"Attachment B"

Compensation to Quota Owners and Growers of All Kinds of Tobacco Allotments and Quotas under a Tobacco Equity Reduction Program (TERP)

     The sub-committee recommends a Tobacco Equity Reduction Program (TERP) for all U.S. tobacco quotas and allotments. TERP is defined as compensation to current tobacco quota owners and growers for loss in value of assets associated with most U.S. tobacco production. Compensation is justified because the Federal Government has, in essence, created a marketable asset upon which quota holders and growers depend. This, together with the crises tobacco farmers face due to large cuts in quotas because of reduced demand for U.S. tobacco justify payments to growers for the reduced value in asset.

     TERP refers to compensation for asset values that were created mainly because of the current tobacco program. A mandatory quota buyout under TERP would in effect reduce the value of these assets (quotas) to zero. Quota owners who do not currently grow tobacco would receive compensation and would no longer be involved in ownership of tobacco production rights. Current growers would have the option of receiving production permits. The permits under TERP would be designed to have zero value because they would be assigned annually to growers for production purposes only. The permits could not be leased-out, rented-out or sold.

     TERP would include burley, flue-cured, fire-cured (type 21), fire-cured (types 22 and 23), dark air-cured (types 35 and 36), Virginia sun-cured (type 37) and cigar filler and binder (types 42-44 and 54-55) tobaccos produced in the United States currently under a marketing quota control program. However, a separate state program has been established for Maryland tobacco, a kind of tobacco not currently under a marketing quota control program. Current Maryland growers can receive payments of $1 per pound per year for up to 10 years in exchange for permanently discontinuing tobacco production.

     The sub-committee recommends that crop year 1997 be used as the base years for TERP. Payments would be based on quota levels for 1997 but would be based on ownership of quota and production levels in 2000. The 1997 base year was chosen because it reflected an increase in quotas that required significant new investments in curing barns and equipment that were essentially rendered valueless after the sharp declines in quota in subsequent years.

TERP Compensation and Related Issues

     The sub-committee recommends that compensation for quota be set at three levels–$8, $4 and $2 per pound. Payments of $8 per pound would be made to the owners of every pound of quota. Payments of $4 per pound would be made to all growers for their share of production on which the grower wants to discontinue production. For growers who want to continue production, a payment of $2 per pound would be made for their share of production, plus the right to receive production permits.

     Compensation for quota should not be restricted to any payment limitation since the loss in asset (quota or allotment and related farming assets) value has been declining over several years. Payments for some U.S. farm programs are restricted to various limits (i.e. for crop year 2000 - production flexibility program -- $40,000 per producer per year [a 7 year program], market gains on commodity loans and loan deficiency payments -- $75,000 per producer per year, and annual disaster program -- $80,000 per producer per year). The TERP compensation would be a one time payment reflecting a loss in asset value over time - not a recurring payment like those just mentioned. Compensation should be paid over as short a period of time (2 to 3 years) because of the desperate financial situation of tobacco quota owners and growers. The compensation should be a non-revocable contract between the Federal government and farmers. Based on payment rates presented earlier, the cost of TERP could total between $15 and $20 billion.

     The sub-committee recommends that various investment strategies be incorporated into the payments to quota holders and growers to lessen the impact of taxes on these receipts. These would include use of funds for 401K type retirement plans (in essence, quotas are currently being used as a retirement plan because they provide a stream of annual income for the owner via payments for quota lease and rental). Recipients should be given up to 1 year to invest TERP funds in 401K type retirement plans. In addition, tax incentives could be provided for reinvestment of TERP funds in communities and permitting capital gains treatment of funds for income tax purposes.

Modification to the Current Tobacco Program under TERP

     The sub-committee recommends continuation of a Federal tobacco price support and production control program. Under TERP, the Agricultural Adjustment Act of 1938 and the Agricultural Act of 1949 (permanent legislation) would be modified as follows:

Production permits would be substituted for quotas. Production permits would be issued to active growers (individuals or entities) only. Permits would be issued for the purpose of growing tobacco only. They could not be sold, leased out, rented out or transferred. The following would be attributes of the proposed permit system.

A grower would be considered an active grower if they are (1) 100 percent "at risk" in the crop and (2) actively engaged in the production of the crop. In order to be considered actively engaged in the production of tobacco, the grower must provide:

(1) a significant contribution of one or a combination of capital, land (rented or owned) and equipment, and

(2) a significant contribution of one or a combination of active personal labor or active personal management.

