes to the structure of U.S. dairy support programs including the elimination of several major price and income support program provisions from the 2008 farm bill (the Food, Conservation, and Energy Act of 2008, P.L. 110-246 ), the extension of several smaller dairy programs, and the addition of two new programs.

This report describes the major dairy provisions contained in the 2014 farm bill as well as Congressional Budget Office (CBO) cost projections of historical program outlays compared with outlays under the new dairy programs. The report also includes a discussion of potential issues related to the new dairy policies. Finally, a table at the end of this report ( Table A-1 ) provides a side-by-side comparison of dairy provisions from the 2008 and 2014 farm bills.

Reaching a final compromise on U.S. dairy policy, as contained in the 2014 farm bill, was a long and arduous task involving considerable debate over what the nature and role of federal support programs should be. The following section provides background on the shift of federal support from dairy product prices to the dairy operating margin.

Origins of the New Dairy Policy

Federal dairy price supports were first established by federal law in 1949 and modified in subsequent legislation including the 2008 farm bill ( P.L. 110-246 ), which established the Dairy Product Price Support Program (DPPSP). DPPSP indirectly supported the farm price of fluid milk at $9.90 per hundred lbs. (i.e., hundredweight or cwt.) through government purchases of dairy products from dairy processors at statutorily set prices. The program was countercyclical, in that government purchases occurred when product prices were low, and ceased as product prices rose above support levels. However, by the mid-1990s, the annual farm price of milk had trended higher, albeit subject to an increasingly volatile pattern ( Figure 1 ), whereas the federal support rate was flat at $9.90 per cwt.

Volatile milk prices made planning more difficult and made dairy producers more vulnerable to unexpected or sustained increases in the cost of feed (the major cost component of dairy production). Milk producers have argued since the early 1990s that support levels had become too low, relative to market prices and costs of production, to provide meaningful support. More recently, milk producers argued that support based strictly on the price of milk failed to account for the sharp escalation of feed costs that has occurred since 2006 ( Figure 2 ).

After the emergence of the U.S. ethanol industry as a major source of corn demand in 2006, coupled with a series of weather-related, below-trend yield years (especially 2010-2012) for the U.S. corn crop, U.S. feed grain markets surged to new price levels by 2012 that were nearly three times above the levels that had persisted during the previous four decades. Rising feed costs are of particular concern to dairy producers because they represent a substantial portion of the cost of milk production—in 2011, feed costs accounted for 80% of operating costs and 54% of total costs of milk production (compared with 71% and 37% shares during the 2000-2004 period).

The combination of volatile milk market prices rising well beyond support levels coupled with rapidly rising feed costs contributed to a shifting of focus away from price supports and towards protecting or guaranteeing some portion of the margin between milk prices and feed costs.

This refocusing of policy interest on the dairy operating margin was formalized by a proposed dairy margin protection program published in June 2010 by the National Milk Producers Federation (NMPF) called the Foundation for the Future (FTF). A version of the FTF was introduced in the 112 th Congress as H.R. 3062 , The Dairy Security Act (DSA), by House Agriculture Committee Ranking Member Collin Peterson on September 23, 2011. Through the legislative process FTF eventually evolved into the new dairy program described in the following sections. An appendix at the end of this report ( Appendix ) provides additional detail on the legislative debate behind the new dairy policy.

Dairy Provisions in the 2014 Farm Bill

The 2014 farm bill repealed several previously existing dairy programs, extended others, added some new programs, and was silent on several existing dairy programs that derive their authority from outside of the farm bill. Each of these aspects is briefly summarized below.

Programs Repealed

The three major price and income support programs from the 2008 farm bill are eliminated. These include the following.

