Impact of the Kyoto Protocol on Agriculture

American Council for Capital Formation
October 1998
By Terry Francl, Richard Nadler and Joseph Bast

By Terry Francl, senior economist and commodity specialist, American Farm Bureau Federation; Richard Nadler, editor-in-chief, K.C. Jones; Joseph Bast, president, The Heartland Institute.

This paper was presented at the September 23, 1998, policy conference sponsored by the ACCF Center for Policy Research, and will be published in the Center's forthcoming book, Climate Change Policy: Practical Strategies to Promote Economic Growth and Environmental Quality.

Executive Summary

Because U.S. agriculture accounts for nearly one-fifth of U.S. greenhouse gas emissions, compliance with the Kyoto Protocol could increase U.S. farm production expenses by $10 billion to $20 billion annually and depress annual farm income by 24 percent to 48 percent. Higher fuel oil, motor oil, fertilizer, and other farm operating costs would also mean higher consumer food prices, greater demand for public assistance with higher costs, a decline in agricultural exports, and a wave of farm consolidations. In short, the Kyoto Protocol represents the single biggest public policy threat to the agricultural community today.

Introduction

The Kyoto Protocol to the United Nations Framework Convention on Climate Change is a proposed treaty that would require industrialized countries to reduce greenhouse gas emissions by sharply restricting their use of coal, oil, and natural gas. At the negotiating session in December, 1997, Administration officials agreed to reduce U.S. greenhouse emissions to 7 percent below 1990 levels by 2010. The U.S. Senate, however, has indicated that it will not approve any treaty that causes economic harm to the United States, and the Administration thus has yet to submit the Kyoto Protocol for ratification.

A number of independent analysts think that implementing the Kyoto Protocol would be costly. WEFA, Inc., a leading economic modeling and forecasting firm, estimates that the Protocol could cause U.S. GDP to fall more than 3 percent by 2010, resulting in a decline in average household income of $2,728 per year. WEFA also estimates that consumer electricity prices would rise more than 55 percent, commercial electricity prices would rise 60 percent, and home heating oil prices would jump some 70 percent. Moreover, WEFA estimates that employment in 2010 would be 2.4 million below baseline projections and that real wages in the manufacturing sector would be 2.1 percent below baseline.

WEFA is not alone in its concern. In May, 1998, Pittsburgh-based CONSAD Research Corporation estimated that 3.1 million fewer Americans would be employed in 2010 as a direct result of the treaty. CONSAD also estimated that U.S. GDP would fall by at least $177 billion-and perhaps by as much as $318 billion-by 2012.

Kyoto's Impact on U.S. Agriculture

U.S. farming is very energy intensive. Fuel and oil costs represent only about 30 percent of the total energy bill farmers pay. The remaining 70 percent is hidden in the prices of manufactured inputs, fertilizer, pesticides, and other chemicals.

The American Petroleum Institute (API) reports that gasoline, diesel fuel, and electricity prices would need to rise, through use of a carbon tax, by 50 percent or more-or about $0.50 per gallon-to cap U.S. greenhouse gas emissions at 1990 levels. The U.S. Department of Commerce has estimated the tax necessary to cap emissions at $0.25 per gallon, on the assumption that the Administration will get other nations to agree to a highly efficient (and controversial) international emissions trading regime while finding a way to boost domestic economic activity by shifting taxes away from capital (an idea that is also contentious). In our study, we use these two conservative estimates as the high and low range of taxes likely to result from the Kyoto Protocol-which requires the United States to cap emissions at 7 percent below the 1990 levels used by API and the Commerce Department in making their estimations.

An energy price increase of $0.25 per gallon of fuel is likely to cause the cost of agricultural inputs such as pesticides, chemicals, and transportation to rise from 5-25 percent; a $0.50 per gallon fuel cost hike would increase the prices of inputs by 10-50 percent.

Using these parameters about the increased costs for agricultural inputs, we first calculated the average expected cost increase of the Kyoto Protocol on six representative commodities per acre or per hundredweight (Table 1). Four are field crops: wheat, soybeans, corn, and cotton. Two are livestock-related: hogs and milk. By looking at the different commodities, the impact of higher production costs can be better understood, since some commodities require more energy-intensive inputs to produce than others. For example, corn and cotton crops use more pesticides and nitrogen fertilizer, products that are quite sensitive to changes in energy prices. Soybean production, on the other hand, is less sensitive to changes in energy costs.

If gasoline taxes are raised by $0.25 per gallon, the average American farmer will see his or her operating expenses increase by between 3.8 percent for milk (Table 1, col. 5) and 15.5 percent for corn (col. 2). A $0.50 per gallon price increase would raise expenses by between 7.5 percent for milk (col. 6) and 31.7 percent for corn (col. 3).

Although in percentage terms the change in operating expenses is nearly the same for the four field crops, a much greater difference exists in real dollars. For example, under the $0.25 per gallon tax scenario, total variable cash expenses for wheat increase by only $7.29 per acre (col. 5 minus col. 4), whereas expenses for cotton increase by more than $35 per acre (col. 5 minus col. 4). Cost increases double when gasoline taxes are hiked by $0.50 per gallon.