For partnerships and corporations the members or stockholders would have to provide the contributions in order to be considered actively engaged. Active personal labor is defined as personally providing physical activities necessary in the farming operation. These activities include land preparation, planting, cultivating, harvesting and marketing the crop. Farm Service Agency (FSA) county committees would be empowered to determine 100 percent "at risk" and actively engaged determinations. (Proof of active grower status would be based on invoices, including evidence of payments such as bank statements and canceled checks, for labor, pesticides, other chemicals, fertilizer, equipment, fuel, repairs, and tobacco sales bills; operating loan documentation or other sources of operating capital and related management decisions; or other proof acceptable to the FSA committee that the grower is 100 percent at risk in the tobacco crop.)

Initial production permits would be established for growers based on the prior year’s effective quota for which the grower was at risk in the crop. A quota owner who currently shares in the risk of production by growing tobacco on shares with a tenant could receive a permit for that share of the crop for which they are at risk (e.g. 1/3 rental arrangement - the owner could get a permit for 1/3 share of the production unit assuming they take the $2 option. But once the owner has the permit, they would have to become an active grower and be 100 percent at risk in the crop and remain so to retain the permit. They could not establish another tenant/landlord relationship. The tenant in this same example would get a permit for 2/3 of the production unit, assuming the $2 option is taken. The tenant would have to become an active grower and be 100 percent at risk in the crop to retain the permit.)

Permits would be issued to and in the name of active growers with 1 permit per active grower per county. Permits would be assigned to active growers for production purposes only. Permits would have no tie to real estate.

Permits would be considered fully utilized if at least 75 percent of the permit is marketed. If the permits were not utilized, they would be subject to permanent forfeiture. FSA county committees would be empowered to make determinations on permit forfeitures within specified parameters (such as conditions beyond the control of the active grower that kept the permit poundage from being produced and marketed).

When production permits are forfeited, permit pounds would return to a county pool for redistribution within the county. If the permit pounds are not redistributed in the county, the permit pounds would revert to a state pool for prorata distribution to all active growers within the state. If permit pounds in a state pool are not redistributed within the current crop year, such pounds would be dropped and redistributed nationally.

Heirs (surviving spouse or direct descendants) or direct descendants of a retiring active grower would be permitted to assume the permit of an active grower and establish a new active grower status. FSA county committees would be empowered to make these determinations. (Discuss how partnerships and corporations differ from individuals?)

Other new provisions of the price support-production control program under TERP would include:

• Requiring all tobacco buyers to submit accurate purchase intentions and if 100 percent of their intentions were not purchased (if production was available), subjecting buyers to the same marketing penalty (75 percent of the previous year’s average market price for the respective kind of tobacco) as producers for program violations on each pound not purchased.

• The sub-committee recommends no change from the current formula in calculating price support levels. But the sub-committee recommends that if requested by the board of directors of a tobacco loan association through which price support for the respective kind of tobacco is made available to growers, USDA may reduce the support level for such kind of tobacco to the extent requested by the association to more accurately reflect the market value and improve the marketability of such tobacco. Any reduction in price supports under this provision shall not be used in establishing subsequent year price support levels.

• Eliminating all tobacco transfer provisions including spring lease and transfer, purchase and sale, and disaster transfers, since permits are issued annually for production purposes only.

• Issuing 1 marketing card for each active grower per county regardless of the number of farms on which tobacco is planted. The active grower would need to report the farms on which the tobacco is planted subject to the permit for compliance purposes only.

• Continuing current overmarketing provisions. (Currently limited to 3 percent of the effective quota and is deducted from subsequent quotas.)

• Continuing new grower and inequity adjustment provisions. Currently, new grower provisions include experience growing the crop in 2 out of the past 5 years, having land, labor and equipment available for production, and expecting to receive at least 50 percent of income from farming, excluding the requested quota. The sub-committee recommends that the income requirement be dropped and that a national reserve of 3 percent be withheld for approving new grower permits and making inequity adjustments. It is further recommended that all reserve poundage not used for new grower permits be utilized for making inequity adjustments. (Should consideration be given to a minimum and maximum new grower permit?)

• With the emergence of contracting, implement an auction warehouse designation program for all kinds of tobacco requiring the grower to designate how many pounds are to be sold at auction and at which warehouse(s) and pounds to be sold at non-auction.

• Requiring all imported tobacco to be subject to the same no-net-cost assessments as domestically produced kinds of tobacco. (Currently, flue-cured and burley imports are the only tobaccos subject to such assessments.)