The Dairy Product Price Support Program (DPPSP) is repealed immediately. DPPSP mandated that USDA directly support the price of cheese, nonfat dry milk, and butter through acquisitions at statutorily set minimum purchase prices in order to support the farm price of milk at $9.90 per hundred lbs. or hundred-weight (cwt.). The program also included USDA resale of acquired dairy products under certain price and stock-volume conditions. Some variation of a dairy price support program has been in effect since the Agricultural Act of 1949 first required USDA to support the farm price of milk. The Milk Income Loss Contract (MILC) program is temporarily extended until September 1, 2014, or until the implementation date of the new margin program (described below), whichever comes earlier and after which it is permanently repealed. MILC is a counter-cyclical payment program first authorized in the 2002 farm bill ( P.L. 107-171 ) that makes payments available on up to 2.985 million lbs. of milk whenever the monthly Boston Class I price of fluid milk falls below a threshold of $16.94/cwt. adjusted for feed cost changes. The Dairy Export Incentives Program (DEIP) , originally authorized by the 1985 farm bill ( P.L. 99-198 ), is repealed immediately. DEIP provided cash bonuses to U.S. dairy exporters when certain international dairy market conditions were met.

The Federal Milk Marketing Order Review Commission —established by the 2008 farm bill (§1509) to conduct a comprehensive review and evaluation of FMMO and non-FMMO systems—is also repealed effective immediately. The review commission-which was subject to annual funding appropriations—was never funded.

Programs Extended

Certain other programs that were reauthorized by the expired 2008 farm bill ( P.L. 110-246 ) are extended through the life of the 2014 farm bill—that is, FY2018. These include the following.

The Dairy Forward Pricing Program allows farmers to voluntarily enter into forward price contracts with milk handlers for pooled milk used for manufactured products (Classes II, III, and IV) under Federal Milk Marketing Orders (FMMOs). The program allows regulated handlers to pay farmers in accordance with the terms of a forward contract instead of paying the minimum FMMO blend price for pooled milk. The prices paid by milk handlers under the contracts are deemed to satisfy the minimum price requirements of FMMOs. The 2014 farm bill allows for new contracts until September 30, 2018, but no contract can extend beyond September 30, 2021. The Dairy Indemnity Payment Program (DIPP) makes payments to dairy producers when a public regulatory agency directs them to remove their raw milk from the commercial market because it has been contaminated by pesticides, nuclear radiation or fallout, or toxic substances and chemical residues other than pesticides through no fault of their own. Payments also are made to manufacturers of dairy products, but only for products removed from the market because of pesticide contamination. The Dairy Promotion and Research Program is a generic dairy product promotion, research, and nutrition education program, funded by a mandatory 15¢/cwt. assessment on milk produced and marketed in the 48 contiguous states. Importers in all 50 states, the District of Columbia, and Puerto Rico must also pay an assessment rate of 7.5¢/cwt. of the milk equivalent in imported dairy products. USDA issues regulations on the time and method of importer payments.

Continuation of Existing Programs Under Non-Farm-Bill Authority

Certain dairy programs derive their operating authority outside of the farm bill and simply continue to operate independent of the enactment of the 2014 farm bill. These include, but are not limited to the following.

Federal Milk Marketing Orders (FMMOs) , which exist under permanent authority, established by federal law in the Agricultural Marketing Agreement Act of 1937, are 10 geographically defined fluid milk marketing areas. The FMMO system regulates milk marketing across state lines but within these 10 explicitly defined and geographically aligned multi-state regions. Within each FMMO, dairy processors or handlers (i.e., milk buyers) are required to pay a minimum price for farm milk depending on its end use. Dairy Import Tariff Rate Quotas (TRQs) are a system of product-specific import quotas—with low in-quota tariffs and high, often-prohibitive above-quota tariffs—designed to protect higher-priced domestic dairy products by limiting the importation of lower-priced foreign dairy products. Dairy TRQs are part of the Harmonized Tariff Schedule of the United States and are unaffected by changes made in the 2014 farm bill. The Dairy Price Support Program is authorized under "permanent farm law" contained in the 1949 Agricultural Act, but is suspended by periodic passage of new farm legislation. Under permanent law, USDA is required to purchase manufactured milk and butterfat products in sufficient quantities to raise demand in order to raise the farm price of fluid milk to the equivalency of 75% to 90% of a 1910-1914 parity price index—which would result in milk support prices near $40/cwt. double the average all-milk farm price of $20/cwt. during 2013. Reversion to permanent dairy law has been referred to as the "milk price cliff." The Dairy Product Mandatory Reporting Program requires manufacturers to report to USDA the price, quantity, and moisture content of dairy products sold. Quarterly audits are to be undertaken to ensure compatibility between submitted information and related dairy market statistics. The Livestock Gross Margin Insurance for Dairy (LGM -D ) is an ongoing pilot program available for purchase from private insurers through USDA's permanently authorized federal crop insurance program. LGM-D provides protection to dairy producers when feed costs rise or milk prices drop. Gross margin is the market value of milk minus feed costs. LGM-D uses futures prices for corn, soybean meal, and milk to determine the expected gross margin and the actual gross margin. The Fluid Milk Processor Promotion Program , established by the 1990 farm bill ( P.L. 101-624 ) with subsequent reauthorizations, develops and finances generic advertising programs designed to maintain and expand markets and uses for fluid milk products produced in the contiguous 48 states and the District of Columbia. The program is funded through a 20¢/cwt. assessment paid by processors on all milk processed for fluid consumption. The fluid milk order was approved by a referendum among fluid milk processors and became effective December 10, 1993. The program originally required periodic congressional reauthorization; however, the 2002 farm bill gave it permanent authority.

