Tobacco Price Support: An Overview of the Program

Order Code 95-129

Updated December 31, 2005

CRS Report for Congress

Received through the CRS Web

Tobacco Price Support:

An Overview of the Program

-name redactedAgricultural Policy Specialist

Resources, Science, and Industry Division

Summary

About 94% of U.S. tobacco production is flue-cured and burley (both being

cigarette tobacco types). These crops are particularly important to the agriculture of

North Carolina (where flue-cured is grown) and Kentucky (where burley is grown).

Together, these two states produce 66% of the total U.S. tobacco crop. The federal

tobacco price support program was designed to support and stabilize prices for farmers.

It operated through a combination of mandatory marketing quotas and nonrecourse

loans. Marketing quotas limit the amount of tobacco each farmer could sell, which

indirectly raised market prices. The loan program established guaranteed minimum

prices. The law required that the loan program operate at no net cost to the federal

government. Apart from year-to-year budget impacts, no-net-cost provisions of the law

were intended to assure that all loan principal plus interest would be recovered.1 The

2004 tobacco crop was the last crop eligible for federal support, as the program was

terminated by P.L. 108-357, Title VI, the Fair and Equitable Tobacco Reform Act of

2004. This report will be not be updated.

Industry Profile

World production of tobacco was estimated at about 12.662 billion pounds (dry

weight) for 2004. Production data are collected in more than 100 countries. However,

nearly 75% of world tobacco is produced in the following seven countries: China (4,439

mil. lbs.), Brazil (1,669 mil. lbs.), India (1,318 mil. lbs.), United States (788 mil. lbs.),

Indonesia (317 mil. lbs.), Malawi (304 mil. lbs.), and Turkey (281 mil. lbs.).

1

Data in this report, unless otherwise specified, are U.S. Department of Agriculture data from

recent issues of Tobacco: World Markets and Trade, published by the Foreign Agriculture

Service, and Tobacco Situation and Outlook Reports, published by the Economic Research

Service.

Congressional Research Service ˜ The Library of Congress

CRS-2

Fewer than 57,000 U.S. farms marketed about 848 million pounds (farm weight) of

tobacco from 408,000 acres in 2004. The estimated farm value of the 2004 crop was

about $1.685 billion ($1.987/lb.). Major U.S. tobaccos are flue-cured (produced primarily

in North Carolina) and burley (produced primarily in Kentucky), which are both cigarette

tobaccos. Other types of tobacco are used for cigars, chewing, and snuff.

Even though tobacco is grown in 21 states, North Carolina and Kentucky originate

about 65% of total production and four other states (Tennessee, Virginia, South Carolina,

and Georgia) produce another 25%. The high per acre value of tobacco sales (averaging

about $4,130 in 2004) makes it critical to the income of the growers and important to the

economies of the major producing states. For North Carolina in 2004, tobacco constituted

7.9% of the value of all farm commodities (crops and livestock); for Kentucky, tobacco

accounted for 11.7% of the value of all commodities.

The United States is the world’s largest exporter of manufactured tobacco products

(cigarettes) and is the second leading exporter, behind Brazil, of unmanufactured tobacco

leaf. During 2004, the United States exported 361 million pounds (dry weight) of leaf

tobacco, valued at $1.044 billion (mostly to the European Union, Japan, and Russia).

U.S. manufactured tobacco product exports could amount to about $1.566 billion (mostly

to Japan, Saudi Arabia, Israel, Iran, Lebanon, Hong Kong, Kuwait, United Arab Emirates,

and Taiwan).

In 2005, U.S. manufacturers produced an estimated 482 billion cigarettes (exporting

about 23%). American blend cigarettes are a combination of flue-cured, burley, and

oriental tobaccos. All of the oriental tobacco is imported (from primarily Turkey).

Consumption of cigarettes has declined nearly 41% in the United States since 1981, from

640 billion to an estimated 378 billion in 2005. However, spending for tobacco products

has increased as a result of price and tax increases. In 2004, according to the Bureau of

Economic Analysis) consumers spent about $87.6 billion on tobacco products (94% for

cigarettes).

