Potential Challenges to U.S. Farm Subsidies in the WTO: A Brief Overview

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This report examines U.S. commodity subsidy programs against an emerging set of criteria that
test their potential vulnerability to challenge in the World Trade Organization. The criteria are
whether the subsidies cause adverse effects contributing to serious prejudice under the Agreement
on Subsidies and Countervailing Measures (SCM), Articles 5 and 6.3. When measured against
these criteria, available evidence suggests that all major U.S. subsidy program crops, particularly
crops receiving benefits under both the counter-cyclical payments program and marketing loan
provisions are potentially vulnerable to dispute settlement challenges. If such challenges occur
and are successful, the WTO remedy likely would imply either elimination, alteration, or
amendment by Congress of the programs in question to remove their adverse effects. Alternately,
in light of an adverse ruling the United States could choose to make compensatory payments
(under agreement with the challenging country) to offset the alleged injury. In spite of U.S.
vulnerability, there are reasons why challenges may rarely be filed. Disputes are economically
and diplomatically costly, and a lost challenge can help to legitimize the disputed program. This
report, which will be updated, is an abridged version of CRS Report RL33697, Potential
Challenges to U.S. Farm Subsidies in the WTO, by Randy Schnepf. Citations to sources appear in
that report.

he World Trade Organization’s (WTO’s) 149 members have agreed to a set of trading
rules, including constraints on domestic subsidies and a process for challenging violations.
Now, the combination of three relatively recent events—(1) the expiration of the WTO T

Peace Clause on January 1, 2004; (2) Brazil’s successful challenge of certain provisions of the
U.S. cotton program in a WTO dispute settlement proceeding (upheld on appeal in March 2005);
and (3) the indefinite suspension of the Doha Round of WTO trade negotiations in July 2006—
have raised concerns that U.S. farm programs could be subject to a new wave of WTO dispute
settlement challenges.
The Peace Clause had provided protection for actionable subsidies provided they met certain
compliance conditions. Now an agricultural subsidy may be challenged under claims of “adverse
effects” in agricultural markets—even if the subsidy remains within specified spending limits.
The potential list of actionable subsidies includes export subsidies, amber box, blue box, green
box, and de minimis domestic support measures. (See CRS Report RL32916, Agriculture in the
WTO: Policy Commitments Made Under the Agreement on Agriculture, by Randy Schnepf, for an
explanation of these categories.) In particular, the “serious prejudice” claim of the Agreement on
Subsidies and Countervailing Measures (SCM), Article 5(c), according to expert opinion, is a
lower threshold for achieving successful challenges than the injury requirement under a
countervailing duty claim.
If challenges are successful, the WTO remedy likely would imply either elimination, alteration, or
amendment by Congress of the programs in question to remove their adverse effects. Since most
governing provisions over U.S. farm programs are statutory, new legislation could be required to
implement even minor changes to achieve compliance. Alternately, in light of an adverse ruling
the United States could choose to make compensatory payments (under agreement with the
challenging country) to offset the alleged injury. USDA Secretary Johanns has stated that one of
his primary objectives for the 2007 farm bill is to make U.S. farm programs “beyond challenge.”
This objective was translated into specifics in the Administration’s 2007 Farm Bill Proposals.
Nevertheless, some trade specialists argue that numerous new WTO challenges of U.S. farm
support are unlikely. They contend that challenges require intense effort, the financial costs are
high, and the broader geopolitical consequences may far outweigh any potential trade gains. Few
developing countries have the needed resources for a challenge. In addition, there is the inherent
risk that, if the challenge fails, the effort could legitimize those very programs targeted for
discipline. However, in January 2007, Canada requested consultations with the United States
under the auspices of the WTO (case DS357) to discuss three explicit charges against U.S. farm
programs: that corn subsidies have caused serious prejudice to Canadian producers in the form of
market price suppression; that the export credit guarantee program operates as an illegal export
subsidy; and that fixed direct payments are not green box compliant and should be counted as
amber box payments, putting the United States in violation of its $19.1 billion amber box
spending limit in six of the past eight years.
Based on precedent from WTO past decisions, several criteria are important in establishing the
existence of adverse effects contributing to serious prejudice: (1) the subsidies constitute a
substantial share of farmer returns or cover a substantial share of production costs; (2) the
subsidized commodity is important to world markets because it forms a large share of either
world production or world trade; and (3) there is a causal relationship between the subsidy and
adverse effects in the relevant market.