Revival of a Previously Expired Provision

The 2014 farm bill also included a provision (§1410(d)) that removed the expiration dates in U.S. code (7 U.S.C. 7235[a][2]) related to the petition and approval by California dairy producers to designate the state of California as a separate Federal Milk Marketing Order (FMMO) with the potential to use a Class I quota plan to determine individual producer payments. California currently operates its dairy industry under a state marketing order, but in recent years has been considering adopting an FMMO in order to alter its current milk class pricing structure. By removing the expiration dates, the 2014 farm bill actively revives the FMMO option for California's dairy industry.

USDA's Agricultural Marketing Service would still have to receive a formal petition from California's producers and conduct a hearing to collect evidence about the market and hear testimony on desired provisions before California's dairy producers actually decide whether to adopt—via referendum—an FMMO.

New Programs

The 2014 farm bill replaced the repealed price support programs—DPPSP, MILC, and DEIP—with two new support programs that are authorized for the five-year period of the 2014 farm bill, FY2014-FY2018—the Margin Protection Program (MPP) and the Dairy Product Donation Program (DPDP). These two programs are described in the following two sections.

The Margin Protection Program (MPP) for Dairy Producers

MPP Implementation Specifics

USDA was mandated to establish a new margin protection program (MPP) for dairy producers no later than September 1, 2014. Although the dairy provisions of the 2014 farm bill provide important structure and direction concerning the application of the new programs, substantial detail concerning the actual functioning of the new programs is contained in the USDA implementation regulations. The final regulations for both the MPP and DPDP were released on August 29, 2014, and the enrollment period began on September 2, 2014, at which point both new dairy programs became operational.

Defining the Margin

MPP is a voluntary program intended to provide milk producers with protection from low operating margins. A key aspect of the MPP is creating a timely and transparent measure of an average dairy-production operating margin that will be useful across all dairy production regions. For MPP purposes, the operating margin is defined as the difference between the farm-level price of a hundred lbs. of milk—referred to as hundredweight or cwt. of milk—and the cost of an average feed ration necessary to produce a cwt. of milk. To construct this margin, MPP will use USDA-reported monthly national average price data for all classes of milk (called the all-milk price) and for the three principal feeds that represent the bulk of purchased feeds in dairy rations (corn, soybean meal, and alfalfa hay) to construct an estimate of the operating margin (see box below).

MPP Eligibility

All U.S. dairy producers are eligible to participate in the margin protection program. If a dairy operation consists of more than one dairy producer, all of the dairy producers shall be treated as a single dairy producer for purposes of participation in the margin protection program. If a dairy producer operates two or more dairy operations, each dairy operation shall separately register to participate in the margin protection program. Participating dairy producers are prohibited from reconstituting a dairy operation for the purpose of capturing payments under MPP.

The dairy operation must have commercial milk sales in the United States (or its territories) at the time of enrollment. Each participating dairy producer must be "actively engaged" in the dairy farm business. Participating dairy operations must certify compliance with two conservation provisions—highly erodible land conservation and wetlands conservation.