• Allowing an active grower to produce the tobacco subject to the permit in the issuing county or any contiguous county to the issuing county, including across state lines if the county is contiguous.

• Continuing an allotment control provision for flue-cured tobacco but adjusting farm yields to reflect more current yield per acre levels.

• Continuing current reduction and penalty provisions including false identification, scheme and devise to defeat the purpose of the program (including falsification of active grower status), failure to return marketing cards, etc.

• Continuing current eminent domain provisions. (Currently, a displaced landowner has three years to acquire new farmland on which to reestablish their operations.)

• Eliminating Review Committees and have all tobacco program appeals handled through the FSA Administrative Appeals process.

• Production permits should not be subject to Conservation Reserve Program reductions. (Currently, tobacco allotments and quotas are reduced by the same percentage as cropland accepted in the CRP is of the total cropland in the farm.)

     The above recommended changes to the tobacco price support-production control program should add stability for active growers since production right costs (rental/lease costs) would be eliminated for all kinds of tobacco, which could make U.S. tobacco more competitive in world markets. Other suggested program changes would more accurately match supply and demand by increasing penalties for failure of manufacturers to meet purchase intentions, reducing production speculation and providing greater certainty and stability in tobacco marketing. These changes would insure continued production of tobacco in current production areas, continue to provide opportunities for new growers and provide more equitable treatment of active tobacco growers.

The sub-committee also recommends the following:

• The maintenance of a viable auction marketing system in face of increasing company contracting. The auction system must be kept viable to attract foreign buyers and maintain a safety net for non-contract tobacco growers. Foreign customers are essential in maintaining prices because of their bidding for better quality leaf. The sub-committee recommends that tobacco loan associations be permitted to establish receiving stations in a production area when it is determined that active growers in this area do not have ready access to traditional auction markets. Tobacco buyers should be provided an opportunity to purchase any tobacco delivered to these receiving stations prior to the tobacco being pledged for a price support loan. The sub-committee recognizes that it will be a challenge to keep the price support program intact with more and more contract buying.

• Requiring all tobacco to be graded and inspected by USDA, whether sold at auction or directly to buyers via contracts or otherwise.

• All imported tobacco should meet the same pesticide regulations as U.S. grown tobacco. Currently, USDA’s Agricultural Marketing Service tests for the presence of certain pesticides on imported flue-cured and burley tobacco. These imports account for approximately 50 percent of all imported tobacco.

TERP and Related Funding Issues

TERP funding must be reliable and guaranteed. There are a number of potential sources; however, there is a lack of assurance of continuation with some sources. Still, options that might be considered include:

• Voluntary funding from tobacco buyers in exchange for guaranteed program modifications.

• modification to the Phase II settlement funds provided by major cigarette manufacturers.

• An increase in manufactured tobacco sales prices by manufacturers to cover the cost of TERP.

• Earmarking a portion of current tobacco excise taxes to cover the cost of TERP.

• Increasing Federal excise taxes (even though Phase II payments would be reduced).

• General funds.

     An increase in Federal excise taxes, though opposed by many, or use of general funds would provide the greatest reliability and assurance of funding for TERP. Other alternatives would be subject to cancellation or reduced funding. A TERP, with payments staggered over a 3 year period, would require a Federal excise tax increase of about 31 cents per pack each year or the three year period at current consumption levels.

     Funding is also needed for other tobacco program related activities to assure measurement and monitoring of tobacco production and consumption in the United States and abroad and to provide U.S. tobacco producers greater opportunities to participate in the world tobacco market. These needs are to:

• Provide adequate funding to the Foreign Agricultural Service for collection and dissemination of world tobacco information regarding production, consumption and related industry information.

• Support and enhance the tobacco data collection and dissemination functions of the Economic Research Service.

• Amend legislation to permit tobacco to participate in USDA’s export credit programs. (Prohibited by The Agricultural, Rural Development, and Food and Drug Administration, and Related Agencies Appropriation Act of 1994.) This would not be an expansion of consumption but simply allow U.S. leaf to be substituted for leaf from other suppliers.

FDA Regulation

• Authorize meaningful FDA control over manufacturing, labeling, distribution and marketing of tobacco products. With respect to labeling, at a minimum, provide labeling of content by country of origin of raw tobacco used in the manufactured product. Continue USDA oversight and control of on-farm tobacco production. For additional FDA and health related recommendations, see the health sub-committee’s report.

Tobacco Company Involvement

• Involve tobacco companies in discussions of Commission issues.