Dairy Policy Proposals in the Next Farm Bill
Released: 2013-10-22T00:00:00

Introduction

Many of the farm commodity programs are set to expire with the extended 2008 farm bill (the Food, Conservation, and Energy Act of 2008, P.L. 110-246 ) in 2013. In anticipation, the 113 th Congress has been considering an omnibus farm bill that would establish the direction of U.S. agricultural policy for the next five years. On June 10, 2013, the full Senate approved its version of the bill ( S. 954 , the Agriculture Reform, Food and Jobs Act of 2013). On July 11, 2013, the House passed its version of the bill ( H.R. 2642 , the Federal Agriculture Reform and Risk Management Act of 2013).

Both bills proposed replacing existing U.S. dairy price and income support programs with a new margin-based income support program. The Senate bill (but not the House bill) also includes an accompanying market stabilization program. 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 to H.R. 1947 ) was introduced by Representatives Goodlatte and Scott that proposed removing the DMSP from H.R. 1947 and making some minor adjustments to DPMPP. The GSA was defeated by a vote of 28 to 26. However, the amendment was reintroduced during the House floor debate of H.R. 1947 and passed by a vote of 291-135 (May 15, 2013). The full House voted to reject the amended bill (195-234) on June 20, 2013. However, on July 11, 2013, the full House passed (216-208) a second version of the 2013 farm bill ( H.R. 2642 ) that contained the Goodlatte-Scott amendment.

This report first briefly describes existing U.S. dairy programs. Then the dairy programs proposed in the 113 th Congress's Senate- and House-passed farm bills are discussed and compared. Several examples of how the proposed dairy programs might operate for an individual dairy operation are provided in the text.

The report also includes Congressional Budget Office (CBO) cost projections of historical program outlays compared with the proposed new dairy programs under both bills, and a summary of academic analyses of potential market effects of the proposed dairy policies. Finally, the report includes an appendix that discusses disagreement over the market stabilization component of proposed new dairy policy and compares it with previous forms of supply management intervention in the U.S. dairy sector.

One-Year Farm Bill Extension

Many provisions of the 2008 farm bill were originally set to expire at the end of FY2012; however, the American Taxpayer Relief Act of 2012 (ATRA; P.L. 112-240 )—signed into law by President Obama on January 2, 2013—extended the 2008 farm bill for one additional year, through FY2013, or, in the case of the farm commodity programs that are on a different calendar, through crop year 2013. ATRA's passage avoided what news media and policymakers viewed as a looming "fiscal cliff." ATRA also extended the Milk Income Loss Contract (MILC) program through September 30, 2013, and the Dairy Product Price Support Program (DPPSP) through December 31, 2013.

In addition to avoiding a "fiscal cliff," the ATRA extension of the 2008 farm bill temporarily avoided a reversion to 1949 permanent law and the so-called "milk cliff." Under permanent law, USDA would be compelled to purchase dairy products (milk and butterfat products) so as to support the all-milk price at 75% to 90% of a 1910-1914 parity price index. According to USDA, in May 2013 the all-milk parity price was $51.50 /cwt. At 75% of parity, the USDA milk-equivalent product purchase price of $38.63/cwt. would be nearly double the May average all-milk farm price of $19.70/cwt. A doubling of farm prices would likely lead to a substantial hike in retail prices, thus engendering the term "milk cliff." The potential reversion to permanent law, should current farm law expire without replacement or extension, is seen as an incentive for policymakers to produce new farm legislation, or at a minimum to extend current law.

Current U.S. Dairy Policy

Current federal dairy policy is based on five major programs—the Dairy Product Price Support Program, the Milk Income Loss Contract Program, Federal Milk Marketing Orders, Dairy Import Tariff Rate Quotas, and the Dairy Export Incentive Program—which together are designed to provide price and income support and market stability for dairy producers. In addition, several smaller programs aid the U.S. dairy sector with market promotion, research, price reporting, risk management, and disaster assistance.

Dairy Product Price Support Program (DPPSP)

Established by federal law in 1949 and modified in subsequent legislation (most recently the 2008 farm bill, P.L. 110-246 ), DPPSP indirectly supports the farm price of fluid milk at $9.90 per hundred pounds (i.e., hundredweight or cwt.) through government purchases of dairy products from dairy processors at statutorily set prices. The program is countercyclical, in that government purchases occur when product prices are low, and cease as product prices rise above support levels. Also, when purchases exceed certain statutory levels, USDA is required to make temporary price adjustments (reductions) to avoid the accumulation of excess government inventories. The DPPSP expires December 31, 2013, and would be eliminated and replaced with new policy under both the Senate- and House-passed farm bills.

Since the mid-1990s, the annual farm price of milk has trended higher, albeit subject to an increasingly volatile pattern ( Figure 1 ), whereas the federal support rate has been flat at $9.90 per cwt. Volatile milk prices have made planning more difficult and have made dairy producers more vulnerable to unexpected or sustained increases in the cost of feed (the major cost component of dairy production). Analysts at the Dairy Policy Analysis Alliance (DPAA) have noted:

The ability of price supports to maintain an effective price floor diminished as the support price was lowered and as dairy product manufacturers became increasingly reluctant to sell product to the government. In some cases, price supports have impeded U.S. dairy exports, distorted domestic markets, and constrained dairy product innovation.

Milk producers have argued since the early 1990s that support levels have become too low, relative to market prices and costs of production, to provide meaningful support. More recently, milk producers contend that support based strictly on the price of milk fails to account for the sharp escalation of feed costs that has occurred since 2006 ( Figure 2 ).

Since the emergence of the U.S. ethanol industry as a major source of corn demand in 2006, U.S. feed grain markets have surged to new price levels that are two to three times above the levels that 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).

Milk Income Loss Contract (MILC) Program

First established by the 2002 farm bill and reauthorized in 2008, MILC provides farm income support by giving participating dairy farmers nationwide a government payment whenever the farm price of milk used for fluid consumption (Class I) falls below a target price (adjusted for feed costs) for Class I farm milk sold to processors in the Boston market ( Figure 3 ). Under the 2002 program, all dairy producers participating in MILC were paid an amount per cwt. of milk production equal to 45% of the difference between the MILC target price of $16.94 and the lower market price.

2008 Farm Bill Adds Feed-Cost Adjustment

Starting in 2008, an adjustment factor was added to the MILC target whenever a weighted formula of dairy feed costs exceeded an established threshold of $7.35/cwt. Thus, the per unit payment rate would rise with rising feed costs. MILC payments were made on the first 2.985 million lbs. of annual milk production per farm (equivalent to annual production from about 150 dairy cows). The MILC production limitation effectively limited MILC protection to about 30% of U.S. milk production. As a result of this payment limitation, the MILC program has not been popular among large dairy producers and has generated strong opposition from regions with predominantly larger herds.