Signing Up for Margin Protection

The initial enrollment period of September 2, 2014, to November 28, 2014, covers, separately, both the last four months of the 2014 program year and the full 2015 program year. In future years, the registration period will run from July 1 through September 30. To participate in MPP for any given year, each dairy operation must sign up and pay an annual registration fee of $100. The administrative fee is due by the end of the enrollment period. Failure to pay the fee precludes the operation from receiving any payments under the program until any outstanding fee has been paid.

Participation in MPP is voluntary. However, once a dairy operation is enrolled in the MPP, it is in the program through 2018 unless there is some change in ownership, including both who is the owner and what share of the operation they own. The operation may defer enrolling until a later year, but once enrolled it must participate for each remaining year through 2018—the exception would be if the producer retires or dies, or the dairy operation is dissolved. As a result, a participating dairy operation is committed to paying at least the minimum $100 annual administration fee for each year in the program.

At the initial sign-up, each dairy operation must complete Form CCC-781 to establish its identity, eligibility, and production history (see box below).

Choosing a Margin Protection Coverage Level

Once CCC-781 is submitted and approved, and the $100 administration fee has been paid, the dairy operation is considered enrolled in the $4/cwt. margin protection level with a 90% coverage level—referred to as Catastrophic Coverage. This is the minimum (or default) protection level for a dairy operation. Dairy producers may, on an annual basis, change their MPP coverage level (see box below). Every participating dairy operation has the annual choice of selecting both higher margin protection levels up to $8/cwt. and PH coverage in a range from 25% to 90%. Higher coverage levels must be paid for with premiums (described below) that vary based on the CPH and producer-selected margin threshold.

If producers want to register for a higher coverage level, they must do so during the enrollment period using Form CCC-782. Failure to successfully submit CCC-782 during the enrollment period results in margin protection equal to the default Catastrophic Coverage of a $4/cwt. margin threshold at 90% PH coverage.

No Cap or Limit on Participation

Unlike the MILC program, where payments each fiscal year were limited to the first 2.985 million lbs. of milk for producers with an adjusted gross income (AGI) under $500,000, participation in the MPP has no explicit cap related to a producer's AGI or the size of a dairy operation—in other words, there is no production or dollar payment limitation associated with the dairy margin program. Instead, margin protection payments would be limited by how much of a producer's historical milk marketings are covered by the program (i.e., the CPH).

Producers who sign up for MPP are ineligible to sign up for the Livestock Gross Margin for Dairy Cattle program (LGM-D) offered by USDA's Risk Management Agency (RMA). Producers may complete pre-existing LGM-D contracts at the time of their first enrollment; however, they will not be allowed to receive an MPP payment until their LGM-D contract is completed.

Timing of Payments

USDA is instructed to determine the ADPM as soon as possible after the necessary prices are reported in order to expedite the payments. However, NASS full-month price estimates—not preliminary estimates—must be used for both months in calculating the two-month average. As a result, the two-month average margin calculation will not be available until a full month after the two-month period has expired. For example, the January-February ADPM will not be available until the end of March when USDA's Agricultural Prices report is issued with full-month, farm-prices-received estimates for February. Thus, if an MPP payment is triggered by the January-February ADPM, the payment will not begin until April.

If a producer is in arrears on payment of administration fees and/or premiums for higher coverage levels (described below), then no payment will be made.

MPP Payments

Whenever the calculated Actual Dairy Production Margin (ADPM) falls below the selected MPP margin threshold for a consecutive two-month period, a payment will be made on the selected coverage-level portion of a participating producer's PH—referred to as the covered production history or CPH. The MPP payment rate per cwt . is equal to the difference between the selected MPP threshold and the average ADPM as calculated for that two-month period.

Each two-month period is assigned an equal share of a participating producer's CPH—since there are six periods, each share will be equal to CPH/6. To determine the total MPP payment for a specific two-month period, the MPP payment rate times the coverage percent is applied to the producer's CPH, but prorated to a two-month period (i.e., CPH divided by six).

MPP payments will continue as long as the ADPM is less than the selected MPP margin threshold for consecutive two-month periods. MPP payments cease when the ADPM reaches or exceeds the selected MPP margin threshold for a two-month period.

