Tobacco Price Support Program

The TPSP, which is designed to support and stabilise tobacco prices, has been operated by the USDA since 1933 when Congress passed the first Agricultural Adjustment Act.1 The primary policy tools within the current TPSP are marketing quotas, price supports, and import restrictions.1

Marketing quotas control production by limiting the number of pounds of tobacco a farmer can market that are eligible for price support; excess sales are subject to prohibitive penalties. The national quota set by USDA is based on: (a) intended purchases by cigarette manufacturers; (b) average annual export for the three preceding years; and (c) the amount of tobacco needed to attain a specific reserve stock level.17 In addition, each year the Secretary of Agriculture can adjust the level of quota up or down by 3% of the calculated level.

The marketing quota of the TPSP began in 1938. Individual tobacco farmers were given quotas based on their historical production.17 The quota was tied specifically to the farmland; farmers not having a quota could grow tobacco only by purchasing or renting land that had one. In 1962, the programme was modified, and tobacco farmers can now rent or purchase a quota without renting or purchasing the land from the quota owner.17However, there are restrictions on the leasing of quotas depending on the type of tobacco produced. For example, a quota for flue-cured tobacco generally cannot be leased, and burley tobacco quotas can be leased but not across county lines (except in Tennessee).17

The price support programme uses a loan system to ensure a minimum price for tobacco farmers. The Commodity Credit Corporation (CCC), which is an agency of the USDA, makes loans to farmer-owned cooperatives. The USDA sets the level of price support through an announced loan price, which varies according to the variety and grade of tobacco leaf. This loan price, the minimum price tobacco farmers receive, is guaranteed through a non-recourse loan mechanism. With a non-recourse loan, the collateral (in this case, tobacco leaf) is accepted as the full settlement of the debt.

Farmers sell cured tobacco to the highest bidder at an auction, unless the bids are below the loan price. In this case, the tobacco farmer is paid the loan price by a cooperative with money borrowed from the CCC. The newly purchased tobacco is then consigned to the cooperative, which redries, packs, and stores the tobacco as collateral for the CCC loan. The cooperative, acting as an agent for the CCC, later sells the tobacco with the proceeds going to repay the loan from the CCC. Losses occur if the cooperative must sell the collateral tobacco at a price insufficient to cover the outstanding loan principal plus interest.18

CCC losses were initially covered by the government with tax money. This was changed in 1982 when Congress passed the No-Net-Cost Act, which imposed an assessment fee on every pound of tobacco sold by tobacco farmers. The fee, which is shared by farmers and buyers, is deposited in an escrow account and used to reimburse the government for any loss resulting from the TPSP.17

Import restrictions limit the quantity of cheaper foreign tobacco coming into the American market to maintain a higher domestic price. The Omnibus Budget Reconciliation Act of 1993 required that cigarettes manufactured in the United States contain at least 75% American-grown tobacco,1 but this requirement was eliminated in September 1995 with adoption of the tariff rate quota. Under this mechanism, each major supplier country can export a specific amount of tobacco to the United States at a normal tariff rate; shipments in excess of this quota are subjected to a 350% duty. However, most of the duty may be refunded if the tobacco is used to manufacture cigarettes that are exported by the United States.17 Thus, with the 1995 provision, tobacco companies have substantial freedom to import tobacco above quota levels with few penalties. As a result, the provision does little to ensure the tobacco companies use more American-grown tobacco.

Impact of the TPSP on domestic cigarette consumption

The primary purpose of controlling the tobacco supply is to keep prices high and relatively stable.17 If the demand for tobacco does not decline, prices will rise as the supply of tobacco is reduced. In their 1984 study, Sumner and Alston14estimated that eliminating the TPSP would reduce the price of American tobacco by 17–30%. A more recent study by Zhang, Husten, and Giovino concluded that the TPSP has increased the price of tobacco by 32–40 cents per pound (70–88 cents per kg; 18–23% of the price between 1990 and 1994). (Unpublished manuscript obtainable from PZ on request. The study consists of the economic model and data used to derive the estimate of the impact of the TPSP on domestic cigarette consumption.)