Tobacco products are subject to federal excise taxes. In addition, all states and some

municipal governments impose excise taxes. Collections in July 2003-June 2004 were

an estimated $20.111 billion (federal, $7.779 billion; state, $11.877 billion; municipal,

$456 million). The federal cigarette excise tax was 39¢ per pack and the weighted

average state-municipal tax was 62.55¢ per pack. In 2003/2004, federal taxes were

collected on 19.945 billion packs.

The Price Support Program

The tobacco price support program (first created in the 1930s along with other

commodity support programs) existed only for the economic benefit of farmers. It was

created for the purpose of supporting the income and stabilizing the price of tobacco

received by farmers. By law, the choice of whether or not federal support would be

provided was determined by growers in a referendum held every three years.

When producers approved federal price support for tobacco, they became subject to

marketing quotas. A marketing quota was a supply control mechanism that indirectly

CRS-3

increased market prices. At the same time, the federal government was required to

guarantee prices at least as high as the level specified in the law.

Legislative Authority

The first commodity price support legislation was the Agricultural Adjustment Act

of 1933. Various problems with this and subsequent legislation ultimately led to adoption

of the Agricultural Adjustment Act of 1938 (P.L. 75-430). This permanent law

established a supply control and price support program for tobacco that, even as amended,

remained much the same. The legal authority and requirements for the federal tobacco

program were contained in 7 U.S.C. 1311-1316 and 7 U.S.C. 1445.

Administering Agency

Program administrative operations were carried out by the U.S. Department of

Agriculture’s (USDA) Farm Service Agency (FSA). Annual administrative costs were

estimated at about $24 million in FY2004 for tobacco price support operations. This cost

covered primarily salaries for some headquarters personnel and staff time devoted to the

tobacco program in about 600 county offices. Price support operations (nonrecourse

loans) were financed by USDA’s Commodity Credit Corporation (CCC). The CCC

obtained needed money by borrowing from the U.S. Treasury (which had to be repaid

with interest).

Program Operation

The federal tobacco price support program limited and stabilized the quantity of

tobacco produced and marketed by farmers. This was achieved through marketing quotas.

In addition, minimum market prices were guaranteed to farmers through CCC

nonrecourse loans.2

Marketing Quotas. When tobacco quota owners voted in favor of price supports,

they were at the same time agreeing to accept government restrictions on the amount of

tobacco they could market. The national marketing quota was the amount judged

sufficient to meet domestic and export demand, but at a price above the government

support price. Each farm’s quota was assigned to the land. So, the right to produce and

market a specified quantity of tobacco resided with the owner of the land. A farmer could

only begin to grow tobacco by purchasing or renting land that had a quota. By limiting

the supply of tobacco, the market price was increased. Total farm revenue was raised

because consumption did not decline enough to offset the price increase. In this way,

farm income was supposed to be supported through artificially high market prices, rather

than through direct government payments. This differed from other commodity support

programs that utilized direct payments, rather than marketing quotas, as the principal

subsidy mechanism.

2

The term nonrecourse means that in cases of default no additional recourse is taken against

borrowers beyond taking ownership of the collateral. The collateral is accepted as full settlement

of the debt.

CRS-4

Loans. Marketing quotas were not always totally effective at supporting market

prices, given the numerous variables that affect tobacco supply and demand.

Consequently, federal support prices were guaranteed through the mechanism of

nonrecourse loans available on each farmer’s marketed crop. The loan price for each type

of tobacco was announced each year by the USDA, using the formula specified in the law

to calculate loan levels. The national loan price on 2004 crops flue-cured tobacco was

$1.69 per pound; the burley loan price was $1.873.

At the auction sale barn, each lot of tobacco went to the highest bidder, unless that

bid did not exceed the government’s loan price. In such cases, the farmer was paid the

loan price by a cooperative, with money borrowed from the CCC. The tobacco was

consigned to the cooperative (known as a price stabilization cooperative), which redried,

packed, and stored the tobacco as collateral for CCC. The cooperative, acting as an agent

for the CCC, later sold the tobacco, with the proceeds going to repay the loan plus

interest. By 2004, about 80% of tobacco was sold under contract, but leaf that did not

meet specifications could be taken to auction, where it might go into the loan program.

