Tobacco Policy
William M. Snell, University of Kentucky
A. Blake Brown, Southern University
Russell W. Sutton, Clemson University
Background
There are two major types of tobacco produced in the United States flue-cured and burley. Flue-cured tobacco is produced in North Carolina, Virginia, South Carolina, Georgia and Florida, with North Carolina being the largest producer. Burley tobacco is produced in Kentucky, Tennessee, Virginia, North Carolina, Ohio, Indiana, West Virginia and Missouri, with Kentucky being the largest producer. In addition to flue-cured and burley tobacco, several other types of tobacco are produced in the United States. These include dark air-cured, dark fire-cured, Maryland and cigar filler, binder and wrapper types. Tobacco is an important income crop in the southeastern United States with 1993 farm sales of about $2.8 billion. According to the USDA, there are approximately 380,000 quota holders and over 100,000 growers in 21 states. This paper concentrates on the flue-cured and burley tobacco programs because production of these types comprise around 95 percent of total U.S. tobacco production.
The U.S. tobacco program originated under the Agricultural Adjustment Act of 1933, with the 1938 bill authorizing marketing quotas and the 1949 act authorizing price supports. While the program has been amended many times over the years, the basic components of the tobacco program remain. Specifically, U.S. tobacco growers are guaranteed minimum prices through price supports in exchange for limiting production via allotments and quotas. The program effectively raises the farm-level price of tobacco which tends to modestly increase the price of tobacco products to consumers and thus slightly lower the consumption of tobacco products. The costs of operating the U.S. tobacco program are paid by producers and purchasers through marketing assessments. Relatively small administrative costs are borne by taxpayers.
The tobacco program operates under continuing legislation and is normally not considered part of the periodic farm bill. Since the legislative guidelines are on-going and rather precise, program adjustments usually require new legislative activity, and a referendum is held every three years for flue-cured and burley to determine whether producers support the continuation of the programs. Past votes have overwhelmingly supported the programs.
Under the current tobacco program national marketing quotas are set each year. These quotas determine the maximum amount of burley and flue-cured tobacco that producers can sell that year. Restricting the supply of U.S. tobacco via national quotas has been successful in garnering a higher price for U.S. tobacco on both the U.S. and world markets. Support prices are set for various grades of tobacco. If a sale lot of tobacco does not bring more than the support price, it is acquired at the support price by grower-owned and grower/buyer financed cooperatives. In the face of expanding world production and declining U.S. market share, the supply restrictions over the past 50 years have gradually become less effective in extracting prices for U.S. tobacco that are above world prices.
The national quotas are allocated among individual allotment holders. This allotment grants each holder the right to market a given amount of tobacco. Allotment holders who are not active producers of tobacco may lease (rent) or sell their quota to active producers within the same county. Cross-county leasing of quota is allowed only under specified disaster conditions and in Tennessee. The current lease rate for quota in some counties averages 30 to 35 percent of the market price. Thus, the return to quota is a significant source of income for many farmers and non-farmers in tobacco producing areas. Conversely, the cost of leasing is also a significant cash expense for producers who lease-in quota.
Since 1980, the U.S. tobacco program has been revised several times in response to economic, political and international pressures. A major change occurred with the Tobacco Improvement Act of 1985. Price supports for tobacco were reduced by this legislation and domestic tobacco manufacturers were required to purchase existing loan stocks. In addition, the price support and quota formulas were revised in an effort to generate more market-oriented price and production levels (see below for more details).
Expanding international markets during the late 1980s resulted in rapidly rising marketing quotas. However, the demand for U.S. tobacco was reduced sharply in 1992 and 1993 in response to a world excess supply of less expensive foreign tobacco and to a changing manufacturing blending practices to accommodate increasing domestic sales of generic cigarettes. U.S. cigarette manufacturers responded by importing record levels of tobacco into the United States.
Faced with declining domestic sales and marketing quotas, the U.S. tobacco program was modified in 1993 to effectively limit the volume of imported tobacco. Under this domestic content legislation, individual domestic cigarette manufacturers would be subject to monetary penalties and loan stock purchase requirements if they use more than 25 percent foreign tobacco in U.S. cigarettes during a given calendar year. However, an international panel has recently ruled this legislation violates GATT. As a result, Congressional members from tobacco producing states are presently attempting to provide import protection while remaining GATT-legal.
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Current Situation and Forces of Change
Tobacco production has escalated worldwide since 1991, resulting in a significant surplus of tobacco in international markets and depressed world prices. However, the U.S. price support structure has generally prevented U.S. tobacco prices from falling during this period of excess world supplies. In recent years, U.S. tobacco prices have averaged two to three times the average price of foreign tobacco. U.S. tobacco still demands a quality price premium in the world market, but this premium is reportedly declining in response to improving foreign tobacco quality and abundant world supplies. World tobacco production is expected to decline in 1994, but it will likely take several years to work-off record world stock levels.
Worldwide tobacco consumption continues to increase to record levels annually. But growth is generally not occurring in traditional U.S. markets. Besides being confronted with stagnant/declining consumption, the U.S. tobacco producers are also faced with a greater substitution of less expensive foreign leaf for U.S. tobacco in these markets.
Demand for U.S. tobacco in the domestic market has also been adversely affected by increases in the number of smoking restrictions/bans, wholesale cigarette prices and taxes. As a result, demand for U.S. tobacco has declined considerably from the record levels established during the early 1990s causing loan stocks to approach critical levels.
U.S. tobacco growers are hopeful that a modified domestic content law will eventually boost U.S. tobacco demand. This legislation will undoubtedly reduce U.S. tobacco imports, but at the probable expense of also reducing U.S. leaf and cigarette exports. Thus, the long-term effects of this legislation on the U.S. tobacco industry are uncertain.
In addition to increasing international competition, the U.S. tobacco industry is also being threatened in the domestic market by proposals for significantly higher excise taxes on tobacco products as well as heightened government regulation on tobacco products. In response to these conditions, the marketing quota formulas for flue-cured and burley tobacco called for an over 40 percent reduction in 1994 farm quotas. However, provisions under the domestic content legislation limited the 1994 downward adjustment in flue-cured and burley quotas to 10 percent. Unless market conditions improve immensely, larger 1995 quota reductions may result.
In summary, the U.S. tobacco industry faces much uncertainty as it enters the mid-1990s. Increasing international competition, proposed higher excise taxes, uncertainty regarding the import restrictions and additional smoking restrictions/bans and other government regulations are major issues confronting the industry. Current market forces indicate that U.S. tobacco quotas/production and world market share will likely continue to decline unless the tobacco program is modified to improve the price competitiveness of U.S. tobacco.
Issues
U.S. policymakers face the choice of either substantially lowering quotas under the current program, pursuing legislation to lower price supports for tobacco or a combination of adjusting both quota and price supports downward. How long policymakers can wait before making such difficult choices will depend to some extent on how effective import restrictions are at increasing domestic tobacco use without causing a decrease in unmanufactured and manufactured exports. Non-producing quota owners and growers who own most of their quota may favor maintaining current price levels with lower production levels (implying higher lease rates), while large scale growers who rent a large portion of their quota may favor lower price supports and higher production levels (implying lower lease rates).