Likelihood of an MPP Payment

The historical frequency of the average margin levels ( Table 1 ) provides information concerning the likelihood of future payments at different margin thresholds. Using ADPM estimates for successive two-month periods since January 2000, the ADPM has been below $4/cwt. in about 7% of the two-month periods and above $8/cwt. in 58% of the periods. Margins within the $6/cwt. to $8/cwt. range occurred in about 30% of the two-month periods. During this same period (January 2000 to March 2014), the national average ADPM was $8.61/cwt. Thus, the maximum MPP coverage level of $8.00/cwt. represents 93% of the national average ADPM.

See Figure 3 for a depiction of how often the monthly margin would have fallen below the $8.00/cwt., $6.00/cwt., and $4.00/cwt. thresholds since January 2000.

MPP Premiums

Participating producers must pay premiums that start at the $4.50/cwt. margin protection level and rise with higher coverage levels up to the $8.00/cwt. maximum. No premium is charged for the minimum $4.00/cwt. margin protection. The premium schedule also differentiates based on the level of covered production history (CPH). A substantially lower premium schedule is used for the first 4 million lbs. of CPH ( Table 2 ). In addition, a special 25% discount is available for premiums on the first 4 million pounds of CPH during each of calendar 2014 and 2015.

The premium rate differential based on APH is significant because, in 2011, approximately 88% of U.S. dairy farms had annual milk production of 4 million lbs. or less, and they produced about 25% of total U.S. milk volume.

Annual premiums are calculated as the product of the premium rate per cwt. (from Table 2 ) and the coverage production history (CPH).

Thus, the premium rate varies with the volume of covered production history (CPH) of the participating dairy operation (i.e., whether it has greater or less than 4 million lbs. of CPH), and the level of margin protection selected (from $4.00/cwt. to $8.00/cwt. in $0.50/cwt. increments).

Premium Calculation Method

The CPH is split into two components—the first 4 million lbs., and the remaining CPH above 4 million lbs. Dairy producers with a CPH in excess of 4 million lbs. would be charged the lower premium rate on the first 4 million lbs. of CPH and the higher premium rate on the amounts of CPH above that.

Premium payments may be paid in full by the end of the enrollment period, or they may be paid in tranches, with the first 25% of the total premium paid no later than February 1 of the relevant year, with the remaining premium balance paid no later than June 1 of the relevant year. The 2014 farm bill states that a participating dairy operation that fails to pay its administrative fee and/or premiums remains legally obligated for such charges, and may not receive any payments under MPP until such charges are fully paid.

Margin Coverage Distinction: $6.50/cwt. vs. $7.00/cwt.

Separately, it is worth noting that the premium structure strongly encourages participation at the $6.50/cwt. level for CPH greater than 4 million lbs. To raise the margin coverage level an additional $0.50/cwt. (from $6.50/cwt. to $7.00/cwt.), an additional $0.54/cwt. of premium must be paid (i.e., $0.83/cwt. - $0.29/cwt.). The total premium cost for insuring 70% of the APH of 120,000 cwt. at a margin of $7.00/cwt. for the same hypothetical scenario would be $40,120—more than double the premium cost of $16,360 for $6.50/cwt. margin protection.

The Dairy Product Donation Program (DPDP)

According to the 2014 farm bill, USDA shall establish and administer a Dairy Product Donation Program (DPDP) to (1) address low dairy operating margins, and (2) provide nutrition assistance to individuals in low-income groups.

A result from the dairy policy debate that preceded the final 2014 farm bill (see Appendix ) was as follows. It is generally agreed that dairy operating margins are low when the equilibrium between milk supply and demand is out of balance with supply exceeding demand. The original proponents of the dairy margin program had argued that an additional policy feature—a supply disincentive component—should be added that would work to reduce supply and bring the milk supply-demand equation back into balance at a higher margin. Opponents of this concept argued that the government should not manage supplies, but should instead work to enhance demand to rebalance the milk supply and demand. This latter argument won out in conference when conferees proposed an entirely new "demand enhancing" program—DPDP.

DPDP Program Activities

USDA must announce and undertake DPDP activities whenever the actual dairy production margin (ADPM) is $4.00/cwt. or less for each of the immediately preceding 2 months. When DPDP has been triggered, USDA must immediately purchase dairy products, at prevailing market prices, until such time as one of the termination conditions (described below) is met.

