Trump's Budget Gets One Thing Right: Crop Insurance Reform

Trump's Budget Gets One Thing Right: Crop Insurance Reform
AP Photo/Pablo Martinez Monsivais

The Trump administration’s budget proposal contains an unpleasant surprise for agricultural interest groups and the leadership of the House and Senate agricultural committees. Many, including president of the American Farm Bureau Mr. Zippy Duvall, believed President Trump owed a political debt to rural America and would therefore be sympathetic — and generous — to the farmers who voted him into office. The administration apparently disagrees — and for good reasons. 

The president’s first budget proposes to curtail subsidies for farmers through the federal crop insurance program in two major ways. According to estimates by the Office of Management and Budget, those reforms would together reduce government spending on crop insurance subsidies by about $28 billion over ten years.  

 

The first initiative is to eliminate a crop insurance policy called the Harvest Price Option (HPO), with an estimated savings of about $10 billion over a 10-year time horizon. The option, which has long been described by critics as gold plated crop insurance, is currently subsidized at an average rate of just over 60 percent of total premium, effectively providing farmers with a futures market-based instrument known as a “call option.”

 

In fact, that option is already available to farmers for almost all of the crops covered by the HPO through private futures markets such as the Chicago Mercantile Exchange. However, the private market instrument is rarely used by farmers, in part because they would then have to pay the full cost of the option plus any brokerage fees, as non-farm business do. Thus the HPO effectively competes with a product already available to farmers through the private market under the terms of the crop insurance provisions included by Congress in the current farm bill and all previous relevant crop insurance legislation. It should never have been offered or subsidized by the USDA Risk Management Agency in the first place.

 

But the problems with the HPO extend well beyond that legal issue. As Iowa State professor Bruce Babcock has pointed out, HPO has allowed farmers at times to enjoy revenues that exceed those they expected to get when they planted their crops. That’s not a crop insurance product; it’s a platinum plated license to earn excess incomes at the taxpayer’s expense.

 

In addition, the HPO is one of a range of widely used products offered through the federal crop insurance program that encourages moral hazard behavior by farmers. That is, the HPO incentivizes farmers to adjust their production practices in ways that increase their indemnities from losses without being monitored effectively by insurance companies or the government.

 

Farm lobby representatives will often tell you that no farmer ever wants to do anything but raise the largest crops they can. But that simply isn’t true. The evidence, based on careful analyses of data by economists over more than two decades, is consistent and clear. When farmers buy subsidized crop insurance coverage based on their farms’ crop yields, they use fewer inputs that reduce the risk of crop losses. In plain language, farmers change their production practices — and on average produce less output — when they have crop insurance coverage. And they do so because they are rational business people who seek to maximize the profits they get from their farm businesses.

 

So, effectively, by subsidizing crop insurance, taxpayers are encouraging farmers to work less efficiently, produce fewer crops, and make smaller contributions to the overall productivity of the U.S. economy. A heavily subsidized HPO makes a substantial contribution to those adverse incentives.

 

The second proposal from the administration is to cap crop insurance subsidies at a maximum of $40,000 per farm for an estimated savings of about $17 billion over ten years. That proposal would affect less than 4 percent of all farms — and those farms are large operations. How large? In terms of revenues from crop sales alone, the smallest farms that would be affected by the cap typically have annual sales of insured crops in excess of $720,000 a year, average household incomes in the hundreds of thousands of dollars, and own assets worth multiple millions of dollars. Most of the farms affected by the $40,000 cut off in crop insurance subsidies have much larger revenues from their farm operations, are much wealthier, carry little debt relative to their sales and assets, and would still receive $40,000 every year in taxpayer subsidies to buy crop insurance coverage.

 

To put it simply, the administration’s proposals to terminate the Harvest Price Option program and to cap crop insurance premium subsidies are grounded in good economic sense. Moreover, they are not new. Thoughtful policy makers on both sides of the political aisle, as well as successive administrations, have put forward and supported similar initiatives over the past decade, on the grounds of both fairness and economic efficiency. Such initiatives have thus far been thwarted, however, by what can reasonably be described as crony capitalism, which seemingly pervades congressional debates about all farm subsidy reform initiatives. Hopefully, good economic common sense will prevail this time around.

 

Vincent H. Smith is the director of agricultural policy studies at the American Enterprise Institute and professor of economics at Montana State University.

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