Econ Focus

A Guide to the Tobacco Program

Tobacco, not mentioned in the farm bill, receives its subsidies under a separate U.S. Department of Agriculture (USDA) program. A system of quotas and nonrecourse loans helps keep farm tobacco prices stable and relatively high. Growers of flue-cured tobacco (grown largely in North Carolina and Virginia) and burley tobacco (grown largely in Kentucky) vote every three years to decide if their products will be part of the program. Both groups of growers have approved the program every year — with one exception — since the Agricultural Adjustment Act of 1938 started the tobacco program.

Quotas determine the quantity of tobacco a producer is allowed to sell each season. The national marketing quota is designed to meet domestic and export demand at a legally mandated support price or higher. The quota is based on the buying intentions of domestic cigarette manufacturers and other factors, with some leeway for adjustment by the Secretary of Agriculture. The effective quota for each individual grower also includes an adjustment of up to 3 percent carried forward from the grower's overproduction or underproduction in earlier years.

A nonrecourse loan program provides a guaranteed price for each grade of tobacco leaf. A USDA inspector assigns a grade to each pile or bale of leaf at an auction warehouse, and then each individual lot of tobacco is sold to the highest bidder. If the bids are less than the government's loan rate, the tobacco grower may sell instead to a price-stabilization cooperative at the support price (the loan rate). The cooperative buys the leaf with money borrowed from the USDA's Commodity Credit Corporation.

The auction system is faltering under pressure from rising production costs, falling domestic demand, and more competition from foreign tobacco. As a result, the volume of quota tobacco has dropped about 50 percent since 1997. Domestic growers are bypassing the auction system and contracting to sell more of their leaf directly to cigarette manufacturers, even as tobacco companies are using more low-cost foreign tobacco in their products.

Growers selling under contract give up their rights to price support but still must not sell more than their quota. Contract prices exceed expected auction prices at present, and some contracts have a clause that lets the grower reject the contract price and instead sell the leaf at auction. Growers see other benefits in contracting: They are paid immediately for all their leaf in a single transaction, and they avoid warehouse commissions and fees.

With the auction system apparently in trouble, a rising number of quota owners are pressing for a quota buyout. Quota owners are attracted by the prospect of a generous payment, but they also fear that shrinking quotas could cause the program to wither and die without a payout if a deal is not struck fairly soon. Delaying a buyout are a range of issues from the question of who should provide the funding to proposals on using a buyout as an occasion to increase government regulation of the tobacco industry.

The interests of quota owners are not necessarily the same as those of tobacco growers. Many growers rent quotas from owners. North Carolina, for instance, has about 80,000 quota owners and just 10,000 tobacco growers. Some growers fear a buyout will lead to lower leaf prices as they are forced to bargain directly with the tobacco companies without recourse to the present system of auctions and price guarantees.