No-Net-Cost and Marketing Assessments. Under the threat of a legislative

dissolution of the program by its opponents, Congress passed the No-Net-Cost Tobacco

Program Act in 1982 (P.L. 97-218). This legislation imposed an assessment on every

pound of tobacco marketed (including imported tobacco since 1994). The no-net-cost

assessment on 2004 crop flue-cured was 10¢ per pound; the burley assessment was 2¢.

Growers and buyers each paid half of the no-net-cost assessment. The no-net-cost

assessment funds were deposited in an escrow account that was held to reimburse the

government for any financial losses resulting from tobacco loan operations. Losses

occurred when a cooperative sold loan collateral tobacco at a price insufficient to cover

the loan principal plus interest. Until its legal authority expired, a budget deficit reduction

assessment (called a marketing assessment) of 1% of the support price was collected on

every pound of tobacco marketed from 1990 through 1997.

Market Loss Payments and Disaster Assistance. In response to low

commodity prices in 1999, 2000, and 2001, Congress authorized market loss payments

to producers of grains, cotton, oilseeds, tobacco, dairy, and several other crops (P.L. 10678, P.L. 106-224, and P.L. 107-25). Tobacco growers were paid about $1 per pound for

diminished quotas, receiving direct payments of $328 in FY2000, and $340 million plus

and $129 million in FY2001. Agricultural disaster assistance legislation in 2003 (P.L.

108-7) provided another $51 million to tobacco producers. These payments were not

constrained by the no-net-cost provisions of the tobacco loan program. Additionally, $2.8

million was approved for tobacco on warehouse auction floors damaged by flooding from

hurricane Floyd in 1999.

Experience

Passage of the No-Net-Cost Tobacco Program Act made a significant change in

federal price support policy. Shifting the financial burden for tobacco program losses

from the federal government to growers encouraged a reduction in support prices (which

was done by legislation in 1985). Initially, this stopped the decline in U.S. tobacco leaf

exports. However, the growing competitiveness of foreign tobacco continued to erode the

U.S. share of export markets. Foreign tobacco had captured 45% of the domestic cigarette

manufacturing market when Congress enacted a domestic content requirement. This

CRS-5

domestic content requirement took effect in 1994 and limited cigarettes to 25% foreign

content. Under new international trading rules, the domestic content requirement was

replaced in September 1995 with a tariff-rate quota, which was less restrictive than the

previous domestic content requirement. In 2004, imported tobacco constituted 61.3% of

U.S.-manufactured cigarettes.

Tobacco-Related CCC Net Outlays, and FSA Administrative

Expenses, by Fiscal Year, 1980-2004

(in millions of dollars)

Fiscal

year

FSA

CCC

administrative

Net outlays

expenses

Fiscal year

CCC

Net outlays

FSA

administrative

expenses

1980

(87.8)

13.9

1993

235.4

15.3

1981

(51.2)

13.1

1994

692.7

14.7

1982

103.0

13.3

1995

(298.2)

15.3

1983

879.8

12.3

1996

(495.9)

14.3

1984

346.4

13.4

1997

(156.2)

14.8

1985

455.4

11.5

1998

376.5

16.1

1986

253.4

10.8

1999

112.7

12.8

1987

(346.0)

10.0

2000

657.1

14.1

1988

(453.3)

8.4

2001

385.8

17.6

1989

(367.0)

10.8

2002

(137.2)

18.1

1990

(307.3)

11.7

2003

179.3

21.4

1991

(143.4)

14.8

2004

18.5

24.1

1992

29.2

13.4

Sum FY80-04

1,881.7

356.0

Source: U.S. Department of Agriculture. Farm Service Agency. History of Budgetary Expenditures of

the Commodity Credit Corporation, annual issues. And, Office of Management and Finance, internal

document titled Program-by-Program Summary, Estimated Costs Related to Tobacco Activities, annual

issues.

Note: Negative numbers indicate negative net outlays (i.e., gains or receipts). Included in the tabulations

are revenues generated by the deficit reduction fees assessed on all tobacco marketings from 1990 through

1998, averaging about $30 million per year. Also included are congressionally mandated farm assistance

payments of in FY2000, FY2001, FY2002, and FY2003 of respectively $328 million, $469 million, $6

million, and $51 million.

