The impact of decoupled payments on the cost of operating capital

Purpose - The purpose of this paper is to investigate how decoupled direct payments, paid to farm operators based on historical yields and base acreage, may lead to production distortions by altering a farmer's access to credit or enabling the farmer to receive more favorable credit terms. The authors estimate the impact of decoupled direct payments under the 2002 Farm Bill on the credit terms of farm operators, specifically the interest rate on short‐term operating loans. If farm operators are able to obtain more favorable credit terms and reduce their operating cost, then this offers an additional mechanism through which decoupled payments may distort current production. Design/methodology/approach - The authors estimate the impact of decoupled direct payments on the interest rate on short‐term operating loans. In the analysis, the authors control for farm financial characteristics, farm operator characteristics, and other factors. Data from the Agricultural Resource Management Survey for the years 2005‐2007, are used in the weighted regression analysis. Jackknifed standard errors are also computed. Findings - As the proportion of base acres to total operated acres increases it is found that interest rates decline by a small but statistically significant amount. This implies that direct payments lead to lower operating costs through better credit terms. Research limitations/implications - Lower operating costs may in turn allow some farmers to expand production or produce on land that would otherwise be unprofitable to operate and hence left idle. Ultimately, this distorts current production. However, the small magnitude of the authors' results suggests that the reduction in interest rates, though positive, may have limited distortionary impacts. Originality/value - The paper provides evidence that decoupled payments alter a farm operator's credit terms and hence could lead to current production distortions. The paper contributes to the growing body of research investigating the mechanisms by which decoupled payments have the potential to distort current production.