A New Season for Crop Subsidies?

By Robert W. Klein and Gregory Krohm
Special to washingtonpost.com's Think Tank Town
Tuesday, January 9, 2007; 12:00 AM

The federal government instituted crop insurance in 1938 in an attempt to end the need for ad hoc aid to farmers following disastrous droughts or floods. But ad hoc aid has not ended in the past seven decades, and the insurance program that was intended to replace it has transformed into a massive, poorly disguised crop subsidy program that provides few benefits to farmers who practice good risk management. Instead, the program rewards poor risk managers with generous subsidies at the expense of taxpayers, contrary to the fundamental principles of insurance.

To be sure, lawmakers have made several efforts to "reform" crop insurance. But each wave of legislative changes has moved the program further away from economic rationality and exacerbated its distortion of incentives and inefficiency.

Federal crop insurance's perverse evolution raises the question of whether the government cure to ad hoc aid has become more costly than the disease it was intended to fix. Political manipulation has seemed to produce the worst of all possible worlds.

The last set of statutory changes enacted in 2000 is scheduled to expire in 2007 when a new farm bill will be enacted. With that deadline looming, The Washington Post has been running a provocative series, "Harvesting Cash," on the perverse politics and economics of U.S. farm subsidies. Other papers across the country have also been running articles, editorials and series pointing out the need to fix agriculture programs. Perhaps this time the public will push lawmakers to truly reform crop insurance. They may need a big push, given special interest pressures to move other crop subsidies into the crop insurance program, where they would be less transparent.

In an effort to expand program participation and reduce disaster aid, the number of insurance-eligible crops and the amount of federal subsidies going to the insurance program have increased dramatically since 1938. This expansion has come at a high cost, even in recent years; from 2000 to 2004 alone, the amount of the annual subsidy increased by 150 percent to $2.5 billion.  Total federal expenditures on crop insurance are projected to increase to $3.6 billion in 2007.

The rise in crop insurance expenditures might be palatable if it were offset by a significant decline in disaster assistance payments for agricultural losses. But that savings has not occurred. Over the period 1989--2005, disaster payments averaged $3.7 billion (in 2005 dollars) annually, and there is no indication that the trend in the amount of payments is declining. From 2000 to 2005, a total of $37.7 billion has been paid in "emergency" appropriations by Congress, averaging $6.3 billion annually (in 2005 dollars).

The current program suffers from a number of flaws that need to be addressed. First, there are significant conflicts between private insurers, who issue and service insurance policies and nominally underwrite a small portion of the risk, and the federal government, which administers the program and underwrites most of the risk. Second, producer incentives are distorted by premium rates that do not adequately and accurately reflect their risk of loss -- in essence building government subsidies into the rate structure for the benefit of high-risk farmers. Third, the introduction of an excessive number of new products to accommodate special interests exacerbates pricing problems. Fourth, both the federal Department of Agriculture and participating insurers are hampered by a number of mandates and constraints created by Congress with the intent of benefiting special interests instead of rationalizing insurance.

Administrative reforms could transform crop insurance into a more legitimate risk management tool based on sound economic and insurance principles, as well as reduce inefficiency and cost to taxpayers. One reform would be to limit the number of federal crop insurance products to those that are economically sound but that are not currently supplied by private markets. A second important reform would to set rates closer to actuarially adequate and fair levels. A third reform would be to move all risk-bearing to the federal government and use insurers as "servicing carriers" -- the approach that is used in other government programs such as flood insurance. Other ideas deserve consideration, such as a proposal by Rep. Terry Everett (R-Ala.), to permit farmers to create tax-free, interest-bearing "risk management accounts" to cover crop losses and other risks such as increases in fuel or fertilizer costs.

These reforms would transform crop insurance into a true insurance program that would rationally manage risk while reducing the cost to taxpayers. Such reforms will receive strong political opposition from the many special interest groups that benefit from the current program's structure and subsidies. Yet, this is a battle worth fighting if we want to promote good public policy and improve the management of agricultural risks. Drawing greater public attention to the subsidies and waste could help tip the political balance in favor of true reform.

Robert W. Klein is director of the Center for Risk Management and Insurance Research at Georgia State University. Gregory Krohm is a professor of actuarial science, risk management and insurance at the University of Wisconsin. Their article "A New Season?" appears in the winter issue of the Cato Institute's Regulation Magazine.

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