Most MILC payments occurred during the 2002 farm bill period (FY2002-FY2007) due to sustained low milk prices. In 2004, milk prices rose briefly, temporarily ending MILC payments, before restarting again in 2006. In 2007, milk prices rose sharply as part of a widespread commodity boom that lasted through most of 2008. In 2009 the U.S. dairy industry was especially hard hit by a combination of low milk prices and high feed costs that put exceptional financial pressure on many dairy producers and generated large MILC payments ( Table 7 ). Milk prices recovered through 2010, but by early 2012, the incorporation of feed-cost adjustments driven by high corn prices pushed the MILC-adjusted price trigger above the price of Boston Class I milk, once again triggering MILC payments. From April through August 2012, MILC payments averaged nearly $1.40 per cwt.

MILC Parameters Adjusted Downward Prior to 2008 Farm Bill Expiration

On September 1, 2012, several MILC program parameters were lowered in advance of the program's original expiration date of September 30, 2012. The altered MILC parameters resulted in the payment rate falling to zero for the month of September 2012. Had MILC continued to operate under the original parameters during September 2012, then the payment rate would have been approximately $0.59/cwt.

ATRA Extension Reset MILC Parameters

The ATRA extension of the 2008 farm bill both extended the MILC program through September 30, 2013, and reset the MILC program parameters to the pre-September 1, 2012, values that were in effect throughout the life of the 2008 farm bill up to that point. Furthermore, the MILC program parameter reset was made retroactive to September 30, 2012. Thus, MILC operated with the more restrictive program parameters (see footnote 17 ) only during the month of September 2012. MILC program parameters returned again to the more restrictive levels on September 1, 2013, such that MILC payments were subject to more stringent market conditions in order to be triggered after that point.

There is no net cost to the extension of the 2008 farm bill because funding to continue most of the major programs was already in the budget baseline, such as for the farm commodity, conservation, trade, and nutrition programs. However, to extend MILC for one year at the higher support rate that existed in the 2008 farm bill before September 2012, an additional $110 million was needed, according to the Congressional Budget Office (CBO). The offset for this authority was a reduction of $110 million from a nutrition education program.

MILC would be eliminated immediately under the 113 th Congress's House-passed farm bill ( H.R. 2642 ), whereas the Senate-passed farm bill proposes temporarily extend MILC (using the 45% payment factor rather than reverting to the 34% factor) for about nine months (through June 30, 2014, assuming that a farm bill was signed into law in September 2013) prior to its elimination.

Federal Milk Marketing Orders (FMMOs)

An FMMO is a geographically defined fluid milk marketing area. Established by federal law in the Agricultural Marketing Agreement Act of 1937, the FMMO system regulates milk marketing across state lines but within explicitly defined and geographically aligned multi-state regions. Ten FMMOs are currently in operation today, down from a peak of 83 in 1962. Nine states have their own separate internal marketing orders that are state-regulated. FMMOs are designed to provide both price support and market stability for dairy producers. Producers delivering milk to FMMOs are affected by two fundamental FMMO provisions: classified pricing of milk according to end use, and pooling of receipts to pay all farmers within an FMMO a blended or weighted-average price.

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—for fluid consumption (Class I) or for manufactured products such as yogurt, ice cream, and sour cream (Class II), cheese and whey (Class III), and butter and powdered milk (Class IV). This is referred to as "classified pricing."

An end-product price formula uses the wholesale prices of storable dairy products (butter, cheddar cheese, whey, and powdered milk) to calculate the value of milk components—protein, butterfat, non-fat solids, and other solids. Another formula adjusts for processing costs (referred to as the make allowance) and for the yield of milk components in the end products. Finally, a constructed price for fluid milk (Class I) is derived that varies by zone. Within each FMMO, the value of all milk sales are "pooled" to generate a uniform average price—the blend price—paid to all dairy farmers that deliver milk within that FMMO. The farm price of approximately two-thirds of U.S. milk production is regulated under FMMOs. State marketing orders account for approximately another 20% of milk production, such that very little milk in the United States escapes classified pricing and pooling, and there is substantial room for federal orders to expand if states elect to give up their control.

FMMOs are permanently authorized, and are therefore not subject to reauthorization in periodic omnibus farm bills. FMMOs are established and amended through a formal public hearing process that allows interested parties to present evidence regarding marketing and economic conditions in support of or in opposition to instituting or amending an order. Most changes are made administratively by USDA through the rulemaking process and approved by farmers in a referendum, although other legislation can address issues related to the FMMO system.

The Senate-passed S. 954 would require USDA to use a specified pre-hearing procedure to consider alternative formulas for Class III milk product pricing (Sec. 1462), and to analyze and report to Congress the potential effects of replacing the use of end-product price formulas with other pricing alternatives (Sec. 1481). In addition, S. 954 (Sec. 1476) would provide an option for the Federal Milk Marketing Order Review Commission—established by the 2008 farm bill (Sec. 1509) to conduct a comprehensive review and evaluation of FMMO and non-FMMO systems—to obtain funding from sources other than annual appropriations. In contrast, the House-passed H.R. 2642 includes a provision that would repeal the Federal Milk Marketing Order Review Commission.

Dairy Export Incentive Program (DEIP)

Established by the 1985 farm bill with subsequent reauthorizations, DEIP subsidizes dairy product exports by providing per-unit cash payments to exporters. The subsidy helps higher-priced U.S. dairy products compete in international markets. As a result, DEIP provides support through enhanced export competitiveness. Originally intended to counter foreign (mostly the European Union) dairy subsidies, DEIP has been rarely used in recent years as the use of dairy export subsidies has declined globally. DEIP (as extended by ARTA) expires on December 31, 2013. DEIP would be eliminated immediately under both the Senate-passed ( S. 954 ) and House-passed (H.R. 2642) farm bills of the 113 th Congress.

Dairy Import Tariff Rate Quotas (TRQs)

TRQs protect higher-priced domestic dairy products by limiting the importation of lower-priced foreign dairy products. A quota level is established for selected dairy products such that under-quota import volumes enter the United States at a zero or reduced duty, whereas above-quota volumes are charged a prohibitive duty. By limiting competition, TRQs provide price support to the domestic dairy industry while protecting less efficient operations and raising consumer prices. DPAA states:

U.S. dairy trade policy does not directly affect milk prices in the same way as marketing orders or the MILC program, but trade policy does influence the competitive environment for U.S. exports and imports of dairy products. Greater exposure to world markets has brought an added element of milk price instability to U.S. dairy markets. At the same time, foreign demand for dairy products is expanding more rapidly than U.S. demand, offering growth in U.S. milk production.

Dairy TRQs are unaffected by proposed changes to the farm bill.