The no-net-cost rule muted much of the criticism that the tobacco loan program was

a taxpayer subsidy for tobacco farmers. The budgetary impact of the tobacco loan

program was determined primarily by loan outlays (new loans made) and loan recoveries

(repayment of old loans). In any given year, new loan outlays might be more or less than

recoveries from the repayment of old loans. Since tobacco is typically stored for extended

periods, it could be several years before the loan inventory was sold. The law required

that any losses of loan principal and interest be repaid from the no-net-cost account, which

was funded from assessments on growers and buyers of leaf tobacco. This requirement

did not apply to 1999 crop loan inventories that Congress authorized be transferred to the

CCC without the action being charged against the no-net-cost program (P.L. 106-387,

CRS-6

Sec. 844). This law cost the CCC $625 million, for acquisition, interest, storage, and

disposal. In the absence of this law, losses from the disposal of these inventories would

have been covered by the no-net-cost account with funds raised from assessments on

tobacco marketings. However, and in spite of no-net-cost legislation, the continuing net

CCC outlays brought criticism.

There were other critics of the tobacco program. Free market advocates pointed to

the competitive disadvantages caused by the program. Economists believed that without

marketing quotas and price support loans, farmers would produce more tobacco, which

would be sold at lower prices. The lower prices would lead to increased exports, and

more domestic production would be used in U.S.-manufactured cigarettes — displacing

some of the imported tobacco. Some health advocates said the federal government should

not be supporting tobacco farm income and should get out of the tobacco business.

The Fair and Equitable Tobacco Reform Act of 2004 (P.L. 108-357, Title VI) was

signed into law October 22, 2004. It eliminated the tobacco program after the 2004 crop.

This “quota buyout” bill paid quota owners $7/lb. on 2002 basic quota and active

producers $3/lb. on 2002 effective quota. The $9.6 billion cost of payments, plus another

$540 million for expected losses on CCC loan inventories is to be paid from assessments

on cigarette manufacturers and importers over a 10-year period (FY2005-2014).

Other USDA Tobacco-Related Activities

The USDA continues to administer several other programs designed to assist tobacco

farmers, facilitate marketing, and provide information to federal policy makers. It

administers subsidized multi-peril crop insurance for tobacco (as well as for other crops),

which was budgeted to cost about $41 million in FY2005. Also, as with other crops, the

Department collects, analyzes, and disseminates data on tobacco production, utilization,

and prices, costing about $1.262 million in FY2005. The USDA, using its own

discretion, has discontinued all federal extension program expenditures on education and

pest management related to tobacco. The Department was specifically prohibited from

spending research funds on the production, processing or marketing of tobacco, and from

promoting the export of tobacco or tobacco products. These prohibitions are contained

in the annual USDA appropriations law.

For More Information

!

!

!

CRS Report RS22046, Tobacco Quota Buyout.

CRS Report RL31790, Tobacco Quota Buyout Proposals in the 108th

Congress.

CRS Report 97-417, Tobacco Related Programs and Activities of the

U.S. Department of Agriculture: Operation and Cost.

EveryCRSReport.com

The Congressional Research Service (CRS) is a federal legislative branch agency, housed inside the

Library of Congress, charged with providing the United States Congress non-partisan advice on

issues that may come before Congress.

EveryCRSReport.com republishes CRS reports that are available to all Congressional staff. The

reports are not classified, and Members of Congress routinely make individual reports available to

the public.

Prior to our republication, we redacted names, phone numbers and email addresses of analysts

who produced the reports. We also added this page to the report. We have not intentionally made

any other changes to any report published on EveryCRSReport.com.

CRS reports, as a work of the United States government, are not subject to copyright protection in

the United States. Any CRS report may be reproduced and distributed in its entirety without

permission from CRS. However, as a CRS report may include copyrighted images or material from a

third party, you may need to obtain permission of the copyright holder if you wish to copy or

otherwise use copyrighted material.

Information in a CRS report should not be relied upon for purposes other than public

understanding of information that has been provided by CRS to members of Congress in

connection with CRS' institutional role.

EveryCRSReport.com is not a government website and is not affiliated with CRS. We do not claim

copyright on any CRS report we have republished.