Agricultural Policies in the Presence of Distorting Taxes

This paper uses analytical and numerical general equilibrium models to assess the efficiency impacts of agricultural policies in a second-best setting with pre-existing distortionary taxes. We analyze production subsidies, production quotas, acreage controls, subsidies for acreage reductions and lump sum transfers to agricultural producers. We find that pre-existing taxes raise the cost of all these policies and by a substantial amount. Under our central estimates this increase in cost is typically at least 100-200 percent. Two effects underlie these results. First, raising the rates of distortionary taxes to finance subsidy policies leads to additional efficiency losses. Second, policies that raise (lower) the costs of producing agricultural output lead to a reduction (increase) in the economy-wide level of employment. This implies an efficiency loss (gain) in the labor market, which is distorted by taxes. The latter effect is not incorporated in earlier studies. Consequently, previous studies have significantly overstated the costs of production subsidies and understated the costs of production quotas, acreage controls and subsidies for acreage reductions.