JANUARY-FEBRUARY 1998



The WTO Decision on the EU Hormone Ban:
Is Anything Left of The SPS Agreement?

by Dale McNiel

On January 6, 1998, the World Trade Organization (WTO) Appellate Body issued its opinion upholding the prior dispute settlement panel's conclusion that the ban maintained by the European Communities in imports of meat derived from cattle treated with six specific hormones for growth promotion violated the risk assessment provisions of the Agreement on the Application of Sanitary and Phytosanitary Measures (the "SPS Agreement"). The Appellate Body also ruled that a risk assessment must sufficiently warrant the SPS measure at stake. However, the Appellate Body reversed the panel's rulings that the hormone ban was inconsistent with international standards established by the Codex Alimentarius Commission in that it constituted arbitrary or unjustifiable inconsistency in appropriate levels of protection.

Although a panel report had been condemned by the EU Commissioner for Agriculture, Frans Fischler, who attacked the WTO as non-democratic, EU officials praised the Appellate Body decision as a "victory for European consumers." At the same time, the Appellate Body report was hailed as a "clear win" by the U.S. Secretary of Agriculture, Dan Glickman, while the U.S. Trade Representative (USTR), Charlene Barshefsky, went as far as saying that the decision was "a sign that the WTO dispute settlement system can handle complex and difficult disputes." However, when the EU announced plans to conduct a new risk assessment before removing the ban on imported beef, the USTR protested, arguing that the Appellate Body "agreed with the United States that the EU has no scientific basis for blocking the sale of American beef in Europe based on the use of growth hormones," and that "given the underlying science respecting the effects of such hormones, the EU will confront extraordinary difficulty in concluding a risk assessment that supports its hormone ban."

The different positions taken by the United States and the EU demonstrates the fundamental problem with the decisions of both the original panel and the Appellate Body. Contrary to the claims of the USTR, neither the panel nor the Appellate Body formally ruled that the EU measure was maintained without sufficient scientific evidence in violation of the central obligation of the SPS Agreement. The panel did state that:

In our view, the scientific conclusion reflected in the EU measures in dispute, i.e., that the use of the hormones in dispute for growth promotion purposes, even in accordance with good veterinary practice, is not safe, does not conform to any of the scientific conclusions reached in the evidence referred to by the European Communities. All the evidence referred to by the European Communities which specifically relates to the use of the hormones at issue for growth promotion purposes concludes that the use of these hormones as growth promoters in accordance with good practice is safe.

However, both the original panel and the Appellate Body declined to formally conclude that the import ban was maintained without sufficient scientific evidence on the grounds that such a ruling was unnecessary. This represents a failure of the WTO dispute settlement system to effectively deal with the central issue in an SPS case, even in the extraordinary situation presented by the hormone ban in which the scientific evidence was plentiful and, for all practical purposes, unanimous.

The Ban and International Standards

The second major issue was whether the import ban violated a provision calling for the use of existing international standards, guidelines and recommendations. In July 1995, the Codex Alimentarius Commission established voluntary standards for safe maximum residue levels for trenbolone acetate (TBA) and zeranol and agreed that limits were unnecessary for the three natural hormones.

These international standards would allow meat derived from animals treated with the natural hormones to be traded freely without any residue testing and would permit meat derived from animals treated with the synthetic hormones to be traded subject to residue testing and transparent standards.

The panel concluded that the EU hormone ban measures with respect to the natural hormones, as well as TBA and zeranol, were not based on existing international standards, guidelines and recommendations in violation of Article 3.1 of the SPS Agreement. The panel reasoned that a sanitary measure cannot be considered to be based on an international standard if the international standard reflects a specific level of sanitary protection and a sanitary measure implies a different level of protection, and concluded that the EU import ban implied a significantly different level of sanitary protection.

