Testimony Before the
U.S. Senate Committee on Agriculture, Nutrition, and Forestry

William M. Snell
University of Kentucky

Thank you Senator Lugar, it is certainly an honor that I have the opportunity to testify before this Committee. My name is Will Snell and I am an agricultural economist at the University of Kentucky. I would like to focus my testimony on the tobacco program and the potential implications of a proposed tobacco settlement. Most of my remarks will pertain to the burley tobacco industry in Kentucky, but they certainly would apply to the other seven states in the burley belt. Let me begin by making a few general comments regarding the tobacco program. The tobacco program has been in existence since the 1930s and can arguably be labeled as one of the most effective farm programs ever administered by the USDA. Over the years, the program has accomplished many of the original goals of farm programs of providing income and price support for a large number of small family farms without incurring large government expenditures. Farmers have shown their support of the program via referendums (held every three years) which have consistently tallied over 90% approval of maintaining the program.

The tobacco program has played a major role in shaping Kentucky's farm and rural economy. Kentucky is comprised primarily of small family farms that have been handed down for generations. Currently Kentucky possesses the fourth largest number of farms in the United States, with approximately 59,000 of Kentucky's 88,000 farms growing tobacco. Kentucky has more farms growing tobacco than 37 states have total farms.

Across the eight state burley belt (which includes Kentucky, Tennessee, Indiana, Ohio, North Carolina, Virginia, West Virginia, and Missouri) over 250,000 farms possess quotas, with almost 75% of these quotas being one acre or less in size. Consolidation of quotas has occurred, but the latest census data reveal that the average tobacco farm in Kentucky grows 4.5 acres of tobacco. Ninety percent of Kentucky tobacco farms produce less than 10 acres of tobacco and Kentucky, by far, has the largest tobacco farms of any burley-producing state.

Overall, tobacco is produced in 119 out of Kentucky's 120 counties, generating sales of $800-$900 million annually, which translates into about 40% of the net cash return from ag sales in Kentucky. Given the uncertainties facing the tobacco industry, Kentucky farmers are currently evaluating various alternatives to supplement their tobacco income. And some of these farmers are certainly achieving success in their diversification efforts. However, given the resource base in Kentucky, there are simply no other agricultural enterprises that for a large number of farms and for a sustained period of time can generate the returns to management and labor comparable to tobacco. Thus, unlike many other farm programs of the past, the price stabilizing/production control measures of the tobacco program have certainly contributed greatly to sustaining thousands of small family farms in Kentucky and other burley tobacco-producing states.

While the program has sustained a large number of family farms over the years, the tobacco program does present some challenges and concerns for growers. First, while the program does provide price stability, it does not protect against quota instability. Second, quota transfer restrictions across county boundaries induces additional inefficiencies as it does not allow production to move to the lowest cost areas. And third, the program's effectiveness has diminished in recent years as production increases and quality improvements overseas have deteriorated U.S. burley price competitiveness and thus market share.

Despite increasing competition, U.S. burley basic quotas escalated to the second highest level on record this year. Many farmers and agribusinesses responded to these high quota levels by making significant long-term investments in their tobacco operations. But some of these investments could be at risk depending on what happens with the program and the settlement.

Abolishing the tobacco program would eliminate the value of quota, representing a major income loss to quota owners. While growers would benefit from not having to pay a rental fee for quota, they would lose price stability which is the primary reason most support the existing program. Without a program, price volatility would increase significantly and U.S. burley prices could fall 25 percent or more. A price decline of this magnitude would likely reduce the number of family farms growing burley tobacco by more than 50 percent and would depress many small rural communities that depend on tobacco income, but lack off-farm employment opportunities. The most vulnerable areas would likely be the Appalachian regions of eastern Kentucky, eastern Tennessee and western North Carolina.

The price decline evolving from a free-market environment would certainly increase the demand for U.S. burley in both domestic and foreign markets, But in the short-term, U.S. burley production without a program would be constrained greatly by a significant loss in growers coupled with tight labor supplies and barn space. After some adjustment period though, U.S. burley tobacco production would likely increase in concentrated low-cost of production areas such as central and western Kentucky and central Tennessee, but certainly could expand into areas outside the traditional burley belt. Without a tobacco program, the economic rents (benefits) associated with the program would transfer from the farmers to the tobacco companies (through lower input prices) and to smokers (through modest declines in cigarette prices). The bottom line is that some of the 250,000 farms possessing burley tobacco quotas could likely survive and compete quite effectively without a program. However, they would be in the minority. Put simply, program elimination will induce major structural changes and significant adjustment costs in the burley belt.

Consequently this is effecting what tobacco farmers want out of a settlement. Based on my interaction with various farm groups over the past two months, burley tobacco farmers in general support the following four items; 1) maintain the program, 2) attempt to stabilize quotas (via replacing imports), 3) provide compensation to growers and quota owners if quotas fall in response to the settlement, and 4) have a release or safety valve in place if the program is eliminated or demand for tobacco declines significantly.

While estimates vary, the current tobacco settlement will undoubtedly reduce domestic consumption and thus demand for domestic tobacco. I estimate that U.S. burley tobacco producers will lose approximately $50 to $100 million annually in the short-term and some $100 to $150 million annually over the long-term based solely on the projected manufacturer price increases associated with the settlement. Obviously other non-price factors (e.g., advertising restrictions, tobacco education/cessation programs, and FDA regulation) will add to these losses.

To offset these likely losses many policy options have surfaced, including a quota buyout. Given the long-term challenges facing the tobacco industry and the tobacco program, a buyout may be in the best financial interest of large quota owners. However, a lot of rural communities in many burley producing counties possess a significant number of full-time tobacco farmers who may own very little or no quota. Thus any compensation plan which does not adequately address these individuals will likely fall short of the desired results.

In conclusion, tobacco farming in Kentucky and surrounding states has been a dominate fixture of rural communities, their economies and their culture for generations. What evolves from this settlement and the policy debate over the program will determine the fait of thousands of farms and their rural communities in Kentucky and surrounding states for generations to come.