New Dairy Policy Proposed in the Next Farm Bill

In the 113 th Congress, both the Senate-passed ( S. 954 ) and House-passed ( H.R. 2642 ) 2013 farm bills propose restructuring the traditional set of dairy programs by replacing DPPSP, MILC, and DEIP with a new margin insurance 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 margin insurance program would operate as an income support program based on the monthly difference (i.e., the margin) between the national average farm all-milk price and a formula-derived estimate of feed costs. The Senate-passed S. 954 would link DPMPP with 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 2013 farm bill also included the DMSP as part of new dairy policy. 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 GSA was defeated 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 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.

Origins of the Proposed New Dairy Policy

The new dairy margin and stabilization programs originated with a proposal published in June 2010 by the National Milk Producers Federation (NMPF) called the Foundation for the Future (FTF) . A version of 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. 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.

Note to Readers

Proposed changes to current U.S. dairy policy as well as the main differences among the Senate-passed S. 954 and the House-passed H.R. 2642 are described below. Both bills assume that a final farm bill will pass at some point prior to the expiration of the extended 2008 farm bill on September 30, 2013. Although both of these bills provide important structure and direction concerning the application of the new programs, substantial detail would need to be worked out by USDA in order to implement the new programs. As a result, this report is "preliminary" in the sense that neither the next farm bill nor the USDA implementing regulations have yet been developed. Instead, this report relies on the program details of S. 954 and H.R. 2642 , supplemented by several related studies and reports produced by prominent U.S. dairy economists and market experts on how the new margin protection and market stabilization programs are expected to function, so as to produce a preliminary description of the main features of the proposed new dairy programs.

Current Dairy Programs That Are Eliminated or Retained

The current price-based Dairy Product Price Support Program (DPPSP) and Milk Income Loss Contract (MILC) programs, as well as the Dairy Export Incentive Program (DEIP) , are eliminated under S. 954 and H.R. 2642 . The elimination of DPPSP and DEIP would be effective October 1, 2013. MILC is eliminated immediately under H.R. 2642 , but is extended through June 30, 2014, under S. 954 to provide income support for a transitional period of time while dairy producers, who might otherwise be hesitant to switch to the new programs, have extra time to better understand and evaluate them.

The S. 954 extension of MILC would be done using the MILC program parameters that were in place through August 31, 2013 (see " ATRA Extension Reset MILC Parameters " for details.). If, at any time during the MILC interim period (the first nine months following enactment), a producer opts for margin protection (DPMPP) in lieu of MILC, the decision is irrevocable. Also, if dairy producers sign up for DPMPP, they become ineligible for the Livestock Gross Margin (LGM) Insurance for Dairy program under S. 954 (Sec. 1412(f)).

The Dairy Forward Pricing , Dairy Indemnity , and Dairy Promotion and Research Programs are extended through the next farm bill period until September 30, 2018, by both bills. S. 954 also requires increased reporting frequency (to at least a monthly basis) for wholesale dairy product prices or commercial stocks of bulk dairy commodities or any product information that may "significantly aid price discovery" under the Dairy Product Mandatory Reporting provisions of current law.

Federal Milk Marketing Orders (FMMOs) , which exist under permanent authority, are left unchanged by H.R. 2642 . In contrast, S. 954 recommends two minor adjustments—first, to establish a specified pre-hearing procedure to consider alternate formulas for Class III milk product pricing, and second, to require USDA to analyze the effects of replacing the use of end-product price formulas with other milk pricing alternatives. In regards to the Federal Milk Marketing Order Review Commission —established by the 2008 farm bill [Sec. 1509] to conduct a comprehensive review and evaluation of FMMO and non-FMMO systems— S. 954 (Sec. 1476) would provide an option to obtain funding from sources other than annual appropriations. In contrast, H.R. 2642 would repeal the Federal Milk Marketing Order Review Commission.

Dairy Margin Insurance

The newly proposed margin insurance program would provide milk producers with protection from low operating margins in place of the DPPSP and MILC programs. Unlike the MILC program, margin insurance would not have an explicit cap related to size of operation—that is, there is no production or dollar payment limitation associated with the dairy margin program. Instead, margin insurance payments would be limited by how much of a producer's historical and/or current milk production is covered—an election made by the producer. A producer's decision to participate in margin insurance is voluntary; however, under S. 954 once a producer elects to participate, he is also electing (by mandate) to subject his dairy operation to the rules of the Dairy Market Stabilization Program (DMSP). H.R. 2642 would void this obligation by eliminating the DMSP.

A key aspect of the proposed margin insurance program is creating a timely and transparent measure of a dairy production margin that will be useful across all dairy production regions. The margin insurance program proposes using USDA-reported monthly national average price data for all classes of milk (the all-milk price) and the cost of three feeds that represent the bulk of purchased feeds in dairy rations (corn, soybean meal, and alfalfa hay) to construct an estimate of the margin between the price for 100 pounds (i.e., a hundredweight or cwt.) of milk produced and the cost of an average feed ration used to produce a hundredweight of milk (see box below).

This formulation is used, in part, because the data are both transparent and readily available at the national level, thus facilitating its routine and timely calculation, and also because feed costs are traditionally the most variable component of dairy production operating margins. It is noteworthy that important milk production costs are necessarily excluded from this formula, including labor, utilities, depreciation, capital, veterinary services, and nutritional supplements. Thus, this operating margin formula is a crude indicator of dairy profitability. The excluded operating cost items vary greatly across individual operations and will likely be addressed by individual producers when determining their desired level of margin coverage.

Effective Date and Implementation Specifics

Under both bills, October 1, 2013, is the effective date whereby the provisions of the new dairy program would take effect—assuming that a final identical version of the next farm bill passes both the House and Senate, and is signed into law by the President. Under both S. 954 and H.R. 2642 , 30 days after the farm bill has become effective, USDA must announce the establishment and availability of a DPMPP program.

According to S. 954 , 120 days after the act has been signed into law, the DPMPP program must be implemented. However, S. 954 exempts DPMPP and DMSP from standard rulemaking procedures. H.R. 2642 (Sec. 1402), via an amendment adopted by the House Judiciary Committee, removes this exemption and authorizes (but does not require) USDA to issue interim rules for the dairy producer margin insurance program (DPMIP). Final rules are to be published for DPMIP within 21 months of enactment.

Signing Up for Margin Insurance

All U.S. dairy producers are eligible to participate in the margin protection program. USDA will announce a registration (or signup) period in the Federal Register including the manner and form of registration (or signup). Under the Senate-passed S. 954 , producers make a one-time election to participate and must register with USDA within the 15-month period beginning on the initiation date of the USDA-announced registration period. In contrast, H.R. 2642 states that dairy producers seeking to participate in dairy margin insurance have a one-year period from the initiation date of the signup period to opt in or out, and annually thereafter. Both dairy proposals— S. 954 and H.R. 2642 —have provisions for new entrants and procedures for transferring eligibility and participation upon sales of a dairy. There are also provisions for owners of multiple operations and multiple owners of one operation.