Turning to net profit, the $0.25 per gallon tax would reduce net profits by at least 10 percent for soybeans (col. 2) to as much as 40 percent for hogs (col. 2). A $0.50 per gallon tax reduces net profits on soybean production by 20.5 percent (col. 3) percent and net profits on hogs by a dramatic 84.5 percent (col. 3). Milk producers would also see their net profits fall by over half with the higher tax. These numbers reflect the fact that livestock feeders and dairy farmers operate on very thin margins. Relatively small changes in the cost of production can result in very significant changes in their profits.

Commodity prices vary from year to year. For example, milk prices declined rather significantly in late 1996 and early 1997. In the case of milk, the higher variable cash expenses would have simply exacerbated the losses producers were already experiencing in our 1994 base year.

A farmer's-eye view of what would happen if the Kyoto Protocol were approved is truly frightening. The average farmer would see his net profit fall by about one-fourth if gasoline taxes were raised by $0.25 per gallon, and he or she would stand to lose about half his net profits if taxes were raised by $0.50 per gallon.

Kyoto's Impact on the Agricultural Community

Table 2 presents the impact of higher energy taxes on the total agricultural sector and should interest people who supply or buy from farmers and ranchers. Note the lower right-hand corner of this table, which shows farm production expenses rising more than $10 billion (col. 4) if gasoline taxes were raised $0.25 per gallon, and more than $20 billion if taxes were raised $0.50 per gallon (col. 5). Those figures represent 5.8 percent and 11.7 percent, respectively, of total 1995 production expenses of $175.6 billion. The Kyoto Protocol would thus shrink the buying power of farmers who would otherwise purchase equipment, tools, buildings, and other goods and services needed by modern farms.

It is also possible to calculate the Kyoto Protocol's impact on the broader agricultural community. We start by looking at annual U.S. net farm income, which averaged $42.7 billion between 1991 and 1995. The increased expense of a $0.25 per gallon gasoline tax would equal 24 percent of net farm income, while a $0.50 per gallon tax would equal 48 percent of net farm income. This means that furniture, grocery, clothing, and other local businesses that sell finished goods to farm families would see their sales slow as agricultural incomes fall by one-fourth to one-half.

Higher energy taxes have the potential for causing an economic downturn in the agricultural sector comparable to what happened in the mid-1980s. Not only would net farm income fall in the short term, but a downturn in land prices would shrink asset values and, most likely, result in another farm-sector mini-depression. Increased production costs and reduced profits and farm income could slow farm loan and mortgage repayments to local banks and other credit institutions.

Implementing the Kyoto Protocol could also lead to consolidations. Many small farmers and young farmers could find themselves in an unprofitable situation that might force them to abandon agriculture. Not only would this hurt lenders, but it would also have an adverse economic impact on small towns and rural America in general.

Agriculture's Impact on the U.S. Economy

No single study can capture the ripple effect that a decline in farm income would have on other aspects of the agricultural and non-agricultural economy. A 1998 study by the Sparks Companies, using data from Standard and Poor's DRI and based on the commitments agreed to by the United States in Kyoto, found significant economic effects:

Consumer food prices would rise. A 2 percent decline in GDP resulting from the Kyoto Protocol would in turn cause a 0.7 percent decline in domestic demand for food. This would create a mild, short-term, downward pressure on food prices, counterbalanced by the inflationary pressures of higher energy costs. On net, food consumption expenditures would rise 2.6 percent. This would have only minor effects on the average U.S. consumer, whose food costs account for 11.9 percent of disposable income. But the impact on poor families would be considerable. The 37.4 percent of U.S. households earning under $20,000 after taxes spend between 21.4 and 100 percent of their income on food.

Public assistance demand and costs would rise. The U.S. Department of Agriculture allocates more than $39 billion annually to six food programs, most notably the child nutrition programs and food stamps. Reduced employment could add roughly 500,000 to the food stamp rolls and raise costs of USDA food programs 5 percent annually, or by $2 billion.

Agricultural exports would fall. By increasing the energy costs of farm production in America while leaving them unchanged in developing countries, the Kyoto Protocol would cause U.S. food exports to decline and imports to rise. Reduced efficiency of the world food system could add to a political backlash against free trade policies at home and abroad.

Farm consolidation would increase. "The higher energy costs," wrote DRI/McGraw-Hill, "together with the reduced domestic and export demand, could lead to a very severe decline in investment in agriculture, and a sharp increase in farm consolidation. Small farm numbers likely would decline much more rapidly than under baseline conditions, while investment even in larger commercial farms likely would stagnate or decline."

Conclusions

The Kyoto Protocol, if implemented, would cause great economic stress in the U.S. agricultural sector. Farmers could see net profits fall as much as 84 percent, and typically around 50 percent, if gasoline taxes were raised $0.50 per gallon to reduce greenhouse gas emissions. Even a $0.25 per gallon tax would likely lower net profits for hog producers by 40 percent and more than 20 percent for farmers raising field crops.

Total annual U.S. farm production expenses would rise between $10 billion and $20 billion while net farm income declined 24 percent to 48 percent. Many farmers, especially those who are just getting started or who are already operating on small margins, would be unable to cope with these declines in income and would be forced off the land.

Farmers and their allies in the agricultural community have a huge stake in the global warming debate. Millions of jobs and thousands of family farms hang in the balance. It is no exaggeration to say the Kyoto Protocol is the biggest single public policy threat to the agricultural community today. That threat will continue unless the Administration negotiates less onerous emissions targets and, equally important, developing nations also agree to take substantive action to limit their rapidly growing emissions.