The Appellate Body reversed the panel's decision on the rationale that the panel erroneously had equated whether the EU measures were based on international standards with whether the measures were in conformity with the standards. The appellate body reasoned as follows:

It is clear to us that harmonization of SPS measures of Members on the basis of international standards is projected in the Agreement, as a goal, yet to be realized in the future. To read Article 3.1 as requiring Members to harmonize their SPS measures by conforming those measures with international standards, guidelines and recommendations, in the here and now, is, in effect, to vest such international standards, guidelines and recommendations (which are by the terms of the Codex recommendatory in form and nature) with obligatory force and effect. The Panel's interpretation of Article 3.1 would, in other words, transform those standards, guidelines and recommendations into binding norms. But, as already noted, the SPS Agreement itself sets out no indication of any intent on the part of the Members to do so.

Although the Appellate Body rejected the panel's ruling that the EU import ban was not based on international standards, it made no attempt to explain how the EU import ban possibly could be said to be based on the existing Codex standards. The Appellate Body suggested that a measure based on an international standards "may adopt some, not necessarily all, of the elements of the international standard," but it did not consider whether the EU import ban adopted any element of the existing international standard. Of course, an import ban cannot be said to adopt any of the elements of the Codex standards for using hormones for growth promotion, which would have allowed trade to flow freely with only residue testing for TBA and zeranol.

Moreover, the Appellate Body interpretation of Article 3.1 limits it to no more than the objective in the prefatory clause - "to harmonize sanitary and phytosanitary measures on as wide a basis as possible" - and gutted the mandatory language that members "shall base" their sanitary or phytosanitary measures on existing international standards, guidelines or recommendations. The Appellate Body's decision leaves the Codex standards as voluntary recommendations and not as WTO norms. As a consequence, it would appear that one of the central features of the SPS Agreement - the obligation to base SPS measures on existing international standards - has been converted into a wholly unenforceable objective.

Since the Appellate Body narrowed the decision down to the lack of a risk assessment supporting the hormone ban, the practical question is raised whether the EU can find a scientist who will issue a report concluding that the consumption of beef derived from animals administered hormones for growth promotion poses a serious risk to human health sufficient to justify a ban on the importation or sale of such meat.

The EU delegation to the WTO proceedings included several scientists who appeared to support the existing ban, and who probably would be available for a new risk assessment. The Appellate Body said that the requirement that an SPS measure be "based on" a risk assessment requires only that there be "a rational relationship between the measure and the risk assessment." Furthermore, the Appellate Body went out of its way to say that an SPS measure could be based on "a divergent opinion coming from qualified and respected sources," rather than only on "mainstream" scientific opinion.

The only formal requirements for a new EU risk assessment appear to be that it: (i) specifically address the safety of consuming meat derived from animals treated with the hormones at issue for growth promotion purposes; (ii) be performed by respected scientists, even if representing a minority view; and (iii) rationally supports the import ban or any other SPS measure taken.

In this light, the WTO ruling may be so narrow as to be tantamount to avoiding a ruling completely. The EU is likely to conjure up a new risk assessment, and the United States is likely to challenge it on the basis of insufficient scientific evidence, causing the dispute to drag on for a few more years.

This does not auger well for the ability of the WTO dispute settlement system to handle complex and difficult disputes. The panel and the Appellate Body failed to deal effectively with the first dispute adjudicated under the SPS Agreement and their decisions seriously weaken both the SPS Agreement and the WTO dispute settlement system.


Dale McNiel is a partner in the firm and he specializes in international trade law in agriculture. Mr. McNiel was recently a senior counsel in the office of the General Counsel at the US Department of Agriculture and participated in the WTO consultations and dispute settlement proceedings on the EU hormone ban.


Clean Water Action Plan Unveiled

by Richard Pasco

The President and Vice President recently announced their long-anticipated "Clean Water Action Plan" (Plan) that calls for further implementation of existing regulations to reduce pollution in the nation's waterways. The Plan targets nutrients (specifically nitrogen and phosphorous) and animal feeding operations, and calls for additional work with the states to develop new enforcement mechanisms.

This major new effort proposes to spend an additional $2.3 billion over five years to protect rivers and lakes and reduce the threat from fish-killing microbes, such as Pfiesteria piscicidia along coasts. Such funds will be used on numerous specific proposals for addressing water quality concerns.

The announcement of this new initiative is designed to begin a process on clean water. Progress reports are to be presented to the President, the nation's governors, and the public at the end of year 2000 and periodically thereafter.