A WTO challenge, under SCM Articles 5 and 6.3, is most likely to focus on those programs that
are production- and trade-distorting (i.e., amber box) or that have been exempted from the amber
box under the blue box, de minimis, or green box criteria, but can be shown to cause adverse
effects in certain markets. To identify commodities that are potentially vulnerable to WTO
challenges, USDA data are used to measure the level of subsidy dependence. Then, those
commodities identified as depending heavily on government subsidies are evaluated in terms of
the potential for the subsidies to be linked to adverse effects in international commodity markets.
When U.S. program crops (i.e., commodities receiving mandatory federal support) are ranked by
the level of subsidy as a share of cash receipts (over the past 10 years beginning with 1996), all of
the “covered commodities,” with the exception of some minor oilseeds, received subsidy
payments amounting to more than 10% of marketplace cash receipts.
Table 1. Subsidy Payments as Share of Cash Receipts,
Average FY1996-FY2005
^{Subsidy as Share o}^f^{Subsidy as Share o}^f
^Commo^dity^{Cash Receipts}^Commo^dity^{Cash Receipts}
^{Rice 72%}^Sunflower^Seed^21%
^{Upland Cotton}^58%^Canola^20%
^{Sorghum 45%}^Flaxseed^13%
^{Wheat 34%}^Dry^Peas^12%
^{Barley 30%}^Peanuts^11%
^{Corn 25%}^Soybeans^10%
^{Oats 25%}
^Source:^Sub^{sidies include commodity support pa}^yment^{s and c}^rop^insura^{nce indem}^{nity payme}^{nts in}^{excess of}
^{farmer-paid p}^{remiums. Calculations were}^{made by CRS from USD}^{A data.}
The averages understate the situation because challenges in the WTO likely would specify the
years when the subsidies were at their highest levels relative to market revenues. In FY2000, for
example, rice and cotton subsidy payments amounted to 174% of cash receipts, and sorghum,
wheat, and corn payments were respectively 110%, 101%, and 66% of cash receipts, according to
USDA data.
On average, for the crops receiving the most program support per unit, market revenue has
covered operating costs but not total costs of production. It is only with the subsidies that these
commodities cover their total cost, and even this was not accomplished for sorghum and wheat.
In the most extreme case, market revenue for rice amounted to 70% of total costs, but with the
addition of subsidies the total revenue amounted to 146% of total costs.

Figure 1. Revenue Components as
Share of Total Costs
^Source:^{Calculated by CRS from}^{USDA data.}
These comparisons suggest that only with the aid of subsidies is a substantial portion of U.S.
production made economically sustainable. Unanswered is the question of whether production
would decline without the subsidies. Some (and possibly a substantial) portion of the lost
production from high-cost farms that would leave the sector in the absence of subsidies would be
offset by increased production from low-cost farms that would likely expand their operations.
Nonetheless, the substantial contribution of subsidies toward covering otherwise unmet produc-
tion costs implies a high chance for adverse rulings for any of the major covered commodities.
Direct payments, the 2002 farm bill successor to production flexibility contract payments, are, on
average, the largest and most constant commodity subsidy payments. Counter-cyclical payments
and marketing loan program payments, as well as milk income loss payments, have the greatest
variation and are large, by design, in years when market prices are low. The cotton user marketing
program, commonly called the Step 2 program, has been terminated by a change in the law
subsequent to the WTO cotton ruling, and expenditures will drop to zero in FY2007. There are
purchase programs for milk and sugar to remove supplies from the market when prices fall below
mandated support levels, but federal costs are comparatively low because price support largely is
achieved through import restrictions. Crop insurance is another sizable and growing direct
subsidy program, benefitting primarily the major crops but other crops as well. Table 2 provides
detailed expenditure data for the major subsidy programs.
Some WTO members, including the EU, have argued that benefits from U.S. marketing loan
provisions should be classified as prohibited export subsidies. They contend that these subsidies
“effectively behave like an export subsidy.” However, under SCM Article 3 an export subsidy
must be based specifically on export performance or upon use of domestic over imported goods:
“The mere fact that a subsidy is granted to enterprises that export shall not for that reason alone
be considered to be an export subsidy...” The United States maintains that all of its farm programs

