Order Code RS22522
October 25, 2006
CRS Report for Congress
Received through the CRS Web
Potential Challenges to U.S. Farm Subsidies
in the WTO: A Brief Overview
Randy Schnepf and Jasper Womach
Specialists in Agricultural Policy
Resources, Science, and Industry Division
Summary
Expiration of the WTO’s so-called Peace Clause on January 1, 2004, appears to
have made U.S. export and domestic support programs more vulnerable to legal
challenge under WTO rules. This report examines U.S. commodity subsidy programs
against an emerging set of criteria that test their potential vulnerability. The criteria are
whether the subsidies cause adverse effects contributing to serious prejudice under the
Agreement on Subsidies and Countervailing Measures (SCM), Articles 5 and 6.3. When
measured against these criteria, available evidence suggests that all major U.S. program
crops, particularly crops receiving benefits under both the counter-cyclical payments
program and marketing loan provisions (i.e., corn, soybeans, wheat, rice, cotton,
peanuts, barley, sorghum, oats, and minor oilseeds), are potentially vulnerable to dispute
settlement challenges. If such challenges occur and are successful, the WTO remedy
likely would imply either elimination, alteration, or amendment by Congress of the
programs in question to remove their adverse effects. Alternately, in light of an adverse
ruling the United States could choose to make compensatory payments (under agreement
with the challenging country) to offset the alleged injury. In spite of U.S. vulnerability,
there are reasons why challenges may rarely be filed. Disputes are economically and
diplomatically costly, and a lost challenge can help to legitimize the disputed program.
This report, which will not be updated, is an abridged version of CRS Report RL33697,
Potential Challenges to U.S. Farm Subsidies in the WTO. Citations to sources appear
in that report.
The World Trade Organization’s (WTO’s) 149 members have agreed to a set of
trading rules, including constraints on domestic subsidies and a process for challenging
violations. Now, the combination of three relatively recent events — (1) the expiration
of the WTO Peace Clause on January 1, 2004; (2) Brazil’s successful challenge of certain
provisions of the U.S. cotton program in a WTO dispute settlement proceeding (upheld
on appeal in March 2005); and (3) the indefinite suspension of the Doha Round of WTO
trade negotiations in July 2006 — have raised concerns that U.S. farm programs could be
subject to a new wave of WTO dispute settlement challenges.
Congressional Research Service ˜ The Library of Congress

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The Peace Clause had provided protection for actionable subsidies provided they met
certain compliance conditions. Now an agricultural subsidy may be challenged under
claims of “adverse effects” in agricultural markets — even if the subsidy remains within
spending limits defined under the country schedule. The potential list of actionable
subsidies includes export subsidies, amber box, blue box, green box, and de minimis
domestic support measures. (See CRS Report RL32916, Agriculture in the WTO: Policy
Commitments Made Under the Agreement on Agriculture, for an explanation of these
categories). In particular, the “serious prejudice” claim of the Agreement on Subsidies
and Countervailing Measures (SCM), Article 5(c), according to expert opinion, is a lower
threshold for achieving successful challenges than the injury requirement under a
countervailing duty claim.
If challenges are successful, the WTO remedy likely would imply either elimination,
alteration, or amendment by Congress of the programs in question to remove their adverse
effects. Since most governing provisions over U.S. farm programs are statutory, new
legislation could be required to implement even minor changes to achieve compliance.
Alternately, in light of an adverse ruling the United States could choose to make
compensatory payments (under agreement with the challenging country) to offset the
alleged injury. USDA Secretary Johanns has stated that one of his primary objectives for
the 2007 farm bill is to make U.S. farm programs “beyond challenge.”
Nevertheless, some trade specialists argue that numerous new WTO challenges of
U.S. farm support are unlikely. They contend that challenges require intense effort, the
financial costs are high, and the broader geopolitical consequences may far outweigh any
potential trade gains. Few developing countries have the needed resources for a
challenge. In addition, there is the inherent risk that, if the challenge fails, the effort could
legitimize those very programs targeted for discipline.
Measuring Vulnerability
Based on precedent from WTO past decisions, several criteria are important in
establishing the existence of adverse effects contributing to serious prejudice: (1) the
subsidies constitute a substantial share of farmer returns or cover a substantial share of
production costs; (2) the subsidized commodity is important to world markets because it
forms a large share of either world production or world trade; and (3) there is a causal
relationship between the subsidy and adverse effects in the relevant market.
A WTO challenge, under SCM Articles 5 and 6.3, is most likely to focus on those
programs that are production- and trade-distorting (i.e., amber box) or that have been
exempted from the amber box under the blue box, de minimis, or green box criteria, but
can be shown to cause adverse effects in certain markets. To identify commodities that
are potentially vulnerable to WTO challenges, USDA data are used to measure the level
of subsidy dependence. Then, those commodities identified as depending heavily on
government subsidies are evaluated in terms of the potential for the subsidies to be linked
to adverse effects in international commodity markets.
How Important Are Farm Subsidies Relative to the Commodity’s Market
Returns? When U.S. program crops (i.e., commodities receiving mandatory federal
support) are ranked by the level of subsidy as a share of cash receipts (over the past 10
years beginning with 1996), all of the “covered commodities,” with the exception of some