Increased Use of Clean Water Loan Funds for Runoff Prevention

State Revolving Loan Funds (SRF) are further targeted to nonpoint source pollution prevention, in a shift of loans away from their traditional use of financing municipal sewage treatment plants. The 1987 amendments to the Clean Water Act created the SRF program to finance the construction of sewage treatment and other water pollution control facilities.

Pursuant to the SRF program, the Environmental Protection Agency (EPA) provides annual grants to states to capitalize the loan funds, and states provide a 20% match. These EPA grants assist states in making low-interest loans to communities for construction of water pollution control facilities. Money that is repaid to the SRF is then loaned to other communities to support additional projects.

Only about three % of the total SRF spending to date has been used for pollution prevention projects. The Plan commits the EPA to "work with the states to increase the number and dollar amount of loans" made through the SRF programs for priority projects to prevent runoff. The goal is to increase the annual percentage of funds loaned for pollution prevention to at least 10%, which is about $200 million by the year 2001.

Nitrogen & Phosphorus-Based Standards for Water Bodies

The proposed standards would establish the first enforceable limits for nitrogen and phosphorous, forcing states and local communities to come up with plans for controlling them. Such proposals to set new national water quality standards for nitrogen and phosphorous could have serious implications for agricultural operations in certain parts of the country, if such standards are set below existing conditions.

Nutrients, including nitrogen and phosphorous, in the appropriate amounts, are essential for crop growth. However, excessive nutrient loadings of nitrogen and phosphorous in the soil can run off into surface water or leach into ground water. The Plan states that nutrient over-enrichment has "been strongly linked to the large dead zone in the Gulf of Mexico and to recent outbreaks of Pfiesteria along the mid-Atlantic Coast.

Unlike proposals to limit the amount of nitrogen and phosphorous applied to the land, the Plan requires the development of specific numeric levels of nitrogen and phosphorous in various bodies of water throughout the country:

"EPA will establish, by the year 2000, numeric criteria for nutrients (i.e., nitrogen and phosphorous) that are tailored to reflect the different types of water bodies (e.g., lakes, rivers, and estuaries) and the different ecoregions of the country, and will assist states in adopting numeric water quality standards based on these criteria over the following three years. If a state does not adopt appropriate nutrient standards, EPA will begin the process of promulgating nutrient standards."

The Plan notes that "state water quality reports indicate that over-enrichment of waters by nutrients (nitrogen and phosphorous) is the biggest overall source of impairment of the nation's rivers and streams, lakes and reservoirs, and estuaries," with agriculture being the most widespread source of impairments. Even though nutrient over-enrichment may be a major challenge to water quality, an overly stringent nitrogen and/or phosphorous-based standard for any area could wreak havoc with some existing agricultural operations.

Improved Monitoring, Assessment & Citizen Access to Information

By the year 2000, EPA, USDA, and the Department of the Interior, in concert with other federal and state agencies, are required to model and produce estimates of inputs, nutrient utilization by major source category, transport, and net contributions of nitrogen and phosphorous in watersheds throughout the nation. In fact, in 1999 the EPA, in collaboration with other federal agencies and states, is to initiate a tracking system to report key indicators of the success of programs to reduce nutrient runoff to waters.

The Plan also requires the EPA to collaborate with other federal agencies and states to develop a "state-of-the-art information system" to present meaningful information over the Internet about the health of aquatic systems in each of the more than 2,000 watersheds in the U.S. Anyone would be able to obtain detailed information about a particular watershed, including data on chemical contamination of surface waters, sediment contamination, wetlands loss rates, and vulnerability to future water quality problems.

It is argued that sustaining clean water compliance will require the supplementation of existing tools with new efforts to ensure that clean water program requirements are understood by both the regulated community and the public. In this vein, it is noted that EPA is working with states to establish sector-based compliance assistance centers. Delivering more detailed information on specific watersheds to interested citizens is viewed as a means to empower people to get involved in restoring and protecting water quality.

