The Farm Security and Rural Investment Act of 2002:
What Is It and What Are The Impacts?

By Dr. Michael Boehlje and Todd A. Doehring

The Farm Security and Rural Investment Act of 2002 -- commonly known as the 2002 Farm Bill -- is expected to have a significant impact on the income and cash flow of most farm businesses. What are the major features of this new legislation? And what impact will it have on income, cash flows and debt servicing ability of farmers? We will attempt to provide answers to these questions by first describing the major provisions of the new Farm Bill, and then discussing the impact of this new legislation on producers.

Attempting to summarize the provisions of a complex piece of legislation like the new Farm Bill is difficult, so we will only highlight key provisions. The new legislation is a six-year bill that is effective for the years 2002 through 2007. It continues the provisions of the 1996 legislation in that price support payments are partially decoupled from actual production, so at least part of the payments farmers receive are not linked to current output but instead are linked to historical yields and acreages. Farmers have the option of maintaining their acreage bases and yields used for the 1996 Farm Bill, or updating them based on production during the 1998-2001 crop years.

The new program adds soybeans and other oilseeds as a program crop, thus making them eligible for direct payments and counter-cyclical payments as well as loan deficiency payments.

With respect to conservation programs, the new legislation expands the current Conservation Reserve Program, and adds a Conservation Security Program which will make payments to farmers who adopt various conservation practices. The payments under the Conservation Security Program will include incentive payments to encourage farmers to adopt conservation measures; these payments would be in addition to cost sharing to help defray incremental cost of adopting the conservation practice.

Finally, a new dimension of the 2002 Farm Bill is a direct payment system for dairy farmers much like that for grain producers. The direct payments on milk production are calculated as 45 percent of the difference between a price of $16.94/cwt and the Class I Boston actual price for milk, and are limited to the first 2.4 million pounds of milk produced by a unit annually the $16.94 target price.

The new Farm Bill includes three different payments for producers of program crops (corn, soybeans, wheat, cotton, rice, oilseeds, grain sorghum, oats, barley). The first payment is the loan deficiency payment (LDP) that occurs if market prices are below the loan rate. The second payment is a counter-cyclical payment (CCP) that is based on historical production and is made to producers if market prices are below target prices. The third payment is a direct payment (DP) that is again based on historical production, but is fixed and does not depend upon market prices.

Figure 1 compares the payment mechanisms under the old (1996 Bill) and new (2002 Bill) legislation. In essence, the new legislation formalizes the supplemental assistance that was part of previous implementation of the 1996 Farm Bill in the form of counter-cyclical payments, and redefines the former AMTA payments as direct payments.

In reality, the payments for corn production under the new Farm Bill compared to previous legislation including supplemental assistance will increase the per acre payments modestly (e.g., somewhere around $5-$15 per acre for corn/soybean farms). Figure 2 shows the sensitivity of the per acre increases (2002 compared to 1996) for corn depending on prices and yields.

Figure 1: Comparison of Price Support Structure

Figure 2: Government Payment Differential for Corn
Between Old and New Farm Bill

Figure 3: Components of Floor Price for Corn

So what does this new Farm Bill mean to farmers? We will highlight the key implications by answering some of the most frequently asked questions we hear being asked about the Farm Bill.

1. Will the farm program increase farmers’ cash incomes? In general, crop farmers’ incomes will increase modestly under the 2002 Farm Bill compared to previous legislation. The increased income is likely to be in the range of $5-15 per acre for corn/soybean farms compared to previous legislation that includes all government program payments as well as emergency payments. An important difference between the 2002 Bill and the 1996 Bill is that the payments are more certain—emergency legislation is not needed each year to make supplemental farm program payments as occurred under previous legislation.

2. Will the program impact cropping/rotation decisions? Because of the rules that restrict planting of specialty crops on base acres and the establishment of a soybean base, it is possible that farmers who have produced specialty crops such as tomatoes, pumpkins, vegetables, and even popcorn in the past may not be able to do so without foregoing government payments.

   This is a major issue that should be discussed with the specialty crop contractor—a producer should be compensated for any government program payments that would be given up in order produce specialty crops.

3. Will farmers likely have to pay higher cash rents to rent farmland? The history of government farm programs is that payments are typically bid, in part at least, into cash rents and land values. Consequently, one should expect that the land rental market will experience some upward pressure under the new farm program.

   Farmers should be careful as they negotiate rental arrangements not to be overly aggressive in bidding on cash rents and suffer the winner’s curse—end up winning the land rent bidding contest, but actually lose money because the rental rate is higher than the return received from farming the land.

4. Will land values continue to go up or will they go down? It is likely that the 2002 Farm Bill will increase farmland returns somewhat, and this increased return combined with the lower price risk in crop production will result in some increase in land values. It is very unlikely that land values will decline because of the 2002 Farm Bill.

   However, farm program payments could possibly change at the end of the Farm Bill in 2007, so caution should be exercised in bidding aggressively for farmland based on the new Farm Bill. It is not the case that the higher incomes expected under this legislation are permanent for the life of the land.

5. Will farmers experience less financial risk under the 2002 Farm Bill? It is likely that crop farmers will be exposed to less downside price risk under the current legislation compared to previous farm bills. In essence, the 2002 Farm Bill creates an effective floor for corn prices at $2.35-$2.50, soybean prices at $5.50-$5.70, and wheat prices at $3.60-$3.70 irrespective of what happens to market prices. 

   At the same time, if the 2002 Farm Bill results in incentives to increase and/or maintain production, there may be less upside potential in prices than might have occurred otherwise.

6. Can a farmer safely borrow more money based on the 2002 Farm Bill? With the modest increases in incomes per acre and the reduced price risk, credit or debt servicing risk should be reduced for many farmers, and it might be possible to safely borrow more operating funds. But remember, that there still is production or yield risk to contend with (so crop insurance may be a critical part of the farmer’s risk and financial management strategy). 

   Borrowing more money to buy farmland should be carefully considered in light of the strategic risk that a future farm bill may change the farm program and the amount of payments before the mortgage is paid down.

The 2002 Farm Bill has significant implications for farmers in terms of reduced risk and modest increases in income. But some words of caution. First, the new bill does not buffer producers from all risk—yield risk still provides the potential for loss exposure. If a producer does have a short crop, he will lose the LDP and CCP if the reduction in aggregate production is enough to result in higher market prices as appears to be the case this year.

And even if prices do not go up, farmers encounter price risk if they exercise their LDP option and speculate by holding the crop for potential price recovery.

Second, better market prices do not necessarily result in improved incomes or cash flows for farmers. In fact, prices need to improve above the thresholds noted earlier to have improved incomes and cash flows. All that happens when prices improve from their relatively low levels of the past is that the increased income from the market replaces government payments with little or no beneficial impact on the bottom line.

A third caution is that generalizations in terms of the impacts of the Farm Bill are difficult to make. In essence, the new Farm Bill will impact different farms in different ways, and it is critical to analyze the individual impacts.

A final caution is to be careful in negotiating cash rents under the new Farm Bill. In essence, cash rents are set in a locale by the lowest cost and/or the most aggressive producers, and one might expect that the new Farm Bill will result in increased pressure in cash rent markets because of both the increased income and reduced risk. But a key question that you must answer is whether you can pay this higher cash rent.

Based on an article appearing in The RMA Journal.