Under S. 954 , DPMPP offers two margin protection plans: Basic Margin Protection (BMP) and Supplemental Margin Protection (SMP). BMP is a fully subsidized program, subject to an annual fee, that insures at a single $4.00/cwt. margin. In contrast, SMP is a partially subsidized program, subject to annual premiums, that offers additional margin protection coverage in $0.50/cwt. increments from $4.50/cwt. to $8.00/cwt. See Figure 4 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 in recent years.

Margin protection coverage is cumulative—a dairy operator must first sign up for BMP before participating in SMP. The decision to participate in BMP is a one-time choice and lasts for the duration of the next farm bill through September 30, 2018. The decision to participate in the higher coverage levels of SMP is made on an annual basis (beginning with the initial signup) whereby a producer may opt in or out of SMP in any given year irrespective of previous SMP participation.

An annual administrative fee is charged for participation in BMP ( Table 1 ) based on the dairy producer's volume of milk marketed during the previous calendar year. The annual administrative fee for BMP is paid at registration (or signup). Under S. 954 , DPMPP would end on December 31, 2018.

Under H.R. 2642 , there is a single voluntary, partially subsidized margin protection (MP) program subject to annual premiums, that offers margin protection coverage ranging from $4.00/cwt. to $8.00/cwt. in $0.50/cwt. increments. Dairy producers may, on an annual basis, change their coverage level or opt out entirely. There is no annual registration fee and coverage at the $4.00/cwt. margin is free for the first 4 million pounds of milk production. Finally, there is no expiration for the dairy margin insurance program under H.R. 2642.

Retroactive Sign Up

H.R. 2642 stipulates that within 30 days after the "effective" date of the farm bill, USDA must publish a notice in the Federal Register (FR) of the availability of "retroactive" margin protection covering the period from the "effective" date of the farm bill until initiation of the signup for margin protection. Under this provision a producer may notify intent to participate prior to the initiation of sign up and receive coverage for that additional period. But to comply, producer signup must occur within 150 days of the USDA FR announcement. S. 954 has no provision for retroactive signup.

S. 954 Basic Margin Protection (BMP)

Basic Margin Protection (BMP) can be thought of as providing protection from catastrophic losses due to low margins. Under BMP, whenever the average operating margin falls below $4.00 per cwt. during a two-month period, then a government payment equal to the difference between $4.00 and the actual margin (up to a maximum per cwt. payment of $4.00) is triggered.

To determine the BMP payment for the specific two-month period in which a positive BMP payment rate occurs, the BMP payment rate is applied to the lesser of 80% of the BPH prorated to a two-month period (i.e., BPH divided by six), or the actual quantity of milk marketed during the two-month period.

BMP payments will continue as long as the average margin is less than $4.00/cwt. for each successive two-month period. BMP payments cease when the average margin reaches or exceeds $4.00/cwt. during any two-month period.

S. 954 Supplemental Margin Protection (SMP)

Supplemental Margin Protection (SMP) can be thought of as providing protection from sustained low operating margins but at levels above the $4.00/cwt. catastrophic level of BMP. Under SMP, dairy producers already participating in BMP can elect to buy additional margin protection each year in $0.50/cwt. increments from $4.50 up to $8.00 per cwt. The decision to participate in SMP is a voluntary choice made annually. This is in contrast to BM P participation, which involves a commitment for the lifetime of the 2013 farm bill.

In addition to selecting an SMP m argin t hreshold ranging from $4.50/cwt. to $8.00/cwt., the producer must elect a c overage percentage of between 25% to 90%. The coverage percentage determines the portion of the farm's milk production that will receive an SMP payment. As mentioned earlier, under SMP, the relevant measure of historical milk production is referred to as the annual production history (APH) and is equivalent to the previous year's milk production. The coverage level is also a key determinant in calculating the premium to be paid for supplemental margin protection.

Whenever the operating margin falls below the selected SMP m argin t hreshold for a consecutive two-month period, a payment will be made on a portion of a participating producer's APH. The SMP payment rate per cwt. is equal to the difference between the selected SMP t hreshold and the greater of the actual margin or $4.00.

The historical frequency of these margin levels ( Table 2 ) provides information concerning the likelihood of future payments at different margin levels. Using margin estimates for the two-month periods since January 2000, the monthly margin has been below $4/cwt. in 7.3% of the months and above $8/cwt. in nearly 55% of the months. Margins within the $6/cwt. to $8/cwt. range occurred in nearly one-third of the months.

To determine the SMP payment , the SMP payment rate times the coverage percent is applied to the lesser of either the APH for which a producer contracted, but prorated to a two-month period (i.e., APH divided by six), or the actual quantity of milk marketed during the two-month period.

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

H.R. 2642 Margin Protection (MP)

H.R. 2642 offers a single margin protection program with elective coverage ranging from $4.00/cwt. to $8.00/cwt. in $0.50/cwt. increments. Important distinctions from S. 954 are that H.R. 2642 eliminates the initial registration fee and does not cap margin protection at a $4.00/cwt. margin payment for the minimum $4.00/cwt. margin protection level. As a result, in the event that the cost of a dairy feed ration, per hundredweight of milk, was to exceed the average all-milk price and result in a negative margin, then the margin payment would incorporate that excess. This feature enhances margin protection; however, it also increases government exposure to higher program outlays. In contrast, S. 954 excludes negative margins from margin payment calculations.

Whenever the operating margin falls below the selected MP m argin t hreshold for a consecutive two-month period, a payment will be made to an elective portion (i.e., the coverage percentage of between 25% and 80%) of a participating producer's production history (PH). The MP payment rate per cwt. is equal to the difference between the selected MP t hreshold and the actual margin.

To determine the MP payment , the MP payment rate times the coverage percentage is applied to the lesser of either the PH for which a producer contracted, but prorated to a two-month period (i.e., PH divided by six), or the actual quantity of milk marketed during the two-month period.

As under S. 954 , margin payments will continue as long as the margin is less than the selected margin threshold for consecutive two-month periods. Payments cease when the margin reaches or exceeds the selected margin threshold for a two-month period.

Special Note on Margin Payments

Neither bill specifies a particular timetable for a margin payment, but it is reasonable to expect that payment would be as soon as practicable. Since all payments are based on data that are collected before a payment action is announced (i.e., coverage level and base marketings), USDA would not have to wait for any new data or action on the part of a producer.

Premiums for Margin Protection

In order to obtain either SMP (of S. 954 ) or MP (of H.R. 2642 ) coverage, a participating farmer would be required to pay an annual premium. Annual premiums are calculated in the same manner under both policy proposals—i.e., the product of the premium rate per cwt., the selected coverage percentage (25% to 90% under S. 954 and 25% to 80% under H.R. 2642 ), and the relevant production history.