Local organizations are seen as another resource that are available to engage "in a range of activities related to clean water, including organizing stream cleanups, volunteering to monitor water quality, planting trees along eroding stream banks, and educating school children and the community about water quality problems." The Administration wants to mobilize "thousands of watershed alliances, volunteer monitoring organizations, and other groups nationwide" to either join existing efforts or create new watershed organizations. The Plan calls for federal agencies to increase information and technical assistance to any public or private organization interested in adopting a watershed or other water body to help protect water quality.

Implementation of "Animal Feeding Operations Strategy"

It is clear that the EPA, together with USDA, intends to develop and implement a new "Animal Feeding Operations Strategy" (AFO Strategy) in a short time frame. In fact, "EPA will publish and, after public comments, implement an AFO Strategy for important and necessary EPA actions on standards and permits by March 1998."

"By November of 1998, EPA and USDA will jointly develop a broad, unified national strategy to minimize the environmental and public health impacts of Animal Feeding Operations." The AFO Strategy will be published for public review and comment in July and will be finalized in November 1998.

The Plan notes that there are approximately 450,000 animal feeding operations throughout the U.S., with only a small percentage currently having discharge permits under the Clean Water Act. In response, the draft AFO strategy calls for "significantly expanding the number of Clean Water Act permits issued" for Confined Animal Feeding Operations (i.e., facilities with more than 1,000 animal units) "with emphasis on the largest, unpermitted facilities."

The Plan sets forth a specific timetable for EPA to work with USDA and states in revising and strengthening existing permit regulations as follows:


The relevant agencies of the federal government are to determine the relative contributions of nutrients in watersheds from all sources. In fact, USDA will soon publish data identifying counties in the U.S. having potential nutrient excess from animal manure.

By the year 1999, EPA is to identify the watersheds at greatest risk from AFO's. By the year 2000, EPA and USDA will estimate a baseline of nutrient loads to individual watersheds.

EPA is also to "increase enforcement of existing permits and unpermitted discharges, require new permits where appropriate, and use emergency powers to address situations presenting an imminent and substantial endangerment, where appropriate."

In addition, the AFO Strategy is directed at ensuring that permits address activities such as land application of animal waste; improving data collection; expanding research on effects and control measures; creating incentives for voluntary implementation of measures to protect the environment and public health; and encouraging the establishment of a certification program to ensure effective development and implementation of management systems for unpermitted AFOs.

Establishment of Enforceable State & Tribal Pollution Controls

The Plan notes that various states, the EPA, and the National Oceanic and Atmospheric Administration (NOAA) have developed considerable experience with state enforceable policies and mechanisms for runoff in working with coastal states to develop coastal nonpoint pollution control programs. Thus, the Plan calls for:

"EPA and, in coastal states and territories NOAA, will promote by the year 2000 the establishment of enforceable state and tribal authorities needed to ensure the implementation of nonpoint source controls to achieve water quality standards. EPA, in consultation with NOAA, will publish guidance describing existing and potential models of enforceable authority related to polluted runoff and will assist states and tribes in this effort."

Incentives for Reducing Runoff

On the positive side, federal agencies are charged with working with diverse stakeholders to develop

creative, new approaches to reducing runoff. The EPA is challenged with developing a means to credit pollution load reductions from local growth management efforts in the Total Maximum Daily Loads submitted by states and tribes under the Clean Water Act.

One of the most potentially fruitful methods of fueling private-sector action, is the implementation of tax incentives to water quality. In this regard, the Plan calls for an interagency task force, in consultation with the Treasury Department, to identify and assess tax incentiveproposals related to water pollution prevention and natural resource enhancement.

Other Clean Water Initiatives

The Plan also includes a number of other initiatives, including the following:


Observations

With so many new initiatives, it is clear that there is no magic bullet for addressing nonpoint source pollution. New restrictions on animal feeding operations, including the expanded permit process and the imposition of tougher federal standards for pollutants found in fertilizers, animal manure and sewage, indicate that the Administration views increasing compliance assistance and enforcement with respect to applicable laws and regulations as critical to improving water quality.