The importance of domestic tobacco as a cost element in the retail price of cigarettes has been declining steadily over time. One reason is that the quantity of tobacco required to produce a unit of cigarettes has decreased because: (a) filter-tipped and smaller-diameter cigarettes have become more popular; (b) new technologies that allow tobacco stems to be blended into cigarettes are being employed; and (c) tobacco sheets are being used more efficiently.19 A second reason that domestic tobacco is a lesser factor in the retail price of cigarettes is that manufacturers are using cheaper imported tobacco.15

From 1980 to 1991, wholesale cigarette prices increased 267%; average retail prices 187% (from $0.62 to $1.78 per pack). During the same period, the farm price of tobacco leaf rose only 18%. Domestic tobacco’s share of total tobacco use fell from 71% to 65%. As a result, the share of the farm value of domestic tobacco in total cigarette retail value declined from 7% in 1980 to only 3% in 1991.15 19

The American cigarette manufacturing industry is oligopolistic, with five manufacturers controlling almost the entire market.20A recent study21 showed that cigarette manufacturers price-discriminate by state but the effect was not large relative to the final retail price. Assuming that tobacco price increases resulting from the TPSP would be fully passed on to the price of cigarettes at the retail level, Sumner and Alston estimated that if the programme increased tobacco price by 30%, the price of cigarettes would increase by 3% or about two cents per pack in 1983. Using a price elasticity of −0.3 for cigarettes, they estimated that the higher cigarette price would reduce cigarette consumption by about 1%.

Considering the decrease in domestic tobacco’s share of total tobacco used, and using more updated price elasticities of supply and demand for American tobacco, Zhang, Husten, and Giovino (unpublished manuscript—see above) recently estimated that a 40-cent per pound (88 cents per kg) increase in tobacco price resulting from the TPSP would lead to a price increase of only one cent per pack of cigarettes. At this higher price, they estimated the resulting decline in cigarette consumption to be 0.23% or 56 million packs of cigarettes in 1994. Assuming that half of this reduction came from the decrease in the number of smokers, these researchers estimated that the TPSP reduced the number of smokers by 66 500 or 0.14% of total smokers in 1994. Per smoker, they estimated a reduction of 12 cigarettes (or 0.14%) annually.

Potential political impact of the TPSP on efforts to reduce smoking

TOBACCO QUOTA OWNERS AND EFFORTS TO REDUCE SMOKING

The adverse impact of the TPSP on efforts to control smoking is indirect, and the programme must be evaluated in the context of policy formulation and implementation.16 Perhaps the most important potential political effect of the TPSP on tobacco control is that it has created quota owners, who have a strong financial interest against efforts to reduce smoking. In 1993, of the 375 073 tobacco quota holders, only about one a grew tobacco.1 18 Thus, the TPSP has produced about 250 000 non-farmer quota owners, largely concentrated in the six biggest tobacco producing states, with a potential stake on tobacco control efforts.

Quota owners are the major beneficiaries of the TPSP. Marketing quotas represent a right, originally bestowed by the federal government; this right allows the owners to sell a limited amount of tobacco at a guaranteed minimum price. This price, which is generally higher than the price would be without the TPSP, provides the owner with a potential stream of income over the years. The expectation of a future profit accruing from the quota transforms the quota itself into an asset with value that can be sold or rented.22

The value of the quota is reflected in its price and the rent paid for it. The average sale price of quota for burley type of tobacco was estimated at $1.79 per pound ($3.94 per kg) in 1995.23 As the total quota was 1500 million pounds (700 million kg),23 the market value of the total national tobacco quota was $2700 million in 1995. The average rent paid for quota in most tobacco production areas currently ranges between $0.40 and $0.50 per pound ($0.88–1.10 per kg).1 Rent revenues of the quota for all quota owners (those who lease their quotas to others and these who use the quota themselves), based on a total quota of 1500 million pounds (700 million kg) in 1995, ranged from $592 to $741 million.