The premium rate varies with both the size of the participating dairy operation (i.e., whether it has greater or less than 4 million lbs. of milk production per year) and the level of margin protection selected (from $4.00/cwt. to $8.00/cwt. in %0.50/cwt. increments) ( Table 3 ).

For dairy producers with a production history in excess of 4 million lbs., they would be charged the lower premium rate on the first 4 million lbs. and the higher premium rate on the amounts above that. In 2011, approximately 88% of U.S. dairy farms had annual milk production of 4 million pounds or less and they produced about 25% of total U.S. milk volume.

The timing and manner of premium payments is something that USDA would have to develop when it promulgates specific rules. S. 954 instructs USDA to provide more than one method of payment and to use a method that "maximizes dairy operation payment flexibility and program integrity." H.R. 2642 provides dairy producers a choice between a single annual payment of 100% of the premium made by January 15 of the calendar year, or semi-annual payments of 50% each of the premium value made by January 15 and June 15 of the calendar year.

Dairy Market Stabilization Program (DMSP)

Under S. 954 , participation in the Dairy Market Stabilization Program (DMSP) is obligatory with participation in DPMPP. In contrast, H.R. 2642 contains no comparable program.

Summary of How DMSP Works

Under DMSP, a dairy operation that participates in DPMPP—in the presence of certain margin conditions (described below)—may receive a lower total return on their milk marketings. The reduction in milk revenues increases as the calculated margin declines below statutorily established thresholds starting at $6.00/cwt. A dairy producer can avoid the payment reductions by restricting his milk deliveries to the percentage of the DMSP base listed in Table 4 .

When the DMSP margin trigger has been met, USDA will announce that the DMSP stabilization program will be in effect (starting the month after USDA's announcement) and that milk purchasers (or handlers) are ordered to split their payments to milk producers with an increasing portion of payments (ranging from 2% to 8%) directed to USDA and a declining portion of payments (ranging from 98% to 92%) going to the milk producers. The funds diverted to USDA from the reduced milk payments are to be used to purchase dairy products for donation to food banks and other programs, and/or for expanding consumption and building demand for dairy products.

If a producer delivers "penalty" milk, he incurs the cost of production and receives no revenue for that milk, while the "penalty" milk is placed into commercial marketing channels and USDA receives money to fund demand enhancing programs. If a producer elects to forgo producing "penalty" milk, he reduces his cost of production but also reduces his current and future stream of revenue, while the "unproduced" milk is off the commercial market in the short term, perhaps with consequences for months beyond as well, and USDA has no revenue for demand stimulation.

Just as DMSP includes statutorily established threshold conditions or "entry triggers" that trigger the announcement of a DMSP action, there are also "exit triggers" that determine the termination of a DMSP action. Once a DMSP action is terminated, a new program cannot be announced until at least two months have passed. The entry and exit triggers are described below.

Concept Behind DMSP

DMSP payment reductions are intended to have one or both of two basic effects, either of which is expected to result in a higher future farm price for milk—(1) a demand effect stimulated by USDA use of diverted milk payment funds, or (2) a supply effect as payment reductions encourage milk producers to reduce their milk deliveries. In theory, the resultant higher farm price for milk would in turn lead to a higher margin that would subsequently lead to a cessation of USDA margin payments. While these effects are theoretically plausible, it has proven difficult to estimate how empirically significant they might be since estimated outcomes vary substantially with assumptions on participation, coverage levels, etc. In particular, the Congressional Budget Office's (CBO's) analysis of an early version of the dairy margin program without the DMSP component showed federal budgetary savings of $21 million over 5 years and $15 million over 10 years compared to the same dairy margin program inclusive of the DMSP component.

Payment reductions can be avoided entirely by reducing milk production (via altered feed rations, early cull, etc.) and associated marketings to a volume that is below the DMSP base times the DMSP payment reduction percentage (as shown in the lower portion of Table 4 ).

Implementing DMSP

Effective Date and Implementation Rules

According to S. 954 , 120 days after the next farm bill has been signed into law, USDA must establish and implement the DPMPP program. Although the Senate bill provides a framework for the DMSP, USDA would have to write rules to fully cover how the program would work.

Selecting the DMSP Base

Any milk producer who registers for DPMPP is automatically covered by the provisions of DMSP. As a result, when dairy producers sign up for DPMPP, they must also elect the method to be used for calculating their dairy operation's DMSP base (i.e., historical milk production) to be used in the determination of possible milk payment reductions. A producer's DMSP base selection may be either (1) the average volume of monthly milk marketings during the three months immediately preceding the month that the stabilization program will become effective, or (2) the volume of monthly milk marketings in the preceding year but for the same month that DMSP becomes effective. Regardless of which base formula is adopted, the DMSP base will likely vary from month to month and year to year over the duration of the next farm bill.

Triggering DMSP Payment Reductions

Two conditions could trigger DMSP payment reductions ( Table 4 ): (1) the margin is equal to or less than $6.00/cwt. for each month of any consecutive two-month period, or (2) the margin for any single month is equal to or less than $4.00/cwt. If either of these conditions is met, then USDA must announce that DMSP payment reductions will be in effect beginning on the first day of the next month. As a result, for each consecutive two-month period, DMSP uses the higher one-month average margin to assess whether the $6.00/cwt. threshold has been breached.

For example, consider the hypothetical data in Table 5 . The January-February two-month average margin of $5.95/cwt. would trigger a DPMPP payment at a $6.00 threshold; however, it would not trigger the DMSP because both months were not below the $6.00 threshold. The February-March, March-April, and April-May two-month combinations would trigger the DMSP because, in each case, both consecutive months are below $6.00.

Calculating the DMSP Payment Reduction

Each successive decline in the DMSP margin threshold (below $6.00, $5.00, and $4.00) has two sets of payment reduction factors associated with it: a first set that is applied to the DMSP base and a second set that is applied to the actual milk marketings for the period ( Table 4 )—milk payments are made on whichever calculated product is greater. However, no payment reduction is made if the actual milk marketings for that period are less than the calculated product of the payment reduction factor and the DMSP base.

Once the DMSP program has been triggered, then the payment reduction is calculated for each succeeding month that the program is in effect, using a rolling two-month average margin to determine which payment reduction factors are to be used. Increasingly larger DMSP payment reductions are required as the margin falls below $6.00/cwt. and $5.00/cwt. for any two consecutive months or $4.00/cwt. for any one month.

The DMSP payment reduction factor remains at the largest reduction level reached during the period that DMSP operates, even if the margin rises above the lower $4.00 and $5.00 thresholds. For example, suppose that the margin fell below $4.00/cwt., triggering the maximum DMSP payment reduction (i.e., 96% of DMSP base or 92% of current marketings). As the margin climbs back up to $6.00/cwt., the payment reduction factor remains at the maximum level until the margin exceeds $6.00/cwt. for two consecutive months, whereupon the DMSP is shut off.