The Plan pushes state and local governments to come up with specific plans to reduce pollutants and targets the most polluted states and local communities for millions of dollars in block grants and other funds to assist them in meeting new standards. The Plan also provides millions of dollars for voluntary programs to keep pollutants from getting into waterways, such as grass buffer strips or other vegetation that would filter out pollutants. Clearly, additional monies would be made available to farmers who agree to make improvements in their operations under EQIP.

While leading to new potential enforcement mechanisms against livestock and crop producers, the Plan provides additional funds to address nonpoint source pollution. The Plan may help avoid enactment of a number of state-level legislative proposals that have been discussed, especially since last year's outbreak of Pfiesteria in the Chesapeake Bay region. For example, one such state legislative proposal would have limited the amount of fertilizer that farmers could apply to their fields.


Richard Pasco is an attorney in the firm specializing in legislative, environmental, agricultural, food safety and trade law.


WHAT THE 1999 BUDGET MEANS FOR AGRICULTURE

by Stephen Frerichs

Don't Count on the "Surplus"

President Clinton submitted his proposed spending and tax plan Feb. 2 with much fanfare about projected budget surpluses. The President's budget indeed does forecast a surplus of $9.5 billion in fiscal year (FY) 1999, with continuing and growing surpluses through the 10-year budget projection period. By FY 2008, the President projects a $259 billion surplus. At the same time, the President proposed that any surplus should be held in reserve until the solvency of Social Security is secured into the future.

In contrast, the Congressional Budget Office (CBO) in testimony Feb. 5 projects a small deficit ($2-$3 billion) in FY 1999 and 2000. CBO projects a surplus starting in FY 2001 ($14 billion) and growing through FY 2008 to $138 billion. Both projections are based on the "unified" budget. The unified budget includes balances of the general fund and all federal trust funds.

The largest trust fund is the Social Security trust fund, which currently is running a surplus of slightly more than $100 billion. Without the Social Security balances, there would be no surplus projection. Without Social Security, the Clinton Administration forecasts a FY 1999 deficit at $96 billion; CBO forecasts a deficit of $115 billion. Without Social Security, CBO does not forecast a surplus at all over the next 10 years, while the President's budget forecasts a surplus starting in FY 2007 if the Social Security balances are not included.

To be fair, talk about surpluses is consistent with the debate in the past regarding deficit spending. However, as the debate shifts to reforming Social Security, it is likely that a different definition or debate will emerge; one that defines the deficit without Social Security. If this happens, surpluses "as far as the eye can see" will require further budget discipline on the part of Congress and the President if they are to become reality.

Continued Budget Discipline is Assumed in Both Forecasts

Both CBO's and the President's forecast hinge on continued fiscal restraint. Both forecasts are predicated upon a continued adherence to budget discipline and rules as agreed to in the 1997 balanced budget agreement. The discretionary caps are expected to decline roughly 10% by 2002 compared to FY 1997 levels. "Pay-as-you-go" rules (the requirement to offset increased spending with equal cuts) still apply. The President's FY 1999 budget would fund additional spending over the 1997 budget agreement from tobacco settlement funds and revenues (like the superfund tax extension). While this approach may be perceived as a technical breach of the discretionary caps, the spirit of "pay-as-you-go" is intact. New spending is not funded by simply adding to the deficit.

The implications for agriculture should be clear. As discussed below, while agriculture would receive some of the additional funds sought by the President for his "investments," agriculture is a net loser compared to FY 1998. Grouped by appropriations subcommittee, there are only four net losers in the President's request: military construction, District of Columbia, energy and water development, and agriculture. As a low presidential priority under ever tighter discretionary caps, agriculture can expect to take real cuts in the future.

Agriculture's Budget

There are many ways to present the Department of Agriculture's (USDA) budget. The following discussion focuses on the budget authority request made by the President to the Agriculture and Rural Development Appropriation Subcommittee with some discussion of mandatory spending.

Budget authority is the amount of new federal commitments that agencies are allowed to make during a given year. Except for loan programs, which fall under credit reform accounting rules, this is the best indicator of program level.

The Agriculture and Rural Development Appropriations Subcommittee excludes the Forest Service, which is under the jurisdiction of the Interior Appropriation Subcommittee. The Food and Drug Administration is not part of USDA, but is under the Agriculture Appropriations Subcommittee and is included in the discussion that follows.