Measures to reduce smoking are expected to reduce demand for tobacco and to change the quota revenues for quota owners.24Whether these revenues will become larger or smaller depends on which of the three possible scenarios becomes the USDA response to a decline in demand for cigarettes24: (1) fix the quantity of tobacco quota and allow the level of price supports to fall; (2) maintain the level of price support and reduce the amount of tobacco quota; or (3) simultaneously reduce the level of price support and the amount of tobacco quota.

Sumner and Wohlgenant24 estimated the magnitude of the change in revenues for quota owners that would result from cigarette tax increases and smoking restrictions; in 1995 Brown25updated their study, assuming a 75-cent increase in cigarette tax per pack and an increase in the smoking restriction index of 0.5. (The smoking restriction index is a measure of smoking restrictions in public places. If a state restricts smoking at worksites, it receives a score of 1. States that restrict smoking in restaurants but not in private worksites receive a score of 0.75. If a state does not restrict smoking in private worksites or restaurants but restricts smoking in at least four other public places, such as public buses and trains, it receives a score of 0.5. States with one to three of these relatively minor restrictions in place get a score of 0.25, and states with no regulation in place receive a score of 0.)

Brown predicted that quota revenues would be reduced by $116 million if the government chose policy 1. According to Brown, choosing policy 2 would mean that quota revenues would increase by $22 million; policy 3 would yield an outcome somewhere between the first two results (table1). A detailed analysis of the impact of the different policy choices on revenues for quota owners as well as for tobacco farmers is provided in the .

Because quota revenues could either increase or decrease in response to a decline in demand for tobacco depending on the policy (reduce quota or level of price support or both) which the government selects, attitudes of quota owners toward cigarette tax increases and smoking restrictions should depend on their perception of the government’s response. The government has chosen policy option 1 in the past. For example, the level of price support was reduced by 15% in response to a market condition of excess supply of tobacco in 1986.1Another way of reducing the level of price support is to decrease the real price level of support. Between 1986 and 1994 the level of price support after adjusting for inflation declined 19%.1 In addition, a negative attitude toward the quota owner could potentially put pressure on policy makers if they choose a policy which favours the quota owner. For example, the quota system used in peanut and tobacco production has already been criticised for providing a windfall benefit to a small group of quota owners.22 This suggests that quota owners can reasonably expect that their revenues would decline from measures that reduce demand for cigarettes. Thus, it would be in their economic interest to oppose tobacco control measures.

TOBACCO FARMERS AND EFFORTS TO REDUCE SMOKING

A second indirect effect of the TPSP on tobacco control results from its impact on the number of tobacco farmers, the size of tobacco farms, and the geographical distribution of tobacco farms.The net impact of the TPSP on the number of farmers engaged in growing tobacco is not clear; the programme exerts both positive and negative effects. On the one hand, it decreases the number of farmers by reducing tobacco production; on the other hand, it keeps the number of tobacco farmers artificially high by slowing the process of consolidating small tobacco farms into fewer and larger operations.

By creating a higher tobacco price, the TPSP keeps small, inefficient farmers in tobacco production. Although the 1962 change in the programme, which permitted quota sale and lease within a county, has promoted production efficiency by facilitating a shift from small, high-cost operations to larger, low-cost operations within the same county, prohibition on sales and leases across county lines has still limited the production shift between counties.14 In addition, the cost of renting quotas represents financial resources that could otherwise be used by efficient farms to expand their scale of operation.

Measures to reduce smoking usually reduce farmers’ revenues; at best they are revenue neutral. Again, assuming a 75-cent increase in cigarette tax per pack and an increase in the smoking restriction index of 0.5, Brown25 found that revenues for tobacco farmers would not change under federal policy 1. In contrast, he found that revenues for farmers would fall by $264 million if the government chose policy 2 and that revenue would fall by a smaller amount if the government chose policy 3 (table 1). Given the possibility of incurring substantial losses resulting from changes in federal tobacco policy following the implementation of measures to reduce smoking, farmers are not likely to be sympathetic to tobacco control efforts.