USDA must consult with public and private nonprofit organizations—organized to feed low-income populations—in order to determine the types and quantities of dairy products to purchase under the DPDP. USDA must distribute, not store, the purchased dairy products. USDA is directed to use the funds, facilities, and authorities of the Commodity Credit Corporation (CCC) to implement and administer the DPDP.

DPDP Distribution of Purchases

The 2014 farm bill directs USDA to distribute, but not store, the dairy products purchased under DPDP so as to encourage greater domestic consumption by diverting them to persons in low-income groups as determined by USDA. USDA shall use public and private nonprofit organizations for distribution of DPDP dairy products to provide, without cost or waste, nutrition assistance to individuals in low-income groups. DPDP purchases are expected to be made in package sizes suitable for immediate household use, to best accommodate the immediate distribution requirement of the 2014 farm bill. Any organization receiving dairy products under the DPDP may not sell the products back to commercial markets.

DPDP Program Termination Conditions

USDA must terminate its DPDP activities whenever any one of the following conditions occurs.

1. After three consecutive months of purchases, the DPDP purchases are required to cease, even if the margin remains < $4.00/cwt. , until there have been at least two more consecutive months of margins below $4.00/cwt. 2. If the margin is > $4.00/cwt. for the preceding month, DPDP purchase activities must cease until the original requirements (i.e., margin < $4.00/cwt. for two consecutive months) are met again. 3. USDA will stop making DPDP purchases, even if the margin remains < $4.00/cwt. , if the U.S. price for dairy products is significantly above world market prices. In particular: a. USDA will stop making DPDP purchases, when $3.00/cwt. < margin < $4.00/cwt. for the preceding month and either: i. the U.S. cheddar cheese price > 105% of world price, or ii. the U.S. non-fat dry milk price > 105% of world price; or b. USDA will stop making DPDP purchases, when the margin < $3.00/cwt. for the preceding month and either: i. the U.S. cheddar cheese price > 107% of world price, or ii. the U.S. non-fat dry milk price > 107% of world price.

The 2014 farm bill gives USDA the latitude to determine which domestic and international prices of cheddar cheese and non-fat skim milk powder will be used to assess the DPDP termination conditions. If DPDP purchases are suspended due to domestic prices being sufficiently above world prices, margins would be tracked for the next two months, and purchases could resume after three months if conditions permit.

Budget Outlays: Historical and Projected

USDA outlays for the major dairy support programs have trended downward since the 1980 farm bill period ( Table 3 ). An outlook for strong dairy product prices for the next several years in the CBO May 2013 baseline accounts for the relatively small net outlay projections of $161 million over 5 years (FY2014-FY2018) and $250 million over 10 years (FY2014-FY2023) for the major dairy programs, assuming an extension of dairy policy as it existed under the 2008 farm bill.

According to CBO, replacing current dairy policy with the new dairy programs of the 2014 farm bill will result in projected additional budgetary outlays above baseline over the 5-year (FY2014-FY2018) and 10-year (FY2014-FY2023) periods of $241 million and $912 million, respectively, under the Agricultural Act of 2014 ( P.L. 113-79 ). In other words, the total 5-year and 10-year outlays projected by CBO under the new dairy programs are $402 million and $1.162 billion, respectively, thus continuing the downward trend in program outlays per farm bill period.

Dairy Issues

Because the MPP and DPDP are new programs that differ notably from previous support programs, several questions have been raised concerning their implementation and potential cost, as well as their effect on U.S. and international dairy markets and consumers. History provides some indications but solid evidence will likely only emerge with implementation. Some of the more noteworthy related issues are briefly discussed here.

1. Will DPDP Activities Supplement or Offset Commercial Sales?

As Bozic et al (2014) have noted:

The fundamental question is whether or not the end-users of donated products would have purchased them on commercial markets anyway. If these donations are strictly additive to total dairy usage then the amount of dairy products served in Food Banks or other settings is increased. If the donation displaces commercial purchases that would have been made with other cash resources, then total commercial sales of dairy products would actually decline.

To the extent that these donations are going to programs that have limited resources and continuously unmet needs, it is not unreasonable to speculate that commercial displacement will be minimal.