Table I presents a historical comparison of the Agriculture and Rural Development Appropriations Subcommittee spending levels and the President's request. The column entitled "602B" is the amount available to the subcommittee as agreed to by the appropriations committee after receiving its total allocation through the congressional budget resolution. This amount almost always is less than the actual amount provided (the second column in Table I) for two primary reasons. First, the actual amount includes supplementals and rescissions that occur subsequent to the initial appropriation. Second, the Agriculture Appropriations Subcommittee traditionally has reduced spending in mandatory programs under the House Agriculture Committee's jurisdiction to boost its discretionary spending. Appropriators get "scored" with savings from limiting mandatory spending. These savings then are used to increase the subcommittee's allocation. Most recently in FY 1998, the subcommittee cut the Export Enhancement Program to increase its allocation. Similar cuts in the past have included limitations to the Conservation Reserve, the Wetlands Reserve and the Market Access Programs.


AGRICULTURE AND RURAL DEVELOPMENT
Appropriations Subcommittee
_____($ in millions)_____
1993
1994
1995
1996
1997
1998
1999 		_______602B /1_______
13,874
14,598
13,397
13,325
12,960 /2
13,751 /3
N/A		 _______Actual /4_______
14,078
14,900
13,763
13,776
13,890
13,944
N/A		 President's Request /4
14,627
13,420
13,700
14,241
13,957
13,839
13,672

The Presidents FY 1999 Budget Request

The President's request for FY 1999 at first glance appears to be a reduction in total spending of a little more than $300 million, or 2% from FY 1998 as enacted. The reduction, however, assumes that the House Agriculture Committee will take responsibility to fund several programs currently under the jurisdiction of the appropriations committee. This shift in authority is not a reduction, rather it simply reduces the need for the administration to increase its spending request to the appropriations committee. There is little incentive for the agriculture committee to accept these new responsibilities because they would be responsible for these controversial changes, but the benefits in the form of increased spending would go to the appropriations committee.

President's Clinton's budget assumes the enactment of a fee by the agriculture committee to cover the cost of the meat, poultry and egg products inspection programs. This fee would bring in additional collections of roughly $573 million, according to the President's budget. The additional collections mean that the President does not have to request an appropriation for this activity. This fee proposal has been advanced by the administration in the past and yet still has not made it to first base with Congress. It is not likely to be enacted this year either due to opposition from consumer, industry, and food safety inspection union groups. In addition, the budget assumes $128 million in new user fees for the Food and Drug Administration. This proposal has also been requested in the past, but not enacted.

The President's budget further requests that the agriculture committee enact legislation to pay for the crop insurance agent's sales commissions, which are currently subject to appropriations. By proposing a shift to the agriculture committee, the administration foregoes requesting roughly $205 million from the appropriations committee.

The Administration has proposed cutting the Export Enhancement Program, cotton "Step 2" payments and federal crop insurance subsidies to pay for the category shift. The administration has not offered its legislative package to date, but initial congressional reaction has not been favorable toward the proposed offsets, and it does not appear that the Congressional Budget Office will score savings as the Administration estimates (especially for the Export Enhancement Program).

If these proposals are not enacted, under current law, the President's request to the appropriations committee is actually $800 million higher than presented in the budget. Relative to FY 1998 actual spending, this would be an increase of $400 million (+3%). It is unlikely that the appropriations subcommittee will be able to afford this type of an increase.

Who are the Winners in the Administration's Budget Request?

The Food, Nutrition, and Consumer Services budget would increase roughly $200 million (+5%), with the bulk of the increase, (more than $150 million), going to the Special Supplemental Nutrition program for Women, Infants, and Children. The rural development mission area would receive a $100 million increase (+5%), primarily for increased loan subsidies and water and wastewater grants. The Natural Resources Conservation Service would get a $40 million increase (+5%) primarily to support the "Clean Water and Watershed Restoration Initiative."