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minor oilseeds, received subsidy payments amounting to more than 10% of marketplace
cash receipts.
Table 1. Subsidy Payments as Share of Cash Receipts,
Average FY1996-FY2005
Subsidy as Share
Subsidy as Share of
Commodity
of Cash Receipts
Commodity
Cash Receipts
Rice
72%
Sunflower Seed
21%
Upland Cotton
58%
Canola
20%
Sorghum
45%
Flaxseed
13%
Wheat
34%
Dry Peas
12%
Barley
30%
Peanuts
11%
Corn
25%
Soybeans
10%
Oats
25%
Source: Subsidies include commodity support payments and crop insurance indemnity payments in excess
of farmer-paid premiums. Calculations were made by CRS from USDA data.
The averages understate the situation because challenges in the WTO likely would
specify the years when the subsidies were at their highest levels relative to market
revenues. In FY2000, for example, rice and cotton subsidy payments amounted to 174%
of cash receipts, and sorghum, wheat, and corn payments were respectively 110%, 101%,
and 66% of cash receipts, according to USDA data.
How Important Are Farm Subsidies Relative to the Commodity’s Costs
of Production? On average, for the crops receiving the most program support per unit,
market revenue has covered operating costs but not total costs of production. It is only
with the subsidies that these commodities cover their total cost, and even this was not
accomplished for sorghum and wheat. In the most extreme case, market revenue for rice
amounted to 70% of total costs, but with the addition of subsidies the total revenue
amounted to 146% of total costs.
These comparisons suggest that only with the aid of subsidies is a substantial portion
of U.S. production made
economically sustainable.
Figure 1. Revenue Components as
Unanswered is the question
Share of Total Costs
of whether production
would decline without the
subsidies. Some (and
possibly a substantial)
portion of the lost
production from high-cost
farms that would leave the
sector in the absence of
subsidies would be offset
by increased production
from low-cost farms that
would likely expand their
operations. Nonetheless,
the substantial contribution