Turning Off the DMSP

Once triggered, a DMSP payment reduction stays in place until one of a set of possible market conditions (referred to as s uspension t hresholds ) is met—either the margins improve relative to certain criteria, or U.S. prices for either of two basic dairy commodities (cheddar cheese or nonfat dry milk) exceed world prices by certain relative amounts, or a combination of higher margins and price relationships occur simultaneously ( Table 6 ).

According to two prominent dairy economists, the logic of the DMSP design hinges on the expectation that the DMSP, either through a demand effect or a supply effect, may cause the price of farm milk, and consequently the price of exportable dairy products, to increase. To prevent unintended negative consequences for U.S. dairy exports, exit triggers are arranged to terminate the program when the U.S. price gets too high relative to the world price.

Mandated USDA Study of DMSP Market Effects

The Senate-passed bill directs USDA to conduct and report on a study of two specific potential effects of the DMSP program: first, the economic impact of DMSP throughout the dairy product value chain, and second, the impact of DMSP on the competitiveness of the U.S. dairy industry in international markets. A report based on the study would be due no later than December 1, 2016, to both the House and Senate Agriculture Committees.

Summary of Dairy Policy Differences: S. 954 versus H.R. 2642

There are several important differences between the dairy proposals of the Senate-passed S. 954 and House-passed H.R. 2642 that would have to be resolved in a conference agreement. The major distinctions are described here.

1. Under S. 954 dairy producers that participate in the DPMPP are subject to the payment reductions or supply restrictions of DMSP. In contrast, H.R. 2642 does not include DMSP or any payment reductions or supply restrictions in response to low margins or in association with receipt of margin insurance payments. 2. Margin insurance under S. 954 includes two sequential programs: a catastrophic margin insurance, BMP, which provides protection at $4.00/cwt. and requires an annual registration fee; and additional elective buy-up coverage, SMP, which offers coverage in $0.50/cwt. increments from $4.50/cwt. to $8.00/cwt. 3. H.R. 2642 folds the two margin insurance programs of S. 954 —BMP and SMP—into a single margin protection program with no annual registration fee. H.R. 2642 uses an almost identical premium rate structure as S. 954 ( Table 3 ), but with: a. $4.00/cwt. margin protection free on the first 4 million lbs. of annual milk marketing; b. slightly higher premiums at $4.00/cwt. to $5.00/cwt. margin protection for milk marketings in excess of 4 million lbs.; and c. sharply lower premiums at $7.00/cwt. margin protection for all milk marketings (i.e., less than and greater than 4 million lbs.). 4. As a result of their different premium structure, S. 954 tends to favor participation at a $6.50/cwt. margin protection level; whereas H.R. 2642 favors participation at a $7.00/cwt. margin protection level. 5. S. 954 requires USDA to use NASS full-month, all-milk price estimates in calculating margins, thus prohibiting the use of preliminary NASS price estimates, which are available a month in advance of the full-month price estimate and which would expedite margin payments. H.R. 2642 is silent on this instruction. 6. H.R. 2642 allows for annual updating of the production history base for each year of the farm bill (i.e., brings annual production growth under the program). S. 954 fixes the BMP base for the life of the farm bill, but allows the SMP production base to be updated each year. 7. S. 954 offers BMP margin payments on 80% of the BMP fixed production history, and on a participant election of from 25% to 90% of the SMP production history base. H.R. 2642 contracts the coverage percent election to a range of 25% to 80% of the production history base. 8. H.R. 2642 places no limit or cap on the size of the potential per-unit payment rate (defined as the difference between the all-milk price and the formula-defined feed-cost ration). In contrast, S. 954 excludes the potential for a negative margin in instances where the feed-cost ration exceeds the all-milk price. 9. Under S. 954 a dairy operation may only participate in DPMPP or the existing Livestock Gross Margin (LGM) dairy program, but not both. H.R. 2642 is silent regarding participation in both DPMPP and LGM. 10. H.R. 2642 ends the MILC program immediately, whereas S. 954 extends it for about nine months (through June 30, 2013), while a dairy producer is deliberating whether to participate in DPMPP or not—once a DPMPP participation decision is made, MILC is no longer an option for a producer. 11. H.R. 2642 requires that USDA announce the establishment and retroactive availability of a DPMPP program within 30 days of the next farm bill being signed into law. S. 954 has no retroactive option, but requires that USDA establish and implement a DPMPP program within 120 days of being signed into law. 12. S. 954 mandates a USDA study of the impact of DMSP program on the economic impact throughout the dairy product value chain, and on the competitiveness of the U.S. dairy industry in international markets. H.R. 2642 has no similar provision. 13. S. 954 exempts DPMPP and DMSP from standard rulemaking procedures. H.R. 2642 , via an amendment adopted by the House Judiciary Committee, removes this exemption and requires USDA to determine the market impacts of the new program during the rulemaking process. 14. Unrelated to the newly proposed programs, H.R. 2642 makes no changes to Federal Milk Marketing Orders (FMMOs). In contrast, S. 954 mandates a pre-hearing procedure to consider alternative formulas for Class III milk product pricing, and mandates a study of the effects of replacing end-use milk pricing with other alternatives. 15. S. 954 provides an option for funding of the FMMO review commission from sources other than annual appropriations. H.R. 2642 eliminates the FMMO review commission. 16. S. 954 adds requirements to mandatory dairy price reporting that specify a reporting periodicity of greater than once per month. H.R. 2642 has no similar provision.

Estimating the Potential Effects of New Dairy Policy

DPMPP and DMSP versus Current Law

Several empirical studies of early versions of the proposed dairy programs—including the elimination of current price and income supports and their replacement with the margin-based protection programs (BMP and SMP) and the dairy market stabilization program (DMSP)—have been undertaken in an attempt to ascertain both the potential federal cost and the potential effectiveness of the new programs for delivering timely assistance to dairy operators while stabilizing dairy operating margins.

The studies have generally concluded that

compared to the current dairy price and income programs, DPMPP will make payments less often, but will provide a higher safety net in extremely low margin events; the combination of DPMPP and DMSP appears to substantially mitigate the dairy operating margin volatility; optimal program benefits are conferred for nearly all dairy farm sizes for participation at either the $6.50/cwt. or $7.00/cwt. supplemental margin protection levels (this results in large part because DMSP payment reductions will begin when the margin drops below $6.00/cwt., so margin protection effectively needs to be at least at the $6.00/cwt. level on average to offset milk payment reductions); and overall effects on milk supply, prices, and trade were relatively small; however, contradictory trade results emerged where one study found that milk exports declined slightly due to lower milk supply (Brown, April 2012), while another study found that net milk exports expanded due in part to slightly lower milk prices (Nicholson and Stephenson, October 2011b).