In addition, the administration proposed a $100 million increase (+50%) in spending for the Environmental Quality Incentives Program. This increase would come from mandatory spending. An additional $46 million is requested to support an interagency food safety initiative. Finally, the President's request includes an increase of $70 million for USDA departmental activities, with the bulk of this increase going to buildings and facilities and the office of the inspector general to reduce waste, fraud and abuse. None of the requested spending increases go directly to farmers.

What Should we Expect in FY 1999

The request sets up an interesting appropriations cycle again this year for agriculture. The Congressional allocation for the Agriculture and Rural Development Subcommittee is not announced yet. But it is not likely to be more than provided in FY 1998. The administration has effectively requested an increase relative to FY 1998 with questionable offsets. Therefore, it is only a matter of what will be cut from the administration's request, not whether there will be cuts.


Stephen Frerichs is an economist specializing in budgetary issues that relate t agricultural programs. Before coming to McLeod, Watkinson & Miller, he was a budget analyst at the Office of Management and Budget for eight years.


USDA PROPOSES MAJOR REFORMS OF FEDERAL MILK MARKETING SYSTEM

by Richard Rossier

Proposed Rule Reduces Number of Milk Orders and Minimum Prices for Fluid Milk

USDA proposed dramatic changes Jan. 23 to the nation's complex federal milk marketing order system. The reform proposal, the broad outlines of which were mandated by Congress in the 1996 Federal Agricultural Improvement and Reform Act (FAIR) would reduce the number of milk marketing orders from 31 to 11 and likely reduce significantly the minimum prices producers receive for their fluid (Class I) milk. Comments on the proposal are due by March 31. After USDA considers those public comments it is expected to issue a final rule by the end of June and then put the new system to a vote by affected producers and handlers so that the new system can be in place by April 1999.

Key Functions of the Federal Order System

The two basic functions of the federal order system are (1) to establish minimum prices that producers receive for their milk, and (2) to pool all receipts for milk sold within each federal order area. As a result of this pooling, each producer receives a so-called "blend price" which reflects the total amount of milk sold in the marketing area at each separate level of quality. Class I milk, the highest quality, is sold for use as fluid milk, Class II milk is sold for soft manufactured products such as yogurt and ice cream. Class III, the lowest quality, is sold for hard manufactured products such as cheese and butter. As a result of the pooling, each producer receives that same blend price for milk regardless of whether it was as Class I, Class II, or Class III. The idea behind the "blend price" concept is to stabilize milk markets by precluding all producers from competing to sell only the highest priced and highest quality milk.

Number of Orders Sharply Reduced

One of the provisions of this reform that was mandated by Congress in the FAIR Act was the requirement that the Department reduce the number of milk marketing orders to between 10 and 14. While the department earlier had considered reducing the number of orders to 10, it more recently has discussed revising the system to consist of 11 orders. The 11 order areas are Upper Midwest, Mideast, Northeast, Appalachian, Southeast, Florida, Central, Southwest, Arizona-Las Vegas, Western, and Pacific Northwest.

Under the reform proposal, no federal order will apply to California which is not part of the current federal order system. In addition, major portions of Pennsylvania and almost all of Virginia and Maine also are not covered by the proposed federal order system. These areas have not been covered under the current federal order system, but in a preliminary proposal issued in May 1997, the USDA had suggested that it would cover almost all of Pennsylvania in its reform proposal. However, it pulled back from this position by the time it announced the proposed rule and no longer is suggesting that western/central Pennsylvania be regulated under this system. In addition to reducing the number of federal milk orders, the proposal also simplifies the system and makes many of the rules and requirements uniform over all 11 consolidated orders.

Revised Class III Price Formula Proposed

Another key provision of the proposal is to change the current method of determining the Class III price (also known as the basic formula price). Currently, the Class III price is determined from a monthly survey of manufacturing grade milk in Minnesota and Wisconsin, adjusted by a formula designed to reflect recent changes in dairy product prices, especially cheese prices. USDA has proposed replacing that approach with one that is based on multiple component pricing.

Multiple component pricing involves determining a value for milk based on the values of protein, butterfat and other nonfat solids used in the manufacturing process and uses those in calculating a six-month moving average. While this proposed approach continues the general connection between the price of milk used in fluid products and the price of milk used in manufactured products, it makes that connection much more flexible and indirect. In a separate proposal, USDA proposed to set a temporary price floor for the basic formula price as that price is used to calculate Class II and Class I prices and called a public hearing on this proposal for Feb. 17. If adopted, this temporary floor would last only until the proposed reforms go into effect next year.

