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PLAIN ECONOMIC SENSE
For release after April 5, 1999
Column 375
Policy Principles for a Self-Help Farm Income Safety Net
By Mark A. Edelman
Extension Public Policy Economist
Iowa State University Extension to Communities
Many farmers continue to believe crop insurance doesn't pay for them in the long run. And, they may be right. Recent publication of historical loss ratios for crop insurance offerings show that Iowa and several other corn belt and western states had loss ratios of 75 to 85 percent, which means that the loss payments were less than the premiums paid by farmers plus the government subsidies.
At the same time some southern and northern plains states had loss ratios of 115 to 160. If crop insurance worked like car insurance, premiums would rise in states with loss ratios above 100 and fall in states below 100 until all states were equalized. But it hasn't worked that way in crop insurance. The costs become too expensive in high risk states, making government ad hoc disaster programs more likely every now and then.
Depending on financial ability to bear risk, some farmers would simply prefer to self insure. This option would become more feasible if the appropriate tools were available. Farmers interested in self-help/self-insurance could potentially benefit from transplanting a Canadian concept called the Net Income Stabilization Account (NISA). The Canadian NISA is a farm-level risk management savings program that matches farmer deposits dollar for dollar with government contributions. It also adds a 3-percent interest rate subsidy on farmer contributions.
Canadian farmers make deposits with after-tax income, but government contributions and interest earnings remain untaxed until withdrawals are made and benefits are realized. Canadian farmers can deposit annually the smaller of $5,000 or two percent of eligible farm sales. This limits the government match to $5,000 per year per farm. Farmers also can make additional unmatched contributions of up to 20 percent of sales. Account balances may not exceed 150 percent of the farm's five-year average sales. Withdrawals are allowed only when farm income falls below the established thresholds for each farm.
Evidence from Canada suggests that most farmers deposit only enough money to earn the maximum match from government contributions. This suggests that the matching contribution is relatively more important than the interest rate subsidy and that similar savings behavior may be achieved by only partially matching the deposits.
Last year and again this year, the concept known as Farm And Ranch Risk Management (FARRM) accounts has been introduced into the U.S. Congress. FARRM accounts are similar in some respects to the Canadian NISA concept. However, several key differences are apparent. The FARRM account proposal has no government match. However, in contrast to the NISA concept, all FARRM account earnings and farmer contributions are tax deferred.
It is important to recognize that deferring taxes on farmer contributions provides a greater incentive for farmers in higher taxable incomes and tax brackets to participate. So, the FARRM account proposal provides less participation incentive for many farmers in moderate and low income groups. Since the Canadian NISA program provides government tax deferred matching funds of up to $5,000 per farm per year, all farmers are encouraged to save up to the maximum matching amount.
Another important difference in the FARRM account proposal is a 20 percent penalty if the funds are not used within five years. The merit of a five year limit may be questionable because historical data show weather cycles of 20 to 30 years. Specific agricultural industries exhibit historical price cycles of six to twelve years. Any time-imposed limits that arbitrarily constrain savings or require premature withdrawals may defeat the intended purpose of the accounts.
In the final analysis, as Congress considers ways to improve the U.S. farm safety net, it would appear that we might be able to learn a few lessons from the Canadians who operate in a more variable weather environment. Part of the agricultural insurance subsidy funding promised by Congressional Agriculture Committee leaders to fix the farm safety net might be more efficiently used as matching dollars to provide incentives for farmers to create their own self-help farm income stabilization safety net.
Edelman is a professor of economics and an extension public policy specialist at Iowa State University.
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