operate within the framework of U.S. commitments to the WTO and are therefore in compliance.
Furthermore, no WTO member has challenged the benefits obtained by U.S. producers under the
marketing loan provisions as prohibited subsidies.
Federal crop insurance costs have grown in recent years because the level of subsidy on each
policy has increased and the pool of subsidized commodities and production locations has grown.
Since FY2002, government net outlays (including premium subsidies and government loss-
sharing and delivery costs) have averaged more than $3 billion annually. Future growth
(according to a January 2006 report by the Food and Agriculture Policy Research Institute
(FAPRI)), is expected to raise net outlays to over $4 billion by 2008 and $4.6 billion by 2015.
This higher expenditure level could bring the crop insurance program under greater scrutiny from
trade competitors.
While crop insurance is available widely, 68% of the subsidy over the FY2002-FY2006 period
went to five crops—corn (20%), wheat (18%), soybeans (16%), cotton (9%), and sorghum
(6%)—and fully 75% of the total crop insurance coverage went to the program crops, while the
remaining 25% went to the non-program crops. When total premiums (including farmer and
federal contributions) are compared to indemnity payments, the loss ratio was 1.09, giving the
overall appearance of being actuarially sound. However, if the federal premium subsidy is
excluded, the loss ratio is 2.70 (indemnities were 2.7 times higher than farmer premium
payments).
Table 2. Commodity Subsidy Outlays, by Program, FY2002-FY2007F
^{($ mill}^ion)
^Progr^am^{FY02 FY03 FY04 FY05 FY06E}^FY07F
^{Direct Payments Program}^a^3,96⁸^3,85⁷^5,27⁸^5,23⁵^4,94⁹^4,17⁰
^{Counter-Cyclical Payments Progr}^am^1,74³⁸⁰⁹^2,77²^3,97⁵^3,14⁷
^{Marketing Loan}^Program^5,98⁷^4,75²^1,04⁷^5,60⁸^5,69³⁴⁰²
^{Loan Deficiency Payments}^5,345⁶⁹³⁴⁶¹^3,856^4,576³⁵¹
^{Commodity Certificate Gains}⁰^3,869²⁶⁸^1,520^1,106³²
^{Marketing Loan G}^ains⁶⁴²¹⁹⁰³¹⁸²³²¹¹¹⁹
^{Milk Income Loss Contract}⁰^1,79⁶²²¹⁹⁵¹⁵⁶⁰⁰
^{Cotton User Marketing P}^rogram¹⁸²⁴⁵⁵³⁶³⁵⁸²³¹²⁰
^{Total CCC C}^{ommodity Payments}^16,1²⁴^17,3⁵⁵^8,76⁵^19,8¹⁴^21,1³⁷^8,72¹
^{Dairy price su}^pport^program⁶²²⁶⁹⁸⁷⁴⁽³⁰⁾⁸⁸¹⁴⁵
^{Sugar price s}^u^p^port^program⁽¹³⁰⁾⁽⁸⁴⁾⁶¹⁽⁸⁶⁾⁰⁰
^{Total Commo}^{dity Purchase Op}^e^rations⁴⁹²⁶¹⁴¹³⁵⁽¹¹⁶⁾⁸⁸¹⁴⁵
^{Crop Ins}^ura^{nce I}^{ndemnities in E}^x^{cess of Farmer-Paid}
^Premiums^b^1,77²^2,89²^1,87¹^1,50⁰⁷⁵⁰^na
^{Total Commo}^dity-^{Specific Suppo}^rt^18,3⁸⁸^20,8⁶¹^10,7⁷¹^21,1⁹⁸^21,9⁷⁵^8,86⁶
^Source:^{Data are f}^{rom USDA, F}^{SA, CCC Net Outlays by Comm}^{odity and Function, July 1}^{1, 20}^06.^{Outlays for}
^FY2006^{and FY2}⁰⁰^{7 are}^{budget f}^orecasts.
^a.^{Direct payment}^{outlays for FY2}⁰^{02 include}^fu^{nds for t}^{he p}^redeces^{sor contract}^paymen^{ts p}^rogram.