Dramatic Class I Pricing Changes Proposed

Class I prices are the minimum prices that regulated handlers are required to pay producers for milk used in fluid milk (Class I) products. They are established in the federal order system currently by adding what is called the Class I differential to the Class III (or basic formula) price. Currently, these Class I differentials generally reflect the distance between the particular milk marketing area and Eau Claire, WI. As a consequence, these differentials now range from a low of $1.20 per hundredweight in the Minnesota-Wisconsin area to a high of more than $4.00 per hundredweight in Florida.

The USDA has issued two proposals for Class I pricing under its reform plan. The first proposal (designated as Option 1A) essentially would continue the current Class I pricing system with only minor modifications. It is based on the premise that the value of fluid milk varies based on location. Those areas with the highest supply relative to local fluid needs would have the lowest differential, and those areas with the lowest supply relative to local fluid needs would have the highest value. Based on this premise, the department's Option 1A would establish Class I differentials that range from a low of $1.60 per hundredweight in the Upper Midwest, the Southwest and the West (where abundant supplies of milk exceed local fluid milk needs) to a high of $4.30 per hundredweight in Florida, where sufficient milk is not produced locally to meet local fluid needs.

However, Option 1A is not USDA's preferred option. Rather, the department favors a much more dramatic minimum price change that is reflected in what it calls Option 1B. Option 1B would establish a national Class I pricing system that recognizes several low pricing areas located primarily in the Upper Midwest and Western regions. It maintains the current Class I differential in Minnesota and then establishes a location-adjusted price differential for every county included in the federal order system based on a computer model that evaluates differences between nearby Class I prices also generated by the computer model. USDA notes that Option 1B would move the dairy industry into a more market-oriented system by establishing differentials on the basis of optimal milk movements across regional milk markets. The net effect of Option 1B would be to reduce dramatically minimum Class I prices in virtually all milk markets across the country. The unweighted average price reduction for all 11 milk marketing areas is approximately 43 cents. For example, the Class I differential for New York City would be reduced from the current $3.14 per hundredweight to a proposed $2.07. The Class I differential in Dallas, TX would fall from the current $3.16 per hundredweight to $1.68, a reduction of almost $1.50. The Tampa Bay, FL differential would be reduced by only seven cents, from $3.88 to $3.81 per hundredweight. Because of the dramatic price reductions for fluid milk that would result from the adoption of Option 1B, USDA has proposed that this approach be phased in over five years in one of three ways. In this way, it hopes to slowly transition the marketplace to the new pricing system and give dairy producers and processors time to adjust to these significantly lower minimum prices.

Conclusion

While time will tell how drastically the department reforms the federal order system for milk, it appears that the reform will simplify the system significantly, dramatically reduce the number of orders and dramatically increase the geographical coverage of each order. While it is less certain what the department ultimately will decide to do on minimum prices for fluid milk, the Department probably will adopt the more aggressive pricing reform outlined in its proposal (Option 1B) along with a five-year transition period to convert the federal system to these lower minimum prices for fluid milk. Anyone interested can access this voluminous proposal on the Internet at wnw.aims.usda.gov/dairy/reform. Copies also are available through the USDA and government bookstores. Public comments are due by March 31.


Richard Rossier is a partner in the law firm of McLeod, Watkinson & Miller which represents various commodity promotion entities created by federal law.




The Agricultural Law Letter is published to highlight recent changes and developments in the law and public policy. As with any publication of this type, it is essential that before any action is taken based upon this information, competent, individualized, and professional advice should be obtained. Copyright 1997 by McLeod, Watkinson & Miller. Reproduction in part or in whole is permitted with permission from McLeod, Watkinson & Miller. Contact Suzanne Bucciarelli at (202) 842-2345, or write to One Massachusetts Avenue, NW, Suite 800, Washington, D.C. 20001. Subscriptions to the newsletter are $25 per year.