Margin Protection With and Without DMSP

An early analysis of a stand-alone margin insurance program without the market stabilization component (Stephenson, July 2012) found that such a program could provide effective risk management results, although costs and results varied under different participation assumptions.

Three studies released in the first half of 2013 include a comparison of the economic effects of the DPMPP/DMSP joint program (referred to as the Dairy Security Act or DSA) of H.R. 1947 and S. 954 with the GSA-amended version of H.R. 1947 . Two of these studies (Newton et. al . (April 15, 2013) and Brown and Madison (May 2013), appear to have used early versions of GSA that included a fixed historical milk base against which margin payments were made. Such a fixed base excludes growth in milk marketings from participation in the margin program and, as a result, keeps program costs down. In contrast, the version of GSA that was passed during the House floor debate ( H.Amdt. 228 to H.R. 1947 ) includes a modification that allows for annual updates of the milk marketing base, thus allowing for growth in milk marketings to be included under the margin protection program. As a result, these two studies potentially overstate the cost savings associated with GSA relative to the dairy policy of House-reported H.R. 1947 . However, the third study (Woodward and Baker (June 9, 2013), incorporated GSA as adopted on the House floor thus fully capturing the annual marketings update aspect.

Results from these three studies are briefly summarized here, but interested parties are encouraged to consult the papers for greater detail.

Newton et al. (April 15, 2013) found that:

Both DSA and GSA effectively provide catastrophic risk insurance and revenue enhancement for farms with stable and moderately growing milk marketings. For sufficiently high DSA participation rates, and sufficiently low price-elasticity of demand for milk in aggregate, DMSP has the potential to reduce government outlays and accelerate margin recovery in low-margin states relative to DSA under low participation, high-price-elasticity environment. Furthermore, DMSP is not likely to provide long-term obstacles to growth for participating farms with an aggressive growth plan unless generous margin insurance induces a long-term oversupply of milk.

Brown and Madison (May 2013) found that:

Government costs would have been over $1 billion higher during the 2009 to 2012 period under GSA than DSA as a result of an assumed higher coverage rate choice (the GSA premium schedule encourages participation at the $7.00/cwt. level whereas DSA encourages a $6.50/cwt. level) and no supply adjustment mechanism to offset any positive supply response from margin payments. Milk production is virtually unchanged under either policy option, although DSA's DMSP operation resulted in a few instances of short-term reductions in milk supplies of up to 3%. Market prices for milk increase on average by $0.06/cwt. under DSA and decline on average by $0.19/cwt. under GSA. Exports of dairy products decline under DSA when DMSP operates. Producer net revenue increases by $0.55/cwt. under DSA and by $0.48/cwt. under GSA. Producers experience the largest revenue increase under DSA with a $6.50/cwt. margin coverage rate, while revenue increases are maximized under GSA with a $7.00/cwt. margin coverage rate.

Woodward and Baker (June 9, 2013) found that:

In general, the government loss ratio [the ratio of expected margin payments divided by the premiums paid] is significantly higher for the DPMPP with DMSP proposal than it is under the GSA proposal. This holds for all coverage levels with the sole exception of the $7.00/cwt. margin.

Rather than focus on the merits of DMSP versus no DMSP, the Woodard and Baker (June 9, 2013) analysis focused instead on equity issues related to the redistribution of program benefits among producers of various sizes under a shift from the MILC program with production cap to the DPMPP program with no production cap. According to their analysis, the payment cap of 2.985 million pounds under the MILC program clearly favors smaller milk producers whereas the DPMPP with no payment cap based on output tends to favor larger producers. Their study suggests that:

There exists a large divergence in program benefits by farm size with MILC strongly favoring smaller dairy farms and DPMPP favoring large farms. This divergence is due almost entirely to the production caps of MILC being removed under DPMPP. For producers with milk marketings under the MILC production cap, MILC tends to pay out more than DPMPP (except under high coverage levels). For producers with milk marketings well over the MILC production cap, DPMPP total payouts average 11 times greater than under MILC.

With respect to DMSP, states that tend to support the DMSP component of the dairy policy proposal (e.g., California, Idaho, New Mexico, Washington, Oregon, and Arizona) tend to also have higher feed costs, import a large proportion of their feed, have a higher concentration of large farms, and/or may not currently be seeking to expand production. These "larger" types of farms also tend to have lower fixed costs per unit of capacity than do smaller firms, implying that they have a lower opportunity cost of idling production capacity. Meanwhile, states that have a higher proportion of small farms, and/or that grow much of their own feed, on balance tend to reject the idea of supply controls (e.g., New York, Wisconsin, Pennsylvania, and Minnesota).

Uncertainties

All of these studies have to make assumptions about farm participation and its distribution across margin thresholds (from $4.00/cwt. to $8.00/cwt.) and across coverage levels (from 25% to 90%) when they try to estimate or discuss marketwide effects. In general, when the studies are based on relatively high participation levels they tend to find more positive program outcomes—for example, lower cost to taxpayers, and greater success at stabilizing operating margins.

Another consideration is the potential supply-inducing effect of indemnity payments, which would likely push prices and margins downward. Evaluating how dairy producers might respond or adjust their milk marketings under the market stabilization program has proven particularly difficult given the unique nature of DMSP and the lack of historical precedent regarding past supply management systems (see the following Appendix B ). The two previous historical examples of supply management in the United States were primarily voluntary programs that provided participation incentives without consequent penalties. DMSP is a penalty-based program with a consequent opportunity of reward.

Most milk processors are strongly opposed to any form of supply management that might restrict milk supplies, prevent full utilization of their investment in processing capacity, and limit their ability to meet growth in consumer demand wherever it may occur. Free-marketers oppose any government program that shelters the dairy sector from market forces, thus limiting flexibility and locking current resources into place.

And Questions for Policymakers

What will be the cost of this program going forward, and what share of that belongs to farmers, or which farmers? The proposed tiered-premium structure appears to favor smaller farmers with a larger premium subsidy (although premiums and subsidies have not been actuarially assessed ex ante ). This is unlike crop insurance. But the flip side is that there is no income eligibility or payment limitation on these "indemnities" as there was with the MILC program.

What is the relationship between dairy output prices and feed costs? As feed costs equilibrate at lower levels, to what extent will milk prices follow suit? Is the supply stabilization component an essential part of a margin-based strategy? If a margin-based dairy program were to achieve high rates of participation, how costly could the program become under supply-inducing indemnity payments in the absence of a supply stabilization component?

Budget Outlays: Historical and Projected

USDA outlays for the major dairy support programs have trended downward since the 1980 farm bill period ( Table 7 ). 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 current dairy policy.