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of subsidies toward covering otherwise unmet production costs implies a high chance for
adverse rulings for any of the major covered commodities.
Which Programs Provide Most of the Farm Subsidies for the
Commodity? Direct payments, the 2002 farm bill successor to production flexibility
contract payments, are, on average, the largest and most constant commodity subsidy
payments. Counter-cyclical payments and marketing loan program payments, as well as
milk income loss payments, have the greatest variation and are large, by design, in years
when market prices are low. The cotton user marketing program, commonly called the
Step 2 program, has been terminated by a change in the law subsequent to the WTO
cotton ruling, and expenditures will drop to zero in FY2007. There are purchase programs
for milk and sugar to remove supplies from the market when prices fall below mandated
support levels, but federal costs are comparatively low because price support largely is
achieved through import restrictions. Crop insurance is another sizable and growing
direct subsidy program, benefitting primarily the major crops but other crops as well.
Table 2 provides detailed expenditure data for the major subsidy programs.
Some WTO members, including the EU, have argued that benefits from U.S.
marketing loan provisions should be classified as prohibited export subsidies. They
contend that these subsidies “effectively behave like an export subsidy.” However, under
SCM Article 3 an export subsidy must be based specifically on export performance or
upon use of domestic over imported goods: “The mere fact that a subsidy is granted to
enterprises that export shall not for that reason alone be considered to be an export
subsidy...” The United States maintains that all of its farm programs operate within the
framework of U.S. commitments to the WTO and are therefore in compliance.
Furthermore, no WTO member has challenged the benefits obtained by U.S. producers
under the marketing loan provisions as prohibited subsidies.
Federal crop insurance costs have grown in recent years because the level of subsidy
on each policy has increased and the pool of subsidized commodities and production
locations has grown. Since FY2002, government net outlays (including premium
subsidies and government loss-sharing and delivery costs) have averaged more than $3
billion annually. Future growth (according to a January 2006 report by the Food and
Agriculture Policy Research Institute (FAPRI)), is expected to raise net outlays to over
$4 billion by 2008 and $4.6 billion by 2015. This higher expenditure level could bring
the crop insurance program under greater scrutiny from trade competitors.
While crop insurance is available widely, 68% of the subsidy over the FY2002-
FY2006 period went to five crops — corn (20%), wheat (18%), soybeans (16%), cotton
(9%), and sorghum (6%) — and fully 75% of the total crop insurance coverage went to
the program crops, while the remaining 25% went to the non-program crops. When total
premiums (including farmer and federal contributions) are compared to indemnity
payments, the loss ratio was 1.09, giving the overall appearance of being actuarially
sound. However, if the federal premium subsidy is excluded, the loss ratio is 2.70
(indemnities were 2.7 times higher than farmer premium payments).

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Table 2. Commodity Subsidy Outlays, by Program, FY2002-FY2007F
Program
FY02
FY03
FY04
FY05
FY06E
FY07F
$ Million
Direct Payments Program a
3,968
3,857
5,278
5,235
4,949
4,170
Counter-Cyclical Payments Program
1,743
809
2,772
3,975
3,147
Marketing Loan Program
5,987
4,752
1,047
5,608
5,693
402
Loan Deficiency Payments
5,345
693
461
3,856
4,576
351
Commodity Certificate Gains
0
3,869
268
1,520
1,106
32
Marketing Loan Gains
642
190
318
232
11
19
Milk Income Loss Contract
0
1,796
221
9
515
600
Cotton User Marketing Program
182
455
363
582
312
0
Total CCC Commodity Payments
16,124
17,355
8,765
19,814
21,137
8,721
Dairy price support program
622
698
74
(30)
88
145
Sugar price support program
(130)
(84)
61
(86)
0
0
Total Commodity Purchase Operations
492
614
135
(116)
88
145
Crop Insurance Indemnities in Excess of
Farmer-Paid Premiums b
1,772
2,892
1,871
1,500
750
na
Total Commodity-Specific Support
18,388
20,861
10,771
21,198
21,975
8,866
Source: Data are from USDA, FSA, CCC Net Outlays by Commodity and Function, July 11, 2006.
Outlays for FY2006 and FY2007 are budget forecasts.
a Direct payment outlays for FY2002 include funds for the predecessor contract payments program.
b There are additional federal costs for crop insurance delivery and administration not included in these
calculations. However, those costs benefit the providers and not directly the farmers.
How Important Are U.S. Production and Trade for Subsidized
Commodities Relative to World Markets? The most heavily subsidized
commodities (with the exception of milk) also are this nation’s largest agricultural
exports. Not only do exports provide a market for a large proportion of U.S. production,
these exports are a large proportion of the entire world’s exports. During the 2002 to
2005 period, U.S. cotton accounted for 20% of world production and 40% of world trade.
Similarly, U.S. rice accounted for 2% of world production and 13% of world trade; U.S.
wheat was 9% of world production and 25% of world trade; U.S. sorghum averaged 18%
of world production and 83% of world trade; and soybeans averaged 38% of world
production and 44% of world trade.
Do U.S. Farm Subsidies Cause Adverse Effects in the Marketplace?
Several economic studies have investigated the causality linkage between U.S.
agricultural policy support and the adverse market effects identified in SCM Article 6.3
— i.e., lost market share, quantity displacement, and suppression of market prices. In
general, these studies support the idea that U.S. (and other developed country) agricultural
support programs negatively influence international market prices and tend to
disadvantage third-country trade of non-subsidized “like” products. (The longer version
of this report, CRS Report RL33697, summarizes these studies.)

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WTO Remedies
The remