We estimate that the sugar program cost domestic sweetener users about $1.5 billion in 1996 and about $1.9 billion in 1998.Sweetener users included (1) sugarcane refiners that bought raw cane sugar, (2) food manufacturers that bought refined sugar and other sweeteners, and (3) final consumers who bought sweeteners and sweetener-containing products. The program’s costs to U.S. sweetener users depend on the world price of sugar and can vary from year to year—they will be higher, other things being equal, when the difference between the domestic and the world price is greater. In 1998, for example, the program’s costs to users were higher than in 1996 because the world price dropped while the domestic price remained about the same. If the sugar program were eliminated and the domestic price of sugar fell, it would be difficult to predict the extent to which and the speed with which sugar refiners and manufacturers of sugar-containing foods would pass their cost reductions through to final consumers. This would depend on, among other things, the degree of competition in their markets. For example, the market for table sugar is likely to be more price-competitive than the markets for sugar-containing foods for several reasons, including that table sugar varies little from brand to brand while most sugar- containing foods have greater product differentiation. As a result, sugar refiners that market table sugar might be more likely than manufacturers of sugar-containing foods (such as candy makers) to lower their prices, and this pass-through might occur more quickly. Assuming that, in absence of a sugar program, competition among sugar refiners had caused them to pass all of their cost reductions for table sugar through to consumers and the manufacturers of sugar-containing foods had not passed through any of their cost reductions, we estimate that final consumers could have benefited generally by about $800 million using 1998 data and by about $600 million using 1996 data. If both sugar refiners and the manufacturers of sugar-containing foods passed through all of their cost reductions, the maximum annual benefit to final consumers would be about $1.9 billion using 1998 data and about $1.4 billion using 1996 data. Table 6 in appendix II provides additional information on the benefits accruing to all sweetener users (refiners, food manufacturers, and final consumers) under these alternative assumptions about the degree to which cost reductions are passed through. The primary beneficiaries of the sugar program’s higher prices are domestic sugar beet and sugarcane producers who, we estimate, received benefits of about $800 million in 1996 and about $1 billion in 1998.About 70 percent of the benefits went to sugar beet growers and processors. Sugarcane producers received about 30 percent of the benefits. HFCS producers received little, if any, benefit from the sugar program in either 1996 or 1998, according to our current model’s estimates. This result contrasts with our finding in 1993. At that time, HFCS cost a few cents per pound less than domestic sugar, and both products cost about twice as much as sugar on the world market. Thus, if the domestic price of sugar had fallen in 1993, HFCS producers would have had to reduce their prices to remain competitive. Since 1993, the price of HFCS has fallen, and today it is much lower than the wholesale price of sugar in the United States. Furthermore, the possibilities for substitution between sugar and HFCS are more limited than in prior years because technological advances have improved HFCS products and created more specialized sweetener markets. As a result, even if the sugar program were removed and the price of domestic sugar fell substantially, the impact on the price of HFCS would be limited—HFCS producers might no longer need to lower their prices to remain competitive. Executives from the Corn Refiners’ Association, which represents HFCS manufacturers, agreed with our model’s results as they pertained to HFCS, stating that HFCS producers do not benefit from the sugar program because domestic HFCS prices are no longer linked to sugar prices. We estimate that the sugar program resulted in net losses to the U.S. economy of about $700 million in 1996 and about $900 million in 1998. Our net loss estimates include economic inefficiencies and transfers to foreign producers. Economic inefficiencies occurred, for example, when the sugar program’s artificially high domestic prices encouraged farmers to grow sugar beets instead of another crop, such as wheat, that, without the sugar program, might have been relatively more profitable. Inefficiencies also occurred when artificially high sugar prices discouraged consumers from purchasing sugar. The cost of these inefficiencies totaled about $300 million in 1996 and about $500 million in 1998. Transfers from the U.S. economy to foreign producers occurred because foreign producers received artificially high prices for the raw sugar they exported to the United States. (See app. V.) We estimate that these transfers amounted to about $400 million in both 1996 and 1998. The transfers were about the same in each year despite the larger difference between domestic and world prices in 1998 because the United States imported less sugar in 1998. We provided the U.S. Department of Agriculture; the American Sugar Alliance, which represents sugarcane and sugar beet growers; and the U.S. Cane Sugar Refiners’ Association with a draft of this report for review and comment. The U.S. Department of Agriculture stated that our model’s results were suspect and should not be quoted authoritatively, citing three broad areas of concerns. First, the Department stated that the report’s methodology was not adequately developed or justified. We disagree. We took several actions to help ensure that our model was methodologically sound. Initially, we contracted with a well-known expert in modeling the international trade of agricultural commodities and with a prominent agricultural economist to work with us in developing the model. Then, in December 1999, we sent our proposed model to four outside academicians who specialize in agricultural economics and international trade economics and revised the model in response to their comments. We also sent the proposed model to the Department at that time, but the Department did not provide comments. Finally, our process for obtaining agency comments on draft reports served as a last check of our methodology. In response to these comments, we adjusted our model to more fully account for certain transportation costs in our final estimates. Second, the Department stated that documentation of the economic model was inadequate. We disagree. We included two appendixes in the draft report that provided detailed information about the model. While we believe that our model was adequately documented, the Department suggested some useful clarifications that we incorporated. Third, the Department stated that in numerous places the model’s results are inconsistent with our description of the model or alternative data sources. For example, the Department disagrees with our model’s finding that HFCS producers would experience few economic losses if the sugar program were eliminated. We continue to believe that this finding is accurate. Recent price data show that while HFCS producers benefited from the sugar program in the 1980s and early 1990s, the domestic HFCS and sugar markets have since been decoupled because of domestic price, cost, and market conditions. After thoroughly examining this and each of the Department’s other concerns about our model’s results and discussing them with experts outside GAO, we continue to believe that the model’s results are reasonable. See appendix VI for the Department’s written comments and our responses. The American Sugar Alliance also disagreed with the draft report’s analysis. Its concerns also fell into three general areas. First, the Alliance stated that our methodology for estimating the sugar program’s cost to users was flawed because our model used world prices of raw sugar that did not reflect each country’s cost of production—the Alliance asserted that our model’s world prices were distorted by, among other things, subsidies provided by other countries and differences in labor and environmental standards. We believe that our methodology is appropriate. Our model estimated the impact of the U.S. sugar program in the world as it exists today—not in a hypothetical “free market” environment, as the Alliance suggested. To isolate the sugar program’s effects, we made the analytical assumption that all factors, other than the U.S. sugar program, would remain unchanged. Second, the Alliance stated that our model incorrectly assumed that food manufacturers and retailers would pass through 100 percent of their savings to final consumers if the sugar program were eliminated. In fact, the draft report noted that the extent to which cost reductions would be passed through to consumers would depend on the degree of competition in their markets. We revised the report, however, to further clarify the different assumptions we used in discussing the extent to which final consumers could benefit if the sugar program were eliminated. Third, the Alliance stated that we did not sufficiently assess the benefits and costs of the sugar program, noting among other things that rural areas would suffer if the sugar program were eliminated. As stated in our study objectives, this report focuses on the U.S. sugar program’s (1) costs to domestic sweetener users, (2) benefits to domestic sugar and HFCS producers, and (3) net effects on the U.S. economy. The American Sugar Alliance also provided comments to clarify what it perceived to be misleading statements and analytical errors in the draft report. We address each of these comments in appendix VII, which contains the American Sugar Alliance’s complete written comments and our responses. The U.S. Cane Sugar Refiners’ Association stated that we had done a thorough job of illuminating the very significant impact of the sugar program on different interests. The Association also provided comments to improve the report’s technical accuracy, which we incorporated as appropriate. See appendix VIII for the written comments of the U.S. Cane Sugar Refiners’ Association. Estimating the total cost of the sugar program to users is controversial because the total cost is not a simple difference between the current U.S. and world sugar prices. Instead, the cost estimate depends in part on assumptions about how much the world price would rise if the United States did not have a sugar program. In developing our model, we: Contracted with Professor John C. Beghin, who heads the Trade and Agricultural Policy Division at Iowa State University’s Center for Agricultural and Rural Development, to work with our staff economists to integrate an economic model of the U.S. sweetener market with the Center’s international trade model for agricultural commodities. Professor Beghin is a recognized expert in agricultural trade policy and has extensive experience in developing econometric models of the U.S. and world markets for agricultural commodities. We also contracted with Professor Bruce Gardner, of the University of Maryland and a former USDA Assistant Secretary for Economics, to consult with Professor Beghin and our economists in developing our model, assessing the reasonableness of its results, and responding to comments from outside consultants and organizations. Provided our proposed model for review and comment in December 1999 to Professor James Anderson of Boston College, Professor Andrew Schmitz of the University of Florida, Professor Daniel Sumner of the University of California at Davis, and Professor Michael Wohlgenant of North Carolina State University. We incorporated many of their comments as we revised the proposed model. We also provided our proposed model to USDA for review and comment in December 1999. However, USDA did not provide comments. Obtained extensive data on sweetener prices and quantities for the U.S. and world markets in 1996 and 1998. These included data on (1) production and prices for sugar, HFCS, and other corn sweeteners and (2) the use of sweeteners by U.S. industries, disaggregated to the fourth level of the U.S. Bureau of the Census’ Standard Industrial Classification. We obtained these data from USDA’s Economic Research Service; the Bureau of the Census and the Bureau of Economic Analysis, within the Department of Commerce; the Bureau of Labor Statistics, within the Department of Labor; and private industry organizations. We selected 1998 because it is the most current year for which price and quantity data were available when we developed our model and 1996 because it was a recent year that provided a contrast in the world price of sugar and the U.S. prices of corn, wheat, and other crops. Used the model to estimate the effect of terminating the U.S. sugar program on (1) the U.S. and world prices of sugar and (2) U.S. sweetener producers and users. The U.S. sweetener part of the model is the U.S. component of the CARD world sugar model, extended on the supply side to include linkages with the corn, HFCS, and wheat markets. In addition, Professor Beghin, in collaboration with our economists, extended the demand side of the CARD domestic sweetener model to include the demand for sweeteners from food processors, as well as the direct demand for sweeteners by final consumers. We interpreted the sugar program’s estimated costs in 1996 and 1998 as the opposite of estimated benefits that would be derived by the program’s elimination. While our model primarily examined the short-run effects of eliminating the sugar program, we also assessed longer-term effects by using alternative elasticities for the supply of sweeteners. Obtained the comments of Professor Gardner and Professor Wohlgenant on the final design of our model and its preliminary results before we provided a draft of our report to USDA for comment. We conducted our work between August 1999 and May 2000 in accordance with generally accepted government auditing standards. We did not independently verify the data that we obtained from USDA, Commerce, Labor, or industry sources and used in our economic model. However, these are the best data available on U.S. and world prices and production. The estimates in this report apply only to the 2 years that we analyzed. Estimates for other years might be larger or smaller than our 1996 and 1998 estimates, depending on the difference between the domestic and world prices of sugar. We are sending copies of this report to the Senate Committee on Agriculture, Nutrition, and Forestry; the House Committee on Agriculture; and other appropriate congressional committees; the Honorable Dan Glickman, Secretary of Agriculture; the Honorable Jacob Lew, Director, Office of Management and Budget; and other interested parties. We will also make copies available to others upon request. Please contact me at (202) 512-5138 if you or your staff have any questions about this report. Key contributors to this report are listed in appendix IX. The United States was the fifth largest producer and the fourth largest consumer of sugar in the world in 1998. Historically, the United States and other countries have protected their domestic growers and processors of cane sugar and beet sugarfrom lower world prices through quotas and/or high tariffs that restrict sugar imports. The U.S. sugar program guarantees domestic sugar producers (growers and processors) a minimum price for sugar by (1) offering loans to sugar processors at a rate established by law and (2) using a tariff-rate quota (TRQ) to restrict the supply of sugar that can be imported at a low tariff rate. The Agriculture and Food Act of 1981 allowed sugar processors to obtain loans from the U.S. Department of Agriculture’s (USDA) Commodity Credit Corporation by pledging their sugar as collateral.The act also gave processors the option to forfeit the sugar that secures their loans to the federal government rather than repay their loans in cash, effectively establishing the loan rate as a floor for domestic sugar prices. Since 1990, USDA has used a TRQ for raw sugar to restrict low-priced imports and maintain domestic prices at levels that are high enough to prevent producers from forfeiting on their sugar loans.Under the TRQ, imported sugar up to the quota is either assessed no tariff or a 0.63-cent-per-pound tariff, while imports above the quota are assessed a 15.82-cents-per-pound tariff, making them prohibitively expensive.In 1994, the United States agreed to set the TRQ for imported sugar at 1.26 million tons or more each year and to administer the TRQ in a manner consistent with its commitments under the World Trade Organization Agreement on Agriculture. USDA normally sets the size of the TRQ at the beginning of a fiscal year. The U.S. Trade Representative then allocates shares of it among 40 designated countries on the basis of their exports to the United States from 1975 through 1981. The Federal Agriculture Improvement and Reform Act of 1996, commonly known as the 1996 Farm Act, modified the sugar program by (1) legislatively establishing USDA’s loan rate at 18 cents per pound for raw cane sugar and 22.9 cents per pound for refined beet sugar, (2) assessing a 1-cent penalty on each pound of raw cane sugar and a 1.07-cent penalty on each pound of refined beet sugar forfeited to the government, (3) eliminating a requirement that the sugar program operate at no net cost to U.S. taxpayers, (4) limiting processors’ opportunities to forfeit their sugar to the Commodity Credit Corporation by not allowing such forfeitures if the TRQ is 1.5 million tons or less, (5) eliminating USDA’s authority to impose marketing allotments for sugar, and (6) increasing the assessment on processors to 0.2475 cents per pound for of raw cane sugar and 0.2654 cents per pound for beet sugar. USDA has established a TRQ greater than 1.5 million tons each year since the 1996 Farm Act was enacted. As a result, processors that have obtained Commodity Credit Corporation loans have had the option to forfeit their pledged sugar instead of repaying their loans. This option becomes important to processors if domestic sugar prices drop below USDA’s loan rate plus transportation and interest costs but minus the 1-cent-per-pound penalty. If sugar is forfeited, USDA can choose to immediately resell the sugar on the domestic market, sell it for such restricted uses as ethanol manufacture, store it, or donate it for humanitarian purposes. Table 1 shows that, since 1985, the sugar program has resulted in U.S. raw sugar prices that have been more than 8 cents per pound higher than world raw sugar prices.In 1998, the U.S. raw sugar price was more than 10 cents per pound higher than the world price. Figure 1 shows that domestic sugar production has grown by about 25 percent in recent years—from 7.2 million tons in fiscal year 1997 to a projected 9 million tons in fiscal year 2000. This growth reflects an 8-percent increase in the estimated acres of sugarcane and sugar beets harvested in 2000 compared with the actual acres harvested in 1997. (See table 2.) Many farmers have increased the size of their sugarcane and sugar beet crops because these crops have offered better returns than cotton, wheat, or other crops that the farmers grew in the past. In addition, sugarcane and sugar beet farmers have increased their crop yields per acre, and sugarcane farmers, in particular, have improved their sugar-per-acre recovery rates. In November 1999, USDA announced that the TRQ for raw sugar imports in fiscal year 2000 would be slightly higher than 1.5 million tons, giving sugar processors that obtained USDA loans the option to forfeit their sugar to the government if domestic prices drop below the loan rate plus certain costs that processors would no longer incur if they forfeit.In February 2000, U.S. raw sugar prices on the New York Coffee, Sugar, and Cocoa Exchange dropped to 16.5 cents per pound as a result of the increasing supply of sugar. As of May 1, 2000, raw sugar prices had recovered to about 19.7 cents per pound—around the minimum price necessary to provide an economic incentive to U.S. sugar processors to repay their USDA loans rather than forfeit the sugar that secures their loans to the government. In May 2000, USDA announced that it would seek to purchase 150,000 tons of domestic sugar to reduce the cost of expected sugar program loan forfeitures later this fiscal year. While data on the total amount of USDA loans to sugar processors in 2000 were not available, table 3 shows that sugarcane processors substantially increased their use of USDA loans in 1999, as compared with 1997. U.S. sugar processors have not forfeited sugar to the government since 1994, when small amounts were forfeited. High-fructose corn syrup (HFCS) competes with sugar for leadership in the U.S. sweetener market. Each year from 1985 through 1994, the weighted average HFCS price was consistently at least 3 cents per pound lower than the wholesale refined beet sugar price. Since 1992, the weighted average HFCS price dropped from 22 cents per pound to 12.4 cents per pound in 1998—13.7 cents per pound less than the wholesale refined beet sugar price. (See table 4; prices are in nominal dollars.) Because of this cost advantage, the domestic supply of HFCS grew by almost 40 percent, from 6.8 million tons (dry weight) in 1992 to 9.5 million tons (dry weight) in 1999. HFCS now accounts for more than half of the total U.S. sweetener output, with approximately 75 percent of the entire HFCS supply going to the beverage industry. However, HFCS represented only about 6 percent of total U.S. corn usage in 1998. The sugar program has used farm commodity and trade policy instruments to maintain domestic sugar prices at levels that exceed world prices without requiring the government to buy large quantities of domestic sugar. Our economic model analyzed the effects of eliminating the sugar program on prices and production by linking a multimarket domestic sweetener model to a multicountry world sweetener model. We estimated the economic welfareeffects of the program—the gains and losses to the most heavily affected producer and consumer groups—by interpreting the estimated welfare loss (gain) resulting from the elimination of the sugar program as an estimate of the gain (loss) accruing to each group from the presence of the program.Our analysis included the markets for sugar beet and sugarcane production, corn and HFCS production, sugar refining, food processing, and the final consumption of sugar and food products containing sweeteners. In addition, we estimated the net loss to the U.S. economy (economic welfare gains minus losses) resulting from artificially high sweetener prices. This net loss includes economic inefficiencies (known as deadweight losses) and economic rent transfers to foreign sugar exporters. This appendix provides (1) our model’s estimates of the sugar program’s costs and benefits; (2) an overview of our modeling process; (3) a description of the policy simulations used in our analysis; (4) a more detailed discussion of the theoretical economic framework of our U.S. sugar model, including the methods used to estimate welfare gains and losses for participants in the various affected markets; and (5) a description of the data and data sources used. Our model estimated the costs and benefits of the sugar program by comparing—for both 1996 and 1998—the actual domestic and world prices for sugar, HFCS, and other sweeteners with the estimated domestic and world prices if the sugar program were eliminated. Both the estimated costs of the sugar program to sweetener users and the estimated benefits to sugar beet and sugarcane producers were higher in 1998 when the difference between the domestic and world prices for sugar was greater. As shown in table 5, we estimated that the sugar program cost domestic sweetener users—sugarcane refiners, food manufacturers, and final consumers—about $1.5 billion in 1996 and about $1.9 billion in 1998. In our analysis, the distribution of these welfare losses resulting from the sugar program among the sweetener user groups depends on assumptions about the extent to which refiners’ and manufacturers’ cost reductions from eliminating the sugar program would be passed on to consumers. We estimated that the total welfare gains by domestic sugar beet and sugarcane producers were about $800 million in 1996 and about $1 billion in 1998. About 70 percent of these benefits went to sugar beet growers and processors, while the remaining 30 percent went to sugarcane producers. We estimated that HFCS producers did not receive welfare gains from the sugar program in either 1996 or 1998 primarily because (1) HFCS prices have been much lower than the wholesale price of sugar in the United States since 1995 and (2) the possibilities for substitution between sugar and HFCS are more limited than in prior years because technological advances have improved the HFCS product and created more specialized sweetener markets.Thus, HFCS producers would not need to lower their price further to remain competitive if the sugar program were eliminated. In contrast, our 1993 model of the sweetener markets in the late 1980s and early 1990s—when the price of HFCS was considerably higher—found that a fall in the domestic price of sugar would have put pressure on HFCS producers to lower the price of HFCS to remain competitive. As a result, our 1993 model found that HFCS producers received substantial welfare gains from the sugar program. Executives from the Corn Refiners’ Association, which represents HFCS manufacturers, agreed with our results as they pertained to HFCS. They told us that the domestic HFCS market was “decoupled” from the domestic sugar market—HFCS prices are no longer linked to sugar prices, and the soft drink industry has relied on competition among HFCS manufacturers to minimize its sweetener costs. We estimated that the sugar program resulted in net losses to the U.S. economy of about $700 million in 1996 and about $900 billion in 1998 because total welfare losses exceeded gains. These net losses included (1) production and consumption inefficiencies of $300 million in 1996 and $500 million in 1998 and (2) transfers of $400 million in 1996 and in 1998 to foreign countries allocated a portion of the TRQ for sugar imports to the United States. If the sugar program were eliminated, it would be difficult to predict the extent to which or the speed with which intermediate users of sweeteners would pass through lower sugar costs to final consumers. Table 6 presents two estimates of how the benefits of eliminating the sugar program might be distributed based on two different sets of pass-through assumptions. The first set of estimates is based on the assumption that (1) competition would lead sugar refiners to pass cost reductions associated with eliminating the sugar program through to final consumers in the form of lower prices for table sugar but (2) manufacturers of sugar-containing foods would retain their cost savings. Under this “partial pass-through” assumption, final consumers would have gained about $600 million using 1996 data and about $800 million using 1998 data if the sugar program had been eliminated.We chose to present estimates based on this assumption because refined white sugar is more homogeneous than sweetener- containing food goods. With a homogeneous product such as sugar, each brand is almost perfectly substitutable for another. When substitutability between products is nearly perfect, it is more difficult for sellers to insulate their products from the price competition of rivals. In contrast, when products are highly differentiated, as many sweetener-containing food products are, firms may be less able to attract customers from competitors by offering lower prices, so there is less incentive to compete by lowering prices. Instead, firms may use other nonprice forms of competition, such as greater advertising. In addition, in sugar refining, the cost of raw sugar is a much larger share of the total cost of production compared with its share in the production of other food products. Therefore, a change in the cost of raw sugar would be likely to have a larger effect on the price of table sugar than on the prices of sugar-containing products. Our second set of estimates is based on the assumption that competition among both food manufacturers and sugar refiners is such that all cost reductions that would result from eliminating the sugar program would be passed on to final consumers. This “full pass-through” assumption yields an upper bound to the potential savings to consumers. Under this assumption, we estimate that the benefits to final consumers of eliminating the sugar program would have been about $1.5 billion in 1996 and about $1.9 billion in 1998. Table 7 compares actual sugar prices and production in 1996 and 1998 with our model’s estimates, which assume the termination of the sugar program. In particular, our model shows that if the sugar program had been eliminated, the domestic price of raw sugar would have dropped from about 22 cents per pound to about 14.9 cents per pound in 1996 and to about 12.5 cents per pound in 1998, with comparable declines in the wholesale price of domestic refined sugar. We estimated that raw sugar imports would have increased by about 1.1 million tons in 1996 and by about 1.6 million tons in 1998 if the sugar program had been eliminated, reflecting both the increased domestic demand for sugar and the decreased domestic production of sugar beets and sugarcane. Table 8 presents our estimates of the welfare changes that would have resulted from eliminating the sugar program in 1998, using larger supply elasticities than the ones we used to obtain our primary estimates to simulate shorter-term changes. Our supply elasticity estimates are arc elasticities evaluated for 1998 between historical and post-reform values. In particular, our short-run domestic supply elasticities were 0.05 for sugarcane and 0.10 for sugar beets, and our short-run import supply elasticity was 7.26. To obtain longer-term welfare estimates, we used a double Nerlovian domestic supply response with supply elasticities of 0.20 for cane and 0.26 for sugar beets and an import supply elasticity of 10.17. These larger elasticities can be interpreted as longer-term elasticities. Therefore, the resulting estimates from our simulation can be interpreted as the welfare gains and losses after more time has passed for the economy to adjust to the lower sugar prices that would result from eliminating the sugar program. Estimating the welfare gains and losses from the U.S. sugar program requires several steps. First, we simulate the elimination of the program to determine price and production responses in both domestic and international sugar markets. This simulation involves specifying complete U.S. and world sweetener models in the presence of the U.S. sugar TRQ and commodity loan program. To do this, we used Iowa State University’s Center for Agricultural and Rural Development (CARD) world sweetener model (see app. III), which contains the U.S. domestic sweetener economy as one of its component countries. However, we extended and modified the U.S. domestic sweetener model to include a more detailed, multimarket approach, including such markets as corn and feed, sugar, and HFCS. In the U.S. domestic model, we simulated the sugar program’s elimination by removing the TRQ for raw and refined sugar and allowing more domestic demand to be satisfied by lower-priced world imports. Simultaneously, as the U.S. demand for sugar increased, the world sugar prices rose somewhat. We also removed USDA’s loan program for sugar processors and allowed the domestic market prices of sugar to fall below the loan rate levels. After these program changes, U.S. domestic raw sugar prices approximated the world prices. On the supply side of the domestic market, we used the domestic component of the CARD sugar model to estimate the welfare changes due to the change in the price of sugar. The new U.S. raw sugar price filtered through the domestic U.S. sugarcane, sugar beet, corn, and HFCS markets, leading to new production quantities. For each of these producing industries, we measured the changes in realized quasi-profits, or producer surplus, that would result from a change in the quantity demanded and/or the price if the sugar program were eliminated. Within the domestic sweetener model, we estimated welfare changes for a comprehensive demand sector, including sugar processors and refiners, sweetener-using industries, and the final consumer. We estimated the changes in realized quasi-profits resulting from higher sweetener prices for sweetener-using food industries, at the 4-digit Standard Industrial Classification (SIC)level, using economic methods to derive industry cost and demand functions for sugar and HFCS. As part of this analysis, we integrated different assumptions about the market power of these industries. Furthermore, we developed two estimates of the welfare effects on consumers by using different assumptions about the extent to which the benefits of eliminating the sugar program would be passed along to the final consumers of sugar and sweetener-containing products. Consumers are directly affected by the sugar program’s elimination through changes in the prices of both refined sugar and food items containing a significant amount of sweetener that they purchase. We applied an incomplete demand system approach called LINQUADand used an exact welfare measure, equivalent variation (EV),to estimate changes in consumers’ expenditures for these items. Finally, we aggregated all welfare gains and losses from these groups by treating the welfare loss (gain) experienced from eliminating the sugar program as an estimate of the gain (loss) accruing to each group from the presence of the program. The difference between welfare gains and losses accruing from the program is the net loss to the U.S. economy, which consists of (1) transfers to foreign producers that resulted from artificially high prices for the raw sugar they exported to the United States and (2) economic inefficiencies, known as deadweight losses. These inefficiencies resulted from the use of higher-cost domestic resources to produce sweeteners (instead of importing lower-priced sugar) and reduced total sugar consumption. These losses did not redistribute income from consumers to producers. Using this approach, we specified a subset of closely related agricultural markets—sugar, HFCS, and corn—that are important in estimating the welfare gains and losses from the sugar program. We also included the influence of wheat prices on planted sugar beet acreage. One possible limitation of our model is that a more general equilibrium approach of modeling the entire agricultural sector may have been able to give us more long-term effects by, for example, identifying what alternative crops would be produced in the absence of the program or how many producers would leave the industry entirely. However, general equilibrium models take a more broad-brushed approach, often leaving out important market details. Our approach is designed to represent the most important sweetener market relationships with the available data, while keeping the model tractable. The policy scenario for this analysis removes the TRQs for imported raw and refined sugar and USDA’s loan program for sugar processors that supports the price of domestic sugar (see app. IV for a discussion of the economics of the TRQ).Figure 2 shows the effects of removing both the raw sugar TRQ and USDA’s loan program: the first panel (a) represents the domestic raw sugar market, while the second panel (b) represents the world raw sugar market. (a) Domestic raw sugar market (b) World raw sugar market In panel (b), we show two world excess supply situations, ESand ES, corresponding to different trade scenarios. As discussed in appendix IV, in the presence of a TRQ, the United States faces a kinked world excess supply function, as in the bold line, ESrepresents the level of the TRQ, below and beyond which there is a supply response to price by foreign exporters. Moreover, at import levels below the quota, QTRQ, the in-quota tariff applies, and beyond that level, the out-of-quota tariff applies. The other excess supply curve, ES, and ED. The excess demand curve, ED, represents an import demand schedule that intersects the excess supply schedule below the level of the TRQ, while the excess demand curve, EDand the kinked excess supply curve, ES, the excess supply curve without import restrictions in the United States, with imports rising to demand of QFM. Because of USDA’s loan program for sugar processors, however, domestic prices would still not be free to drop to the world price level. Under the loan program, producers would still be eligible to forfeit their sugar to the government and receive the loan rate, PLR. The loan rate mechanism provides a price floor for domestic sugar producers, maintaining domestic sugar prices at the loan level, PLR, as in panel (a). However, with the simultaneous elimination of the TRQ and the sugar loan program, the domestic sugar price is free to fall below the loan rate level. In panel (b) of figure 2, this situation corresponds to a new price and trade equilibrium level. In the domestic market in panel (a), this corresponds to imports increasing from Qto QQ. However, Pand a decrease in freight and refining costs. In general, removing the TRQ for refined sugar would have the same effect as removing the TRQ for raw sugar–the U.S. price for refined sugar would decrease with an increase in imports of refined sugar. A lower U.S. refined sugar price would then cause a decrease in the quantity of domestic refined sugar supplied and a decline in refiners’ demand for domestic raw sugar. This section describes our framework for modeling the economic gains and losses to the various groups affected by the removal of the sugar program. First, we describe the agricultural markets that transform sugar beets and sugarcane into white sugar and corn into HFCS, an alternative to sugar in soft drinks and other food products. The removal of import restrictions under the TRQ would affect the raw cane and refined beet and cane sugar markets by allowing free imports in these domestic markets. Second, we estimate the welfare effects to sweetener processors, such as cane refiners, HFCS refiners, and beet processors. Since a lower price for refined sugar would increase the demand for it and could decrease the use of HFCS, the price of HFCS could also decrease. The lower price for refined sugar would also lead to a decrease in the quantity supplied by refiners, which in turn would decrease the demand for sugar beets and sugarcane and, thus, the price received by their producers. Third, lower prices for refined sugar and HFCS would, other things being equal, lower the cost of production to sweetener-intensive food goods industries. As a result, final consumers would gain from lower prices for these foods as well as a lower price for white table sugar. with l and m summarizing the information on parameters band prices Pand P. +b(P/P) and m =b/P. If the price of a competing crop changes, then l will change as well. and ace are available from the CARD sugar model. If the market price were higher than the loan rate, as it was earlier in the 1990s, then corn farmers would respond to this price. If there were a decrease in the demand for corn caused by reduced HFCS production, corn farmers would lose through a decrease in corn price and production. Therefore, corn farmers would lose: However, when the loan rate is higher than the market price, as it currently is, the price signal perceived by corn farmers is the fixed loan rate. In this case, farmers are eligible to receive loan deficiency payments from the government. where abe denotes the extraction margin parameter in beet sugar extraction. We then estimate the economic welfare effects from changes in sweetener prices for food-processing industries under two scenarios. The first scenario assumes a constant markup, and thus a full pass-through of benefits to consumers of lower input prices and thus output prices. The second scenario holds output prices constant but allows food processors to absorb the lower sweetener costs from eliminating the program in their marginal cost function and thus in their profit margin. where C represents total cost, c~ represents the cost of a composite sweetener (sugar and HFCS), “a” is an intercept term, b is a scaling term, Pis the price of white sugar, PHFCS is the price of high-fructose corn syrup, Qfgi is output produced by food sector i, and A represents information from the prices of other inputs. The derivative of the cost function of the composite sweetener (15), with respect to the price of sugar, is a nonhomothetic transformation of a Cobb-Douglas functional formand represents the output-constant industrial white sugar demand:  '':6L &IJL3V DEa Similarly, the derivative of (15) with respect to HFCS in each food-processing industry represents HFCS demand, HFCSD:  +)&6'L &IJL3+)&6 FE
a +)&6L3for all i in sweetener-using food goods where c is an intercept term and once again b is a scaling factor to calibrate the own-price elasticity of demand between –0.1 and –0.2. where d is an intercept term that reflects the cost of other inputs. Therefore, the price schedule of industry i is: 3IJL ƨL0&IJL Equations (16), (17), (18), (19), and (20) determine the transmission of lower sweetener prices into lower prices Pfgi to consumers of sweetener- containing food goods. Several factors have a role in the price transmission: the cost share of sweeteners in the cost of food processing, the substitution possibilities within sweeteners (fructose and sugar) and between sweeteners and other inputs, and finally the markup and its evolution as prices change (McCorristonet al.).In equation (18), we calibrated to replicate a “historical” marginal cost for the industry using data from the Bureau of Economic Analysis on output price indexes for 4- digit SIC industries 2023 to 2099. The historical marginal cost is estimated to be the historical price divided by 1.2, or a constant 20-percent markup of price over marginal cost. We use a 20-percent markup of price over marginal cost as this figure is well within the estimates of other analysts for the food manufacturing sector. IJL@`>0ƮZV3 Thus, we compute the change in expenditure, that would produce a change in utility equivalent to the price changes, with superscripts 0 and 1 denoting initial and final prices. Finally, we list the welfare gains and losses from the presence of the sugar program accruing to the various groups represented in the model. This net welfare loss that results from the sugar program consists of (1) production and consumption inefficiencies and (2) the transfer of rents to foreign suppliers. On the supply side, all data, parameters, and extraction rates used in the U.S. component of the world sugar model are from CARD. To estimate welfare effects for the food-processing industry, we identified a subset of 21 sweetener-using industries at the 4-digit SIC level (2023 to 2099). We took these industries from the major categories of (1) dairy and frozen desserts, (2) canned and preserved fruits and vegetables, (3) bread and bakery products, (4) confectionery and chocolate products, (5) beverages, and (6) miscellaneous food products industries. To calculate the demand and marginal cost for sweeteners from these industries, we used data on the value of shipments for each industry, the price of sugar and HFCS, and the total quantities of sugar and HFCS sold for the years 1996 and 1998. For 1998 HFCS cost data, we scaled each industry proportionately, using 1997 Bureau of the Census data, to reproduce the exact total disappearance of HFCS in 1998. For 1996 HFCS data, we used cost data on corn sweeteners from the Bureau of Economic Analysis. We obtained price data for sugar, HFCS-42, and HFCS-55 from USDA and industry sources. For the LINQUAD model of final consumer demand, we used producer price index data from the Bureau of Labor Statistics for each of our 21 4-digit SIC industries. We rebased the index numbers such that 1992=100. We then divided each index number by the consumer price index number for that year, also based with 1992=100, to capture how prices for each food group compared with prices in the overall economy. USDA provided data on total deliveries of sugar and HFCS. As previously noted, we obtained data on income elasticities and own- and cross-price elasticities from several sources in the economics literature. Our analysis replaced the U.S. sugar module of the CARD model with the model described in app. II. Per-capita sugar consumption = f(RSP, PCRGDP), and Ending stocks = f(ESt-1, SC, RSP), with AH denoting acreage, RSPP the cane or beet price, RGP the price of alternative crops, PCRGDP real income per capita, ES ending stocks, SC sugar consumption, and RSP the real raw sugar price. In many countries, beet or cane prices are set by policy and can be treated as predetermined. Because some countries lack information on the agricultural price, the model uses the raw cane sugar price, RSP, instead of the agricultural price in specifying the acreage response. In some countries, yield improvements are captured by a time trend. Although the CARD model in general can be used in either a dynamic or static framework, we used its static version. In this way, the CARD international sugar model uses contemporaneous price responses in supply, consumption and inventory demand. Lagged acreage is fixed at the previous year level in the acreage equations. Short-term supply elasticities are based on the short-term price responses of the acreage equations, which reflect the cost of adjustment between desired acreage and actual acreage. Long-term responses are obtained by using the Nerlovian long- term response, which is the short-term response divided by the partial adjustment coefficient of the corresponding acreage equation. In addition, the elasticity values our analysis uses are arc elasticities evaluated for 1998 between the historical and post-reform levels. We obtained data for the area harvested, yield, and sugarcane and sugar beet production from the Food and Agricultural Organization of the United Nations and data for sugar production, consumption, and ending stocks from USDA’s Production, Supply, and Distribution database. Cane and beet production is tied to sugar production through the extraction rate. We obtained macroeconomic data, such as the real gross domestic product, consumer price index, population, and exchange rate from sources including the WEFA Group; Project Link; and S&P/DRI. We estimated the model for the period 1980 through 1998. We used simple linear specifications and ordinary least squares in the estimation of these equations to save degrees of freedom, given the short time series used. This estimation approach overlooks the potential endogeneity of each country’s domestic sugar prices and treats them as exogenous in estimating acreage response equations. The Caribbean raw sugar price is generally considered to be the world market price. Most elasticities in the CARD model are comparable to those used by Devadoss and Kropf (1996), Hafi et al. (1993),and Wohlgenant (1999).The lagged own-price supply elasticities for sugarcane for Australia (0.02), Brazil (0.07), Colombia (0.05), Cuba (0.01), Guatemala (0.02), Mexico (0.002), South Africa (0.005), and Thailand (0.014) are highly inelastic in the short run. This is consistent with the fact that these countries are large producers of sugarcane and exporters of sugar and can harvest several annual crops, called ratoons, from one planting of sugarcane. Therefore, there is limited acreage adjustment to price fluctuations in the short run. These low elasticities are largely the result of the historical policy of acreage allotment. The own-price supply elasticities for sugar beet production are generally not as inelastic as they are for sugarcane, except for the former Soviet Union (0.002). The own-price demand and income elasticities reflect the fact that in many developing countries, sugar is considered a staple in the diet and consumers look to sugar to fulfill basic caloric requirements. The elasticities implied in the CARD model are very comparable to ones reported in the literature. For several countries, when more recent data were not available for the econometric estimation, we borrowed elasticities from Hafi et al. (1993) and from Devadoss and Kropf (1996). Although the CARD international sugar model does not disaggregate raw and refined sugar, we complemented the existing model with an additional equation to endogenize the world price of refined sugar following the removal of the refined sugar TRQ in the United States. Consistent with Hafi et al. (1993), we specified a reduced form to approximate the rest-of-the- world supply faced by the United States. However, there is no explicit aggregation of excess supply in the various countries to derive this equation, as is the case for the raw sugar market. This equation is of the form IWSrow =a(Pwws)ws (Pwrcs)cs where IWS is imports of white sugar and the elasticities of white sugar and raw cane sugar are a ws = 0.83 and b cs = -0.44, respectively. These elasticity values come from Hafi et al. (1993) and are medium-run estimates. Parameter a is chosen to calibrate the IWS to the existing refined sugar TRQ level in the United States, prior to the TRQ’s removal. This equation is treated as the rest-of-the-world supply, which underlies the import supply faced by the United States. The latter is then equated to the U.S. excess demand for white sugar to close the white sugar market in our analysis, once the TRQ is removed. The sugar program includes the use of a TRQ to limit imports of raw and refined sugar that come into the United States. Under a TRQ, a lower, “in- quota” tariff applies to a limited quantity of imports, while a higher, often prohibitive, “over-quota” tariff applies to any imports that exceed the quota. Our model follows Moschini,as well as Meilke and Lariviere,in its representation of the import supply under a TRQ. G. Moschini, "Economic Issues in Tariffication: An Overview," AgriculturalEconomics,Vol. 5 (1991), pp. 101-120. Karl Meilke and Sylvain Lariviere, “The Problems and Pitfalls in Modeling International Dairy Trade Liberalization,” Working Paper #99-3, International Agricultural Trade Research Consortium (Mar. 1999). We employed the “large country” assumption in our analysis of excess supply under a TRQ, in the sense that changes in U.S. imports would be sufficient to affect international prices. Thus, the excess supply curve is upward sloping at import volumes in ranges other than where the TRQ is binding. the quota rights corresponding to the binding TRQ. In this case, the quota rent will be equal to the difference between the domestic price and the world price. This situation corresponds to the current U.S. sugar import situation. Third, if the excess demand schedule intersects the excess supply schedule sufficiently beyond the TRQ, such as ED, both the price and the quantity of imports supplied will respond to shifts in the excess demand for the imports and the rest of the world will satisfy this demand. The following are GAO’s comments on the U.S. Department of Agriculture’s written response to our draft report dated May 16, 2000. Based on agency and industry comments, we adjusted our model to more fully account for certain transportation costs. As a result, cost and benefit estimates referenced in USDA’s comments do not reflect those contained in the final report. 1. After thoroughly examining each of the Department’s concerns and discussing them with experts outside GAO, we continue to believe that our analytical approach and model for estimating the costs and benefits of the sugar program are comprehensive and methodologically sound and that the estimates yielded by our model are reasonable. In developing the model, we took a number of actions to ensure that it was methodologically sound. First, we contracted with a well-known expert in modeling the international trade of agricultural commodities and with a prominent agricultural economist to work with us in developing the model. In December 1999, we sent our proposed model to four outside academicians specializing in agricultural economics and international trade economics and revised the model in response to their comments. We also sent our proposed model to USDA for review at that time. However, USDA did not provide any comments. Furthermore, we asked two of the agricultural economists to review our final model and results before we sent our draft report to USDA for comment. 2. Our approach is not strictly based on a traditional “gains-to-trade” argument, and its validity does not depend on world prices being free of market distortions. We did not distinguish between the effects of comparative advantage and export subsidies or other forms of market intervention in determining the price at which U.S. sugar users would be able to purchase sugar. To estimate the costs and benefits of the sugar program, our model compared baseline domestic and world prices for sugar in 1996 and 1998 with the domestic and world prices that we estimated would occur if the sugar program were eliminated, other things being equal. These estimated prices were higher than the baseline world prices because our model accounted for the impact on world prices of the higher U.S. sugar imports that would have occurred if the program had been eliminated. Comparing these estimated prices with the baseline prices was appropriate for estimating the effects of the sugar program because the estimated world prices reflect what domestic sugar users would have been expected to pay for sugar in those years if the sugar program had been eliminated. This comparison remains appropriate regardless of whether the world price is influenced by subsidies by countries with surplus production. 3. While the world sugar price that would result from multilateral reform is uncertain, we believe that several elements of the Schmitz and Vercammen analysis (University of California, Berkeley, 1990) led to a high price estimate that is unlikely to be observed. In particular, they assume a relatively high (in absolute value) excess demand elasticity of - 0.5 and a very inelastic excess supply schedule from the rest of the world. That is, they assume that a small increase in the world price will lead to a large reduction in the quantity of sugar demanded but only a small increase in the quantity of sugar that producers in other countries would want to supply. Both assumptions tend to cause the world price to rise more following multilateral reform than would happen if assumptions of less elastic excess demand and more elastic excess supply were used. Schmitz and Vercammen also overstate the world price that would follow multilateral reform because they do not account for the supply responses of all exporting countries. 4. On the basis of our review of the literature, we believe that the effect of multilateral reform of sweetener markets on world sugar prices is highly uncertain. Even if world prices were to rise, this increase would likely be gradual because the reforms would likely be phased in over a substantial period of time. Therefore, we regard as speculative USDA’s view that multilateral reform following the elimination of the U.S. sugar program would erase the welfare gains that we attributed to the program’s elimination. 5. We disagree with USDA’s assertion that our model is not well documented and includes incomplete references. However, we added language to the scope and methodology section of our report to explain further the relationship between the model we used in our analysis and the CARD model. 6. We clarified where on the linear supply schedule the supply elasticities that we use were estimated. 7. We disagree with USDA that the import supply elasticities are inconsistent with our model. We clarified our report to indicate that these elasticities are derived explicitly from the CARD model, which includes the sugar sectors of the countries listed in appendix III. 8. We disagree with USDA’s assertion that our model presumes instantaneous and costless adjustments within the United States. In fact, our short-run elasticities are smaller than our longer-term elasticities because they take adjustment costs into account. However, we added clarifying language to appendix III. 9. We disagree. Our draft report defined each of the symbols describing the variables used in the LINQUAD model. 10. We disagree with USDA’s assertion that the LINQUAD model is experimental and not well documented. The LINQUAD approach is the latest development of the incomplete demand system approach pioneered by Professor Jeffrey LaFrance at the University of California, Berkeley. The LINQUAD approach is fully documented in several working papers that are publicly available, and Professor LaFrance’s work on incomplete demand systems has appeared in many leading economics journals. Professor LaFrance first published his results in 1990 in an article of the AustralianJournalofAgriculturalEconomics. The method was first empirically implemented in an application to dairy in a 1991 article of the AmericanJournalofAgricultural Economics. The model was also documented in a thesis that received the American Agricultural Economics Association’s OutstandingThesis Awardin 1999. The incomplete demand system model was appropriate for our work in modeling sugar demand because it allowed us to compute a consistent welfare measure that included direct and indirect sugar consumption in food. 11. We disagree that our model’s treatment of the sugar-processing sector was inadequate. Although no equations for sugarcane and sugar beet acreage are presented in the report, our model solves for acreage as well as prices and production levels. We clarified this point in appendix II. 12. We disagree with USDA’s characterization of equation 15 (now equation 13). This equation establishes a condition that must be met for the model to solve—at the margin, the cost of producing more white cane sugar and more beet sugar must be equal to each other and to the price of white sugar. Although we do not explicitly model the decision to exit the industry, the parameter representing the refining margin takes into account changes in output. 13. Our draft report inadvertently reported slopes rather than elasticities. We revised the report to present the correct elasticities, which are much lower. The supply response reported in table 7 is consistent with these lower elasticities. 14. We agree with USDA that the revenues that producers receive are based on contracts with processors. However, we believe that the contractual arrangements, and the sugar program itself, lead to stable price expectations for producers that are captured in equations 3 and 4 (now equations 1 and 2) — producers’ supply functions. In our model, prices at all stages are determined simultaneously by the satisfaction of equilibrium conditions in all markets. 15. We do not think that producers’ ownership of processing plants is an important issue in our analysis. If producers’ ownership were an important influence on the supply responses of producers to price changes, the expected direction of that influence would be to make supply less elastic (that is, producers might reduce supply less in response to a price decline than if they did not own the processing plants). We do not believe that incorporating this possibility into our model would have much effect because the supply elasticities we use are already low. 16. The requirement for minimum payments from processors to producers is not a concern for our model because the supply decisions in our model are calibrated using historical data that include minimum payments when relevant. 17. We added language to the report to clarify that the model’s assumption of constant returns to scale in sugarcane processing implies that there are no welfare changes to sugarcane processors from price changes due to the elimination of the sugar program. Accordingly, we did not report any welfare effects. 18. We disagree with USDA that conducting the analysis at the national level implies any misspecification of our model, although we agree that more detail about regional production might be interesting. Our model does not specifically account for regional differences in cost structure or alternative crops and we agree with USDA that producers in different regions would be affected differently. Nevertheless, we remain confident that our model measures the total effects of the U.S. sugar program appropriately. 19. We revised our discussion of equation 20 (now equation 18) to say that the intercept term represents the cost to food manufacturers of inputs other than sweeteners (rather than a reflection of market power). As shown in equation 22 (now equation 20), market power results in a markup of price above marginal cost. 20. We added a definition of “conjectural variation” and explained how this parameter of market interdependence is related to industry markup. 21. We disagree with USDA’s assertion that our model did not include some of the factors cited by McCorriston et al. For example, our model includes the influence of the retail price elasticity of demand on price pass-through. It also includes the influences of substitution between sugar and HFCS and the cost share of sweeteners in food products, but it does not include the role of marketing inputs. 22. We clarified that the ESsupply curve in figure 2 (and the ESsupply curve in figure 3) refer to the excess supply curves that would exist in the absence of import restrictions in the United States. They were not meant to represent excess supply curves that would result from free trade in all world sugar markets. 23. USDA’s conjecture that the domestic sugar industry could successfully pursue an antidumping action that would raise the price of foreign sugar for U.S. sugar users is speculative. Accordingly, we believe that it is appropriate to compare baseline prices with estimated world prices in the absence of the program, other things being equal, as we have done. See comment 2. 24. See comment 3. 25. We do not question the objective of pursuing international trade reform and free world markets through trade negotiation. To estimate the effects of the U.S. sugar program in this report, we needed to make the analytical assumption that all other factors, including other countries’ sugar programs, would remain unchanged. If we had not done so, we would not have been able to separate the effects of the U.S. program from those of other countries’ programs. Accordingly, when we say that domestic sugar prices are artificially high, we mean in comparison with the prices that would prevail if the U.S. sugar program were eliminated and other conditions remained unchanged. See also comment 37. 26. We disagree with USDA and stand behind our finding that eliminating the sugar program would have a limited impact on the price of HFCS. While HFCS producers benefited from the sugar program in the 1980s and early 1990s, we believe that the domestic HFCS and sugar markets have since been decoupled because of domestic price, cost, and market conditions. The president of the U.S. Corn Refiners’ Association has also expressed that view. As shown in table 4 in appendix I, the weighted average wholesale price of HFCS dropped from 22 cents per pound (dry weight) in 1992 to 12.4 cents per pound (dry weight) in 1998, while the U.S. wholesale price of refined beet sugar was above 25 cents per pound throughout this period. The likelihood of substitution between sugar and HFCS is less than in prior years because technological advances have improved HFCS products and created more specialized sweetener markets. 27. We revised appendix II to clarify that the functional form we used does not imply that the cost shares of sugar and HFCS need to remain constant as the price of sugar changes. 28. We added references to the literature on the price elasticity of demand for sugar and HFCS. 29. We added language to the report to indicate that the lack of substitution between sugar and HFCS is due not just to the relative prices of the sweeteners but also to the increasingly specialized uses of sweeteners, which have limited the substitutability between sugar and HFCS. 30. In our model, the relationship between raw and refined sugar prices depends on the refining margin as well as on technical coefficients involved in the refining process. Since the refining margin will be smaller at lower levels of output, our model takes into account the lower margins for domestic cane refiners that will result from increased imports of refined cane sugar. 31. We disagree with USDA’s assertion that we have not adequately analyzed the increased competition that the domestic refining industry could face as a result of the elimination of the refined sugar TRQ. If imports of refined sugar increased following the elimination of the refined sugar TRQ, the refining margin for domestic refiners would decline, according to our model. See comment 30. 32. Our report does not predict the degree to which cost reductions resulting from the elimination of the sugar program would be passed through to consumers. We present two estimates of potential benefits to consumers based on different assumptions about the pass-through of cost reductions from food manufacturers to consumers; both estimates are based on a full pass-through of cost reductions for the production of table sugar. For reasons given in the report, we believe that a full pass-through is more likely for table sugar than for sugar-containing products. In estimating potential benefits, we assumed “other things being equal” (no other changes in input costs) while the data that USDA presents on changes in wholesale and retail prices do not. Changes in the prices of marketing inputs could have offset the reduction in wholesale prices in determining retail prices. 33. It is unclear what effect accounting for marketing inputs would have had on our results. 34. See comment 32. 35. We disagree with USDA’s assertion that a comparison of our estimate of the benefits that sugar beet growers receive from the program with data on growers’ revenues and expenses implies that our estimate is clearly overstated. The benefits of a program that keeps price substantially higher than it otherwise would be can be very high in the short run, when supply elasticities are low. In the long run, the benefits of maintaining the sugar program are less because in the absence of the program a wider set of adjustment opportunities would be available to producers, implying larger supply elasticities. 36. We revised the report to address USDA’s concern. 37. We disagree that our characterization of domestic sugar prices as artificially high is inflammatory and unprofessional. The sugar program keeps domestic sugar prices above the level at which they would be if the program were eliminated (other things being equal), which is what we mean by artificially high. Furthermore, USDA has some flexibility in its implementation of the sugar program, and our report entitled Sugar Program:ChangingtheMethodforSettingImportQuotasCould ReduceCosttoUsers(GAO/RCED-99-209, July 26, 1999) found that, from 1996 through 1998, domestic sugar prices were over 2 cents per pound higher than necessary to avoid sugar loan forfeitures. 38. We agree that the current conditions in sugar markets differ from those observed in 1996 and 1998. However, 1998 was the most recent year for which price and quantity data were available for our analysis when we began our study. As stated in the report, our estimates apply only to 1996 and 1998. 39. We agree that the North American Free Trade Agreement has the potential to significantly influence the operation of the sugar program and the domestic sugar market. We note in appendix I that USDA will spend substantial federal funds this fiscal year because the sugar program has resulted in significantly increased domestic sugar production—USDA recently announced that it will seek to purchase 150,000 tons of domestic sugar to reduce the cost of expected sugar program forfeitures. Because of our need to establish a base case for our economic model, we examined 1998, the most recent year for which sweetener price and quantity data were available. Accordingly, we state on page 4 of our report, “we did not analyze how the gradual reduction of U.S. tariffs for Mexican sugar through 2008 under the North American Free Trade Agreement might affect domestic sugar prices. However, our model could be used for this analysis as well as other types of analyses in the future.” 40. The comments of former Under Secretary Moos on our 1993 report contrast with USDA’s official written comments in 1993 (included as an appendix to the 1993 report), which state, “Overall, this is a reasonable report with no major data problems. The costs and benefits, derived using assumptions of hypothetical policy alternatives, are well within the range of most research.” We continue to believe that our 1993 report provided a reasonable estimate of the cost of the sugar program to U.S. sugar users for the period analyzed. More important, we believe that although the precise level of the price premium is subject to debate, the program and policy problems we identified in 1993 are still relevant. 41. In preparing this report, we developed a more comprehensive model than the one we used for our 1993 report. Under our current approach, the estimated prices that would exist in the absence of the sugar program were derived by our model rather than assumed from outside the model, as was done for the 1993 report. Comparing these estimated prices with the baseline prices was appropriate for estimating the effects of the sugar program because the estimated world price reflects what domestic sugar users would have been expected to pay for sugar in those years if the sugar program had been eliminated. To estimate the effects of the U.S. sugar program by itself, we needed to make the analytical assumption that all other factors, including other countries’ sugar programs, would remain unchanged. Without this assumption, we would not have been able to isolate the effects of the U.S. program from the effects of other countries’ programs. In preparing the 1993 report, if we had chosen to use a price that seemed more consistent with the elimination of the U.S. program alone, we might have selected a lower price for the “no program” scenario, which would have led to higher estimates of the cost of the program to sugar users and the benefits to producers. 42. We revised the report to address USDA’s concern. 43. We revised the report to indicate that while the minimum requirement of the refined sugar TRQ is 30,900 tons, USDA has set the TRQ above this level in recent years. 44. We revised the report to address USDA’s concern. The Agriculture Appropriations Act for fiscal year 2000 suspended the sugar marketing assessment for fiscal years 2000 and 2001. 45. We revised the report to address USDA’s concern. 46. We revised table 1 to note that the basis point for the world raw sugar contract price is the Caribbean. According to a sugar market expert, the cost to transport raw sugar from the Caribbean to the United States is about 1.5 cents per pound. We also refined our model to more fully account for these transportation costs in our welfare analysis. 47. We revised the report to address USDA’s concern. 48. We did not include a line in table 5 for the revenues that the federal government derives from sugar marketing assessments because those revenues represent only part of the sugar program’s financial effects on the federal government. For example, other effects include increases in the government’s costs of purchasing food and conducting food assistance programs because the prices for sugar and sugar-containing foods are higher under the sugar program. Several years ago, we estimated that the government’s additional cost of purchasing food and providing the level of food assistance that it delivered in 1994 was approximately $90 million. At that time, the government collected about $30 million annually in marketing assessments. 49. We did not include a line for the benefits of the sugar program to sugarcane processors because they would see no welfare change from the elimination of the sugar program. See comment 17. The cost reported in table 5 for HFCS manufacturers and corn growers is very small; in general, the sugar program has little effect on these groups because of the decoupling of the sugar and HFCS markets. See comment 26. 50. We adjusted our model to more fully account for certain transportation costs. As a result, the 1996 estimated U.S. wholesale refined sugar price without the sugar program increased from 20.5 cents per pound in the draft report to 21.77 cents per pound in the final report. This revised price is higher than the 1996 average price of HFCS-55 of 20.6 cents per pound. To further clarify our model’s results, the final report states that specialization in sweetener use was also important in estimating the effect of the sugar program on HFCS producers. See comment 29. 51. We continue to believe that transfers to foreign sugar producers that receive quota allocations are appropriately treated as a component of estimated net losses to the U.S. economy due to the sugar program. The additional revenues that they receive from higher prices as a result of the program represent a transfer outside the United States and, therefore, are a net loss to the U.S. economy. By suggesting that these transfers are more of a foreign policy issue than a sugar program issue, USDA implies that in the absence of the program the United States would provide the quota-holding countries with other forms of assistance equal to the benefits their producers currently derive from the program. We believe such a conclusion is speculative. 52. Although the estimated refining margin for 1996 is high, it is not as high relative to other years once adjustments are made for price level differences (see table 1 in app. I). Our estimate of 6.89 cents per pound for 1996 is in 1999 dollars. Expressed in 1999 dollars, the 14-year high (achieved in 1990) was 5.73 cents per pound, not 4.77 cents. Nonetheless, one limitation of our model is that the world refined and raw sugar markets are not fully linked. If our estimated price for refined sugar without the program is too high relative to the estimated no- program price for raw sugar for 1996, the implication is that we have overestimated the benefits to refiners and underestimated the benefits to other sugar users (food manufacturers and consumers) from eliminating the sugar program. 53. See comment 13. 54. We revised the report to address USDA’s concern. 55. Our model does not conduct a general equilibrium analysis to determine the effects of eliminating the sugar program on the prices of other crops because of acreage being transferred from sugar to these other crops. However, we believe that any transfers out of sugar would likely have minimal effects on the total production of most other crops because of the relatively small acreage involved compared with the acreage already planted in those crops. 56. We added language to the report to show that the 20-percent markup we use is consistent with what others have used in their analyses. The following are GAO’s comments on the American Sugar Alliance’s (ASA) written response to our draft report dated May 5, 2000. Based on USDA and industry comments, we revised our model’s final estimates to more fully account for certain transportation costs. As a result, cost and benefit estimates referenced in ASA’s comments do not reflect those contained in the final report. 1. We disagree that the methodology used in our 1993 report on the sugar program was flawed. Nonetheless, we developed a more comprehensive economic model for our current analysis, and while we acknowledge that no economic model completely depicts reality, we are convinced that our current model is methodologically sound and that the estimates yielded by our model are reasonable. In developing the model, we took a number of actions to ensure that it was methodologically sound. First, we contracted with a well-known expert in modeling the international trade of agricultural commodities and with a prominent agricultural economist to work with us in developing the model. In December 1999, we sent our proposed model to four outside academicians specializing in agricultural economics and international trade economics and revised the model in response to their comments. We also sent our proposed model to USDA for review at that time. However, USDA did not to provide any comments. Furthermore, we asked two of the agricultural economists to review our final model and results before we sent our draft report to USDA, ASA, and the U.S. Cane Sugar Refiners’ Association for comment. 2. We disagree with ASA’s assertion that our findings are based on comparisons with a meaningless world price. In estimating the costs and benefits of the sugar program, our model compared baseline domestic and world sugar prices with an estimate of the domestic and world prices that would have been observed if the sugar program had been eliminated, other things being equal. Regarding the extent to which cost reductions would be passed through to consumers in the absence of the sugar program, the report presents two estimates showing how the benefits might be distributed based on two different sets of pass-through assumptions. We did not predict the extent to which cost reductions would be passed through to final consumers. See comments 4 and 5. 3. We disagree that our report is biased toward the views of the sugar program’s critics. We used a standard economic welfare analysis methodology that many economists have applied to evaluate how different groups within a society are affected by specific economic policies.Our report provides a quantitative analysis of the U.S. sugar program’s effects, but we do not take a position on what modifications, if any, need to be made. Those decisions rest with the Congress. See comment 5 for a discussion of our assumptions about manufacturers’ and retailers’ behavior in passing through cost reductions. 4. As discussed in comment 2, we disagree with ASA’s assertion that our findings are based on comparisons with a meaningless world price. Our model estimated domestic and world sugar prices in the absence of the program. These estimated prices were higher than the baseline world prices because our model accounted for the impact on world prices of higher U.S. sugar imports that would have occurred if the program had been eliminated. Comparing these estimated prices with the baseline prices was appropriate for estimating the effects of the sugar program because the estimated world price reflects what domestic sugar users would have been expected to pay for sugar in those years if the sugar program had been eliminated. This comparison remains appropriate regardless of whether the world price is influenced by subsidies by countries with surplus production or whether sugar is produced in countries with lower labor and environmental standards. 5. As discussed in comment 2, we disagree with ASA’s assertion that our findings are based on the assumption that food manufacturers and retailers would pass all of their cost reductions through to final consumers. Our report estimated the total cost of the sugar program to sweetener users—sugarcane refiners, manufacturers of sugar- containing foods, and final consumers. We did not predict the extent to which cost reductions would be passed through to final consumers. Instead, we presented two estimates of the benefits to consumers if the sugar program were eliminated, using different assumptions about the pass-through of cost reductions. One estimate assumed that (1) cost reductions for table sugar were passed through to final consumers (because it is a homogeneous product and likely to be more price competitive) but (2) cost reductions for sugar-containing food were not passed through. The other estimate, which shows the maximum benefit that consumers could receive, is based on the assumption that all cost reductions were passed through to consumers. We revised our discussion on page 4of the pass-through of cost reductions if the sugar program were eliminated to further clarify the effects under alternative pass-through scenarios. 6. We agree with ASA that other countries intervene in the world sugar market. However, to estimate the effects of the U.S. sugar program by itself, we needed to make the analytical assumption that all other factors, including other countries’ sugar programs, would remain unchanged. Without this assumption, we could not isolate the effects of the U.S. program from the effects of other countries’ programs. Our estimates represent the actual cost of the sugar program to the U.S. economy under conditions as they were in 1996 and 1998. 7. As discussed in comment 6, we did not attempt to estimate the free trade price of sugar. In addition, as discussed in comment 4, we believe that the appropriate price comparison is between baseline domestic and world sugar prices in 1996 and 1998 and an estimate of the prices that would have been observed if the sugar program had been eliminated, other things being equal. 8. As stated in the objectives, this report focuses on the U.S. sugar program’s (1) costs to domestic sweetener users, (2) benefits to domestic sugar and HFCS producers, and (3) net effects on the U.S. economy. Both the resport’s letter and appendix II present the results of our model, including the estimated benefits to sugarcase, sugar beet and HFCS producers. However, our model does not attempt to quantify every indirect cost and benefit associated with the program. See comments 13 and 17. 9. We disagree with ASA that our estimates of the net costs of the sugar program are “misleadingly high.” See comments 10 and 11. 10. We disagree that transfers from the U.S. economy to foreign sugar producers should not be considered as a component of the estimated net losses associated with the sugar program. From the perspective of the U.S. economy, higher prices paid by domestic sugar users and received by domestic producers and processors as a result of the program are internal transfers with no net effect. However, foreign producers selling sugar in the United States also receive higher prices because of the program. The additional revenues they receive as a result of the program represent a transfer outside the United States and, therefore, are a net loss to the U.S. economy. Whether the United States would incur similar costs if the sugar program did not exist in the form of either direct aid to countries whose producers are benefiting from the program or costs resulting from instability, as suggested by ASA, is speculative. 11. We disagree with ASA’s assertion that our model assumes that U.S. sugar producers are inefficient. The types of efficiency losses we discuss occur when efficient producers produce too much of the wrong crop, or consumers consume too little of certain foods, because government programs maintain artificially high prices. 12. The report does not state that sugar production is a less efficient use of resources than any other agricultural enterprise. 13. We agree that we did not estimate the effects on other crops if acreage were transferred out of sugar, but we disagree that not doing so was egregious. Our model does not conduct a general equilibrium analysis to determine the effects on acreage and price of all other commodities. However, we believe that any transfers out of sugar into other field crops would likely have minimal effects on total production because of the relatively small acreage involved compared with the acreage already planted in those crops. For example, a transfer of 33 percent of sugar beet acreage into hard red spring wheat acreage, would have increased the hard red spring wheat acreage by only about 3 percent in 1998. See comment 17. 14. We disagree. Using generally accepted economic principles, total U.S. consumption of sugar and sweetener-containing products would rise, other things being equal, as U.S. sugar prices were reduced. 15. In the absence of the sugar program, we believe that it is unlikely that no cost reductions would be passed through to final consumers, particularly in the case of table sugar. In our analysis, we assumed “other things being equal” (no changes in other input costs), while the data that ASA presents comparing prices at different levels—especially for sugar-containing foods—do not. Changes in the prices of other food inputs between 1990 and 1999 could have been more important and could have overwhelmed the effect of declining wholesale refined sugar prices on retail prices. Moreover, wholesale refined sugar prices did not stay down continuously over the entire decade, but increased again in 1996, 1997, and 1998. See comment 5. 16. We recognize that the demand for table sugar and many sugar-related products is relatively inelastic with respect to price (that is, price increases will lead to only relatively small declines in consumption), and we included these assumptions in our model. However, we disagree with ASA’s assertion that there would be no effect on consumption at higher prices. 17. We recognize that we did not consider indirect effects associated with the elimination of the sugar program in our analysis. These effects could include losses to some groups, as suggested by ASA, but could also include gains by other groups. For example, if sugar users paid lower prices for sugar, they would be able to spend more on other items, which could lead to increased economic activity in some other sectors. Our approach estimated the program’s major costs and benefits, while still maintaining tractability as well as appropriate market detail. A general equilibrium analysis would take both these gains and losses into account. We added to the report a discussion of the differences between the partial equilibrium approach we used and a general equilibrium analysis, indicating that using the latter approach would require sacrificing considerable detail. 18. We did not assess the competitiveness of U.S. sugar producers relative to producers in other countries. We assessed the costs and benefits of the sugar program in the context of the world market in 1996 and 1998. See also comment 6. 19. See comment 11. 20. We disagree that comparing U.S. and foreign retail sugar prices would have been the most direct way to assess the effect of the U.S. sugar program on consumers. Retail sugar prices in other countries do not represent the price at which U.S. sugar users could have obtained sugar in the absence of the program, which is the appropriate price to compare with current U.S. prices (see comment 4). As a result, we did not compare U.S. retail sugar prices with other countries’ retail sugar prices. However, ASA’s chart C shows that countries whose retail sugar prices were higher than the U.S. prices are mostly countries from the European Union and Japan, where support for sugar producers is also high. (The Organization for Economic Cooperation and Development estimates that sugar consumer support in the European Union was even higher than in the United States in 1998.) Chart C also shows that retail sugar prices in Australia and Canada, which have relatively free trade in sugar, were lower than prices in the United States and the other countries shown. 21. The minutes worked analysis in chart D may be a misleading indicator of low sugar prices for U.S. consumers in comparison with consumers in other countries. This analysis appears to be more dependent on a country’s average wage rate than on the retail price of sugar in explaining the differences in the minutes of work required to buy a pound of sugar among countries. See also comment 20. 22. We agree that U.S. sugar processors have not forfeited sugar to the government since 1994. However, USDA recently announced plans to purchase 150,000 tons of sugar to reduce the cost of expected sugar program forfeitures this fiscal year. 23. We revised the report by adding these increased assessments to the list of the 1996 Farm Act’s modifications. According to a USDA official, the assessment on processors raised revenues of about $30 million in fiscal year 1998 but has been suspended for fiscal years 2000 and 2001. We note, however, that these revenues represent only part of the sugar program’s financial effects on the federal government. The higher domestic cost of sugar increases the government’s expenditures for the military’s food purchases and for funding domestic food assistance programs. Several years ago, we estimated that the sugar program increased the government’s expenditures for these purposes by about $90 million in 1994. 24. As discussed in comment 31, we disagree with ASA’s statement that we underestimated the number of U.S. sugar producers. As discussed in comment 28, we also disagree with ASA’s assertion that the corn sweetener industry continues to benefit from the sugar program. 25. We disagree with ASA that the benefits received by producers are derived “theoretical” benefits. Gains that result from higher prices paid by sugar users—rather than from direct government payments to producers—are nonetheless real gains in income to producers and are a direct result of the sugar program. 26. The production and acreage levels we report were the results of our simulation of the impact of eliminating the sugar program, as estimated by our model. We agree with ASA that over time, larger production responses are likely to result than in the short run. 27. We revised page 25 of the draft report (now on page xx) to clarify that our model analyzed the HFCS market to determine whether lower refined sugar prices resulting from the program’s elimination would cause a substitution from HFCS to sugar in certain markets for sugar- containing products. We found that eliminating the sugar program had a limited effect on the HFCS market. See comment 28. 28. We disagree with ASA’s assertion that refined sugar from the world market would replace HFCS if the sugar program were eliminated. While HFCS producers benefited from the sugar program in the 1980s and early 1990s, we believe that the domestic HFCS and sugar markets have since been decoupled because of domestic price, cost, and market conditions. The president of the U.S. Corn Refiners’ Association has also expressed this view. As shown in table 4 in appendix I, the weighted average wholesale price of HFCS in the United States dropped from 22 cents per pound (dry weight) in 1992 to 12.4 cents per pound (dry weight) in 1998, while the U.S. wholesale refined beet sugar price was above 25 cents per pound throughout this period. In particular, for 1998, the higher-priced HFCS-55 (13.43 cents per pound) was below our model’s estimated world refined sugar price (14.12 cents per pound) if the sugar program were eliminated. Furthermore, the likelihood of substitution between sugar and HFCS is more limited than in prior years because technological advances have improved the HFCS product and created more specialized sweetener markets. See also comments 24 and 27. 29. Although the 1996 Farm Act made some changes to the sugar program, we disagree that it substantially pared back the U.S. sugar program because the basic structure of USDA’s loan program and the TRQ remained unchanged. In addition, we disagree with ASA’s implication that a fall in the U.S. price for refined sugar should necessarily result in a lower estimate of the cost of the program. Because the cost of the program depends on the difference between domestic and world sugar prices, changes in the world price are also important in determining the program’s cost. 30. We disagree with ASA’s argument for using a world cost-of-production estimate as a benchmark. Because of a scarcity of data, estimating the international cost of production would require numerous assumptions about other countries’ costs of production as well as the effects of their policies to support producers. See also comments 4 and 7. 31. We used the 1997 census of agriculture, conducted by USDA’s National Agricultural Statistics Service, to identify the number of sugarcane farms and sugar beet farms for table 3 in appendix 1. USDA’s census of agriculture provided a consistent and rigorous methodology for estimating the number of sugarcane and sugar beet farms. However, as ASA mentioned, table 3 also notes that the census of agriculture’s estimate of 7,102 beet farms varied substantially from the USDA Farm Service Agency’s estimate of 11,800 sugar beet farms in 1997. This difference reflects differences in the definition of what constitutes a farm. In any case, the draft and final reports include both estimates. 32. We disagree with ASA’s conclusion. See comments 1 and 3 on our methodology and objectivity. The following are GAO’s comments on the letter of the U.S. Cane Sugar Refiners’ Association to our draft report. 1. We revised the report to address the concern of the U.S. Cane Sugar Refiners’ Association. 2. We revised table 1 to note that the basis point for the world raw sugar contract price is the Caribbean. According to a sugar market expert, the cost to transport raw sugar from the Caribbean to the United States is about 1.5 cents per pound. We also refined our model to more fully account for certain transportation costs in our welfare analysis. 3. We revised the report to clarify that USDA’s census of agriculture and the Farm Service Agency used different definitions of a “farm”. In addition to those named above, Jay Cherlow and Barbara J. El-Osta made key contributions to this report. The first copy of each GAO report is free. Additional copies of reports are $2 each. 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Summary: Pursuant to a congressional request, GAO estimated the Department of Agriculture's (USDA) sugar program's: (1) costs to domestic sweetener users; (2) benefits to domestic sugar and high-fructose corn syrup producers; and (3) net effects on the U.S. economy--the differences between the costs to users and the benefits to producers that result from artificially high sweetener prices. GAO noted that: (1) GAO estimates that the sugar program cost domestic sweetener users about $1.5 billion in 1996 and about $1.9 billion in 1998; (2) sweetener users included: (a) sugarcane refiners that bought raw cane sugar; (b) food manufacturers that bought refined sugar and other sweeteners; and (c) final consumers who bought sweeteners and sweetener-containing products; (3) the program's costs to U.S. sweetener users depend on the world price of sugar and can vary from year to year--they will be higher, other things being equal, when the difference between the domestic and the world price is greater; (4) in 1998, for example, the program's costs to users were higher than in 1996 because the world price dropped while the domestic price remained about the same; (5) the primary beneficiaries of the sugar program's higher prices are domestic sugar beet and sugarcane producers who, GAO estimates, received benefits of about $800 million in 1996 and about $1 billion in 1998; (6) about 70 percent of the benefits went to sugar beet growers and processors; (7) sugarcane producers received about 30 percent of the benefits; (8) GAO estimates that the sugar program resulted in net losses to the U.S. economy of about $700 million in 1996 and about $900 million in 1998; (9) GAO net loss estimates include economic inefficiencies and transfers to foreign producers; (10) economic inefficiencies occurred, for example, when the sugar program's artificially high domestic prices encouraged farmers to grow sugar beets instead of another crop, such as wheat, that, without the sugar program, might have been relatively more profitable; (11) inefficiencies also occurred when artificially high sugar prices discouraged consumers from purchasing sugar; (12) the cost of these inefficiencies totalled about $300 million in 1996 and about $500 million in 1998; (13) transfers from the U.S. economy to foreign producers occurred because foreign producers received artificially high prices for the raw sugar they exported to the United States; (14) GAO estimates that these transfers amounted to about $400 million in both 1996 and 1998; and (15) the transfers were about the same in each year despite the larger difference between domestic and world prices in 1998 because the United States imported less sugar in 1998.