2. Will MPP Work as a Safety Net? If So, With What Consequences?

Economic analysis indicates that, by focusing on the national average milk operating margin rather than strictly on the price of milk and offering a range of margin protection and coverage choices, U.S. dairy producers, regardless of their geographic location or management style, will be provided with substantial opportunity to manage their milk-production risk environment under the new dairy programs.

Another related, but unanswered question is, if MPP is effective as a safety net, will its subsidized premiums crowd out private sector risk markets?

3. Will Production Incentives Result from MPP and DPDP?

The margin protection program will likely have a risk reduction effect, and the fixed premium structure likely has a significant federal subsidy component embedded in it—although the actual extent of implicit subsidy has yet to be assessed. This combination can be expected to provide some degree of production incentives to participating milk producers.

Overly strong production incentives can disrupt the traditional market signals that lead to reduced milk production via herd culling. Furthermore, MPP provisions could inadvertently result in a policy framework that gives advantage to "lumpy" over "incremental" growth at the farm level as producers may choose to respond by starting new dairy operations at new locations to be able to enroll new milk production in the MPP.

The nature by which DPDP will be implemented and its subsequent effect on dairy markets is unknown at present. Will DPDP act as a catalyst for further milk production by artificially inflating the true underlying demand for dairy products, thus encouraging greater milk production and leading to lower prices and higher program payments down the road?

Unlike early versions of the Dairy Security Act—the precursor to the dairy subtitle contained in the 2014 farm bill—which contained a strong production disincentive component in the form of the proposed Supply Management Program, MPP has only a mild disincentive in the form of its exclusion of new milk production in excess of the national average milk production growth rate. If producers act in unison to expand production beyond normal annual growth rates, even that milk restriction is minimized.

4. Can the MPP Program be Gamed by Participants?

MPP does not follow sound insurance principles—premiums are not set to reflect the risk environment in milk and feed markets but instead are fixed over the life of the farm bill. This fixed premium structure combined with the ability of the producer to annually choose a margin insurance level creates incentives to adversely game the program to one's financial advantage.

Publicly available information on futures contract prices from the Chicago Mercantile Exchange for milk and feed can be used to forecast near-term milk production margins that, in turn, indicate the probability of indemnity payments under various MPP coverage levels. As a result, strong adverse gaming incentives exist for participants in the MPP. Economic analysis suggests that the adverse gaming incentives can be reduced or mitigated by specifying an earlier sign-up date for coverage decisions—for example, 60 to 90 days ahead of each year's program starting date of January 1. The initial enrollment unavoidably falls within this range; however, the enrollment period of July 1 to September 30 for the out years 2016, 2017, and 2018 meets the 90-day threshold.

5. How Will MPP Payments Be Distributed Across Farm Sizes?

Economic analysis suggests that, under the fixed premium structure of the 2014 farm bill—with strong differentiation between premiums on the first 4 million lbs. and on marketings above 4 million lbs.—net expected benefits under MPP will closely align with those under the previous MILC program, but with slightly less skewed results. Farms with fewer than 100 cows would receive approximately 38% of the expected benefits (compared with 39% under MILC), while farms with over 1,000 cows would account for approximately 15% of benefits (compared with 9% under MILC) during low margin periods. Furthermore, the same analysis concluded that, "only when higher coverage levels are deep in-the-money will payments per cwt. be more consistent across farm sizes and result in the distribution of net benefits following closely to the distribution of milk production."

6. What Are the Trade Implications of MPP and DPDP?

The 2014 farm bill dairy provisions made several changes that have profound implications for U.S. and international trade agreements. First and foremost, by repealing the Dairy Product Price Support Program (DPPSP) and the Dairy Export Incentive Program (DEIP), U.S. dairy programs have made a significant step in better complying with its domestic support commitments under the World Trade Organization (WTO).

During the 17-year period from 1995 through 2011 (the most recent year for which notification data is available), the implicit program costs of DPPSP have represented the single largest U.S. domestic support outlay of any single program commodity accounting for $93.5 billion ($5.5 billion annually) or 39% of all U.S. amber box domestic support notifications to the WTO. Thus, the repeal of DPPSP is likely to have a substantial effect in lowering annual U.S. domestic support notifications to the WTO, and keeping U.S. domestic support outlays well below the United States' $19.1 billion ceiling.

It is not yet clear how USDA will notify program outlays under MPP and DPDP—for example, possibly as amber box but exempt under the de minimis exclusion—but current CBO spending projections of about $1.2 billion over 10 years or about $120 million per year pale in comparison with the DPPSP's annual average notification of $5.5 billion. In addition, repeal of DEIP fulfills a general commitment by WTO members to end use of agricultural export subsidies, and brings greater pressure to bear on the European Union, Switzerland, Norway, and the rest of the world to act similarly.

Finally, U.S. dairy TRQs remain in place but are WTO legal as they were included in the original U.S. country schedule of tariffs and quotas that was approved and accepted by all WTO-member countries.

Given the very favorable market conditions for the U.S. dairy sector with near record high milk prices in 2014 coupled with prospects for relatively low feed costs, it is expected that market incentives will dominate producer decision making for the foreseeable future.

Conclusion

The answers to these questions may emerge only slowly. The new MPP and DPDP programs are likely to be implemented during a period of sustained strong milk prices, moderate to weak feed costs, and sustained large margins that, if realized, would minimize the impact of the new dairy programs ( Figure 3 ).

Appendix. Debate Behind the New MPP and DPDP

As mentioned earlier in the text (" Origins of the New Dairy Policy "), a version of the National Milk Producers Federation's (NMPF's) Feed the Future (FTF) proposal was introduced in the 112 th Congress as H.R. 3062 , The Dairy Security Act (DSA), by House Agriculture Committee Ranking Member Collin Peterson on September 23, 2011. A modified version of DSA appeared as "Subtitle D—Dairy," in Title I of both the House-reported ( H.R. 6083 ) and Senate-passed ( S. 3240 ) farm bills of the 112 th Congress.

Dairy Policy in the 113 th Congress

In the 113 th Congress, both the Senate and the House passed different farm bills ( S. 954 , passed by the Senate on June 10, 2013, and H.R. 2642 , passed by the House on July 11, 2013) that proposed replacing the traditional set of dairy price and income support programs with a new margin-based income support program—called the Dairy Production Margin Protection Program (DPMPP) under S. 954 , and the Dairy Producer Margin Insurance Program (DPMIP) under H.R. 2642 . The two proposed margin programs were similar in many respects; however, the Senate bill (but not the House bill) also included an accompanying market stabilization program—the Dairy Market Stabilization Program (DMSP), which, under certain conditions, would reduce payments to participating producers for their milk marketings when the margin falls below proposed statutory thresholds.

Early versions of the House farm bill in the 113 th Congress also included the DMSP as part of new dairy policy. However, during the House Agriculture Committee's markup of its first version of the 2013 farm bill ( H.R. 1947 ) in May 2013, an amendment ( H.Amdt. 228 ) was introduced by Representatives Goodlatte and Scott that proposed removing the DMSP from H.R. 1947 and making some minor adjustments to DPMPP. The Goodlatte-Scott amendment (GSA) was defeated in committee by a vote of 28 to 26. The amendment was reintroduced during the House floor debate of H.R. 1947 and passed by a vote of 291-135 (May 15, 2013). However, the full House voted to reject the amended farm bill (195-234) on June 20, 2013. On July 11, 2013, the full House passed (by a vote of 216-208) a second version of the 2013 farm bill ( H.R. 2642 ) which included the Goodlatte-Scott amendment—thus removing DMSP and replacing DPMPP with DPMIP.

Conference Committee Resolves Differences

The differences between the Senate- and House-passed farm bills were resolved when conferees reported a conference agreement on January 27, 2014 (the Agricultural Act of 2014, H.R. 2642 / H.Rept. 113-333 ). The dairy supply management debate was resolved when the conferees included an entirely new program—the Dairy Product Distribution Program (DPDP)—focused on demand enhancement, rather than supply control. Prior to the conference, the dairy debate had been limited to whether a supply management component should be included in the final bill—the concept of a DPDP did not emerge until conference. The full House and Senate approved the conference agreement on January 29 and February 4, respectively, and the President signed the measure into law on February 7, 2014 ( P.L. 113-79 ).