CBO also has produced budget scores for different versions of the Senate and House 2013 farm bills. With respect to the House version of the 2013 farm bill, CBO scored dairy policy in the initial H.R. 1947 as reported by the House Agriculture Committee and a scenario of H.R. 1947 that included the Goodlatte-Scott Amendment ( Table 7 ). It is assumed that this latter cost estimate is representative of the dairy proposal in the House-passed H.R. 2642 .

According to CBO, replacing current dairy policy with the new dairy proposals of the House and Senate would result in projected additional budgetary outlays above baseline over the 5-year (FY2014-FY2018) and 10-year (FY2014-FY2023) periods of:

$28 million and $302 million, respectively, under S. 954 , $44 million and $436 million, respectively, under H.R. 1947 (as reported by the House Agriculture Committee), and $23 million and $421 million, respectively, under a version of H.R. 1947 as amended by the proposed Goodlatte-Scott amendment ( H.Amdt. 228 to H.R. 1947 ) without the supply restrictions proposed under DMSP of S. 954 .

A CBO score of the program details of Title I in House-passed H.R. 2642 was not yet available as of the date of this report. Instead, the CBO score of the dairy proposal for H.R. 1947 inclusive of the Goodlatte-Scott amendment, which eliminates DMSP, is cited above and in Table 7 .

Appendix A. Debate Over the Market Stabilization Proposal

What Is DMSP's Intended Purpose?

The DMSP market stabilization proposal is being debated by dairy producer groups, which generally support it, and dairy processors and certain consumer groups who oppose it. The National Milk Producers Federation (NMPF), the largest U.S. dairy producer organization, is a principal proponent of the dairy market stabilization concept. NMPF describes the purpose and need for DMSP as follows:

What is the purpose of the DMSP? The purpose of the DMSP is to reduce margin volatility for dairy producers. The DMSP acts as an early warning system that sends strong and timely signals to producers participating in the margin protection program that small temporary adjustments in their milk production need to be made to stave off long-term reductions in their overall margins. The DMSP is designed to act swiftly and infrequently to address brief market imbalances.

Why is any type of supply management needed in the U.S. dairy industry? The DMSP does not fit the traditional definition of a supply management program. However, market stabilization is part of this proposal because there are times when imbalances occur in the marketplace that negatively impact dairy farmer margins. In 2009, dairy farmers did not overproduce their way into extremely low margins, but demand, both domestically and internationally, collapsed with the global recession. The low milk prices combined with high feed costs resulted in the lowest margins most producers have ever experienced. Situations like this ultimately correct themselves, but without timely and effective intervention, they can drag on too long and drag down too many farmers along the way.

Alternate Viewpoints

The International Dairy Foods Association (IDFA), representing the nation's dairy manufacturing and marketing industries and their suppliers, is a principal opponent of the dairy market stabilization program. IDFA argues: "A new government "Dairy Stabilization" program would routinely increase our domestic prices above international prices and make our dairy industry less competitive.... Government supply management programs thwart export growth. That's why no other U.S. commodity has limits on production."

During the House Agriculture Committee markup of H.R. 1947 in the 112 th Congress, Representatives Goodlatte and Scott first introduced their amendment (No. 085) to remove the market stabilization program from the dairy subtitle D while retaining the dairy producer margin protection program. In a "Dear Colleague" letter dated July 10, 2012, they argued:

A government supply management program arbitrarily penalizes consumers and dairy product manufacturers who respond to consumer demands, by uniformly requiring milk supply contraction and raising milk prices above not [sic] market clearing levels. The Dairy Market Stabilization Program, which our amendment eliminates, is the only U.S. commodity program that would allow this level of government market intervention in domestic commodity supply decisions.

A major concern expressed by urban constituencies in regard to domestic milk supplies is that a "supply management" program would potentially both limit the volume of milk supply available to consumers and raise the price for the milk that is available.

Appendix B. Historical Dairy Supply Management Programs

The goal of dairy supply management programs is generally to enhance and stabilize farm-level milk prices by controlling the amount of milk marketed or to mitigate the increased production that would be stimulated by policy that supports diary product markets at a higher-than-market-equilibrium price. Unlike Canada and the European Union (EU), the United States has never implemented a mandatory dairy supply management program; however, the 1990 farm bill had a requirement that USDA implement a supply management program if federal dairy product purchases exceeded 7 billion lbs.—this requirement was never implemented. Since the mid-1980s there have been two government-sponsored and one industry-sponsored major voluntary supply management dairy programs in the United States, all funded in part through dairy farmer assessments.

U.S. Government-Sponsored, Voluntary Supply Management Programs

In the mid-1980s Congress authorized two voluntary dairy supply management programs—the 1984-85 Milk Diversion Program and the 1987 Dairy Termination Program (Whole Herd Buyout) . Under the Milk Diversion Program, dairy farmers who reduced milk marketings 5% to 30% from a base level were paid $10/cwt. on the reduced marketings. The Milk Diversion Program cut milk production sharply in 1985, but had no long-term effect. Under the 1987 Dairy Termination Program, the government accepted bids from dairy farmers who were willing to slaughter all their dairy cattle and remain out of the dairy business for at least five years. The Whole Herd Buyout Program was more successful in moderating milk production trends, but the induced slaughter of dairy cows negatively affected beef markets.

Novakovic and Stephenson have pointed out that, in contrast to the Milk Diversion Program and Dairy Termination Program, which rewarded farmers for cutting back on milk production, the DMSP program punishes farmers for increasing milk marketings relative to a base.

U.S. Industry-Sponsored Supply Management Programs

An industry-sponsored voluntary supply management program— Cooperatives Working Together (CWT) —was initiated in 2003 by the National Milk Producers Federation and remains ongoing. Participating dairy farmers commit 2¢ per cwt. of milk marketed. Presently, participants in CWT include dairy farmers from every state, producing almost 70% of the nation's milk. CWT funds have been used for both herd retirement (the last round was conducted in 2010) and export assistance.

Foreign Government-Sponsored Mandatory Supply Management Programs

Canada and the EU have used marketing quotas which explicitly specify the maximum amount of milk that individual dairy farmers can sell and usually apply stiff economic penalties to any sales in excess of the assigned farm quota. The EU will gradually increase its dairy quotas until an entire phase-out of its milk quota system in April 2015 in accordance with implementation of its 2009 Health Check. Canada continues to maintain its milk quota system.

Potential Problems Associated With Supply Management Programs

Potential problems associated with voluntary supply management programs are adequate participation and funding (which is linked directly to participation), free riders (i.e., nonparticipants benefit fully from the success of any supply management program but without the supply limits), and some export market issues. Since CWT dairy product export support varies with market conditions, exports under this program may not be viewed as a reliable source by less price sensitive markets. In addition, there is some uncertainty about whether CWT export subsidies are compatible with World Trade Organization obligations.