About 80% of tobacco farmers own their production quota either entirely or in part.1 These farmers derive revenues from both farm operations and from the value of their quota. Measures to reduce smoking would always have a negative impact on these farmers’ revenues because the impact of tobacco control measures on the sum of the two revenues is always negative—for example, for policy 2, a $22 million increase plus a $264 million decrease equals a $242 million decrease (table 1).

It is impossible to quantify the change in potential political impact of tobacco farmers on tobacco control measures as a result of the TPSP because one cannot know how the tobacco production sector would change in the absence of the programme. It appears that more tobacco would be produced and the size of tobacco farms would be larger without the TPSP, but how these large farmers would organise themselves and how effective they would be in influencing legislation is difficult to predict. (Larger production is the result of increasing sales in both domestic and export markets due to lower prices. Zhang, Husten, and Giovino (unpublished manuscript) estimated that without the TPSP, American tobacco production would be 47–68% greater than the current level, consistent with Sumner and Alston’s prediction that tobacco production could be increased by 50–100% if the support programme were abolished.14 In addition, without the Tobacco Price Support Program, most of the small and inefficient farms would no longer be in production and thus the size of tobacco farm would be larger.)

Tobacco farmers have been able to exert influence against tobacco control policies. For example, during the announcement in the United States of the Food and Drug Administration’s new regulations on cigarettes and smokeless tobacco on 21 August 1996, although there were many groups being affected negatively by the regulation, President Clinton singled out only tobacco farmers as a group. He promised farmers that the government would help them financially. The TPSP gives farmers a strong economic incentive to oppose tobacco control measures. Because the TPSP raises the price of American tobacco and reduces tobacco exports, tobacco farmers derive a larger proportion of their revenues from domestic tobacco use than they would without the programme. In addition, the TPSP may have contributed to the organisation of tobacco farmers. On the one hand, as a group, tobacco farmers are economically dependent on the programme. The programme benefit, which is measured as a percentage of the value of production between 1991 and 1994, was 20%.3 On the other hand, public perceptions of the quota system are negative because it decreases efficiency, benefits only a small group of people, and reduces American competitiveness in world markets.22 Both of these factors could have the effect of bringing farmers together to fight for the programme’s continuation. Tobacco farmers can use this “political infrastructure” not only to fight for the TPSP, but also to oppose other public policies that affect them negatively, such as tobacco control measures.

Conclusion

In this review, we reported that the impact of the Tobacco Price Support Program on smoking is small. The price per pack of cigarettes is increased by only about one cent as a result of the higher tobacco price induced by the TPSP, an increase that is estimated to reduce cigarette consumption by 0.23%.

For proponents of tobacco control, the small beneficial effect of the TPSP must be weighed against the potential political influence of quota owners on opposing efforts to reduce smoking. In addition, we do not expect a larger political influence from tobacco farmers in the absence of the TPSP. Thus, it is very likely that the TPSP has strengthened potential political opposition to smoking control.

The key issue is whether the reduction in smoking attributable to the current TPSP exceeds the negative effect of the opposition to tobacco control measures generated by quota owners and tobacco farmers. Because the decrease in cigarette consumption resulting from the TPSP is less than the effect from a two-cent increase per pack in the federal excise tax, the effect of the TPSP on reducing smoking is minimal compared with the expected effect of virtually all tobacco policy measures currently under consideration.16 If the potential political forces attributable to the TPSP can block policies such as a cigarette tax increase or other tobacco control initiatives, the net impact of the TPSP on tobacco control would be negative.

Logically, cigarette manufacturers should be against the TPSP because a higher tobacco price increases their production costs and reduces cigarette consumption. However, tobacco manufacturers are not lobbying the federal government to abolish the TPSP. This suggests that the potential political benefit (active opposition of quota holders and tobacco farmers to tobacco control measures) of the TPSP for manufacturers is greater than the financial loss resulting from a higher domestic price of tobacco. We conclude that the negative impact of the TPSP (opposition to tobacco control measures) probably exceeds the positive impact of the programme (reducing smoking by lowering cigarette consumption).