Decoupled Payments as Income wages, interest and dividends, and gifts and bequests Transfers: Conceptual (fig. 1). Similar to other sources of income, a household Framework of the Study makes decisions about the expenditure of its govern- ment benefit on consumption or savings, taking into This section presents the conceptual framework of the account its tax liabilities. In general, these expenditure analysis, explaining how income transfer payments in decisions can be understood within a lifetime planning general change household income, wealth, risk attitudes, framework, with households choosing to consume the and expectations, and lead to changes in household payment now or to save and invest it to pay for future consumption, saving, investment, and work. We also consumption. The consumption and savings tradeoff is describe our methodology for analyzing the impacts on influenced by the characteristics of the household such households and U.S. agricultural production. as age, its subjective preferences (such as risk atti- tudes), and the expected yield on investments. Decoupled Payments: Fundamentally Different From Coupled Payments A transfer payment immediately increases a house- Decoupled payments are fundamentally different from hold’s ability to both consume and save. Market the traditional, “coupled” commodity programs that have expectations about the size and the duration of future historically provided most income support to U.S. agri- income transfers are reflected in the household’s asset cultural producers. Decoupled payments are fixed income values, and consequently its wealth. Higher wealth transfers that do not subsidize production activities, also influences current consumption and savings. It inputs, or practices. They are “lump-sum” transfers increases the household’s propensity to consume cur- because no production decision or change in market rent income by reducing its need for savings to finance price can alter the size of the payment due to eligible future consumption. Consumption includes both goods producers. This program design effectively cuts the link and leisure. Government transfer payments in effect between payments, production, and prices, and makes make leisure, like other goods, more affordable. They the payments a direct transfer of income to the farm increase the value of leisure relative to the marginal household. In contrast, coupled subsidies directly affect value of additional wage earnings and in theory lead to production decisions by changing the prices received by a reduction in hours worked. the producer for commodities or the prices of inputs, A household’s savings represent its plan to pay for either of which change the marginal returns from pro- consumption in the future. In the lifecycle framework, duction. Price signals attract resources into subsidized a household typically consumes a large share of its sectors and lead to higher levels of production and income in its early years, when income is still low. lower world prices. Some types of coupled programs Households have a higher savings rate in midlife, also impose supply controls, which raise commodity when earnings typically peak (although the level of prices for consumers. (See box, “Increased Market consumption can be highest in these years as well). Orientation of World Agriculture.”) The savings rate declines in later years when incomes Income Transfers and Income fall and hours of work are reduced. In addition, when a and Wealth Effects household’s income has high year-to-year variability, it has an incentive to accumulate precautionary savings Income transfers are not unique to agriculture. Many for short-term consumption smoothing, allowing it to U.S. programs are designed to redistribute income and maintain some threshold consumption when income is wealth to specific recipients. Most of these are targeted low. A household typically allocates its savings across to household socioeconomic characteristics, such as an investment asset portfolio, and its savings rate is poverty, unemployment, and old age. Research on sensitive to the expected (risk- and tax-adjusted) rate social welfare programs has addressed several issues of return on its investments. of relevance for the U.S. decoupled farm program. Foremost, it has focused attention on the ways that Changes in income and wealth can also change a changes in income and wealth affect household con- household’s tolerance for risk. Farmers’ risk aversion sumption, savings, and work effort (Atkinson and is sometimes argued to affect production decisions, Stiglitz; Myles; Danziger et al.). and wealth-induced increases in risk tolerance are argued to influence production levels, input use, or Transfer payments are one component of household crop mix. Instead, from a household’s perspective, income, which can also include farm and nonfarm changes in risk tolerance due to an income transfer are Economic Research Service/USDA Decoupled Payments: Household Income Transfers in Contemporary U.S. Agriculture/AER-822 ✥ 3 Increased Market Orientation of World Agriculture Many countries in addition to the United States have reformed base production had to be planted to the same crop for which their farm subsidies in an effort to increase the market orienta- they had base acres, or farmers would forego benefits. The tion of their agricultural sectors. In recent years, countries have “normal flex acres” (15 percent of base) in the 1990 Act were not introduced a wide variety of domestic programs that have less- eligible for deficiency payments, but loan benefits remained avail- ened the degree of producers’ price insulation. Only subsidies able if the acres were planted in a program crop. The “optional that do not depend on current prices, factor use, or production flex acres” (an additional 10 percent of base) in the 1990 Act can be considered fully decoupled from farm production deci- also allowed farmers to plant any crop. Deficiency payments sions. Most countries have achieved a greater degree of market were foregone if this acreage was switched to an alternative crop, orientation but their subsidies still depend on either current although producers did not lose this acreage from their base. price or current production. “Decoupling” can be defined in terms of the actual impact of Domestic subsidies are compared here according to their links the program on production levels or the way a subsidy program or “coupling” to current prices or production. Subsidies fully is implemented. Implementation rules offer a neutral way to com- decoupled from price are fixed payments made irrespective of pare farm programs, and they are the basis for WTO criteria on market price conditions. Payments fully decoupled from price, exemption from expenditure limits. Actual production impacts such as EU compensatory payments, are still essentially cou- can vary by country for reasons that are not related to program pled if current production is required in order to receive bene- design but are instead related to local market conditions. fits. Japan has moved to partially de-link its support from cur- Market conditions can cause even fully decoupled payments to rent prices by basing subsidy levels on recent moving averages have supply impacts, but these conditions are outside the con- of market prices. Payments fully coupled to price, such as the trol of policymakers. In Mexico, for instance, the PROCAMPO U.S. counter-cyclical payments, insulate producers from price payments have significantly affected agricultural investment signals because payments increase when prices fall and vice because they have enabled credit-constrained farmers to invest versa. U.S. counter-cyclical payments are decoupled from cur- onfarm (Sadoulet, de Janvry, and Davis). Although this rent production, but most countries typically require some cur- increased investment can lead to production impacts, Mexico rent production for households to receive price subsidies. notifies the payments as “green box” compliant to the WTO because of the program’s implementation rules. Some coupled programs allow planting flexibility—farmers can choose crop mixes and their program participation. Farmers’ The description of programs’ links to production and prices in resource allocation therefore becomes, to some extent, a “tilling the table is based on a stylized representation of complex pro- for benefits” decision. When fully coupled price subsidies are grams. Programs often have multiple components with different combined with rigid crop mix requirements, as in the 1990 Act links to production or prices. For example, components of U.S. deficiency payments, there is no room at all for market price 1990 Act deficiency payments had different eligibility rules, signals or program benefits to allocate resources. U.S. farmers’ and only some appear in the table. Increased market orientation of domestic support: Subsidies’ links to current prices and production Links to production Full planting Full planting flexibility, flexibility, Planting flexibility Limited or no Links to prices including idling excluding idling within program crops planting flexibility Payment U.S. PFC and U.S. 2002 Mexican PROCAMPO EU compensatory and not linked to Act direct payments set-aside payments, Japan current price payments for mountain and hilly areas, Japan area payments for other crops grown on riceland and for manufactured milk Payment Japan income stabilization linked to programs, Japan vegetable recent trends and milk price stabilization in market price programs