^b.^{There are additional federal costs for crop ins}^ura^{nce delivery and a}^{dministration not included in the}^se
^{calculations. However, those costs bene}^{fit the}^{providers and}^{not directly the farme}^rs.
The most heavily subsidized commodities (with the exception of milk) also are this nation’s
largest agricultural exports. Not only do exports provide a market for a large proportion of U.S.
production, these exports are a large proportion of the entire world’s exports. During the 2002 to

2005 period, U.S. cotton accounted for 20% of world production and 40% of world trade.

Similarly, U.S. rice accounted for 2% of world production and 13% of world trade; U.S. wheat
was 9% of world production and 25% of world trade; U.S. sorghum averaged 18% of world
production and 83% of world trade; and soybeans averaged 38% of world production and 44% of
world trade.
Several economic studies have investigated the causality linkage between U.S. agricultural policy
support and the adverse market effects identified in SCM Article 6.3 (i.e., lost market share,
quantity displacement, and suppression of market prices). In general, these studies support the
idea that U.S. (and other developed country) agricultural support programs negatively influence
international market prices and tend to disadvantage third-country trade of non-subsidized “like”
products. (The longer version of this report, CRS Report RL33697, Potential Challenges to U.S.
Farm Subsidies in the WTO, by Randy Schnepf, summarizes these studies.)
The remedy to a successful WTO legal challenge of a subsidy program depends on the nature of
the subsidy—prohibited versus actionable—and on the recommendation of the panel hearing the
case. Prohibited subsidies must be withdrawn without delay (SCM Article 4.7) according to a
time period specified by the panel in its recommendation. If withdrawal is not accomplished
within the specified time frame, then the Dispute Settlement Body (DSB) shall grant
authorization to the complaining member to take appropriate retaliatory countermeasures (SCM
Article 4.10).
With respect to actionable subsidies, the remedy is to remove the subsidy’s adverse effects or
withdraw the subsidy (SCM Article 7.8). The subsidizing party is given some leeway in deciding
how to remove the adverse effect. Options could include eliminating the subsidy program,
reducing the subsidy amounts, reducing the linkage between the subsidy and the adverse effects
(e.g., decoupling), or making some sort of mutually acceptable compensatory payment.
Furthermore, if the recommendation is not followed within six months of the adoption of the
panel report (or the Appellate Body report on appeal), then the DSB shall grant the complaining
member authority to take appropriate retaliatory countermeasures commensurate with the degree
and nature of the adverse effects determined to exist (SCM Article 7.9). An arbitrator may be
asked to determine whether proposed countermeasures are commensurate.

When measured against WTO criteria, all major U.S. subsidized crops (both “covered
commodities” and “loan commodities”) appear potentially vulnerable to WTO legal challenges.
Furthermore, several commodities may be more vulnerable to challenges because of impacts in
specific export markets (rather than on a global basis) or in sub-product domestic and export
markets. Another important concern is the potential for certain U.S. farm programs (e.g., foreign
market development programs) to be ruled prohibited subsidies when subject to detailed analysis
by a WTO Panel.
A review of recent economic analyses suggests that a partial U.S. policy reform (such as the U.S.
Doha-Round Proposal to reduce U.S. amber box spending by 60%) would provide only a modest
reduction in adverse effects in international markets. This happens because the United States
plays such a large role in world commodity markets. As a result, U.S. subsidy programs would
appear vulnerable to WTO challenge under SCM Article 5 and 6.3 following even such a policy
reform.
The most clear method for decreasing exposure to WTO legal challenges is through extensive
decoupling (i.e., remove the linkage between payments and producer or consumer behavior).
Such decoupling would sever the causality linkage necessary to accomplish a successful WTO
challenge. Several options for decoupling have been considered or discussed as part of the
ongoing 2007 farm bill debate. These include fully decoupled direct payments, whole-farm
revenue-insurance-type programs, and conservation or “green” payments. The attraction of these
alternatives is their likely qualification as green box programs. The costs thus would fall outside
the WTO’s aggregate measures of support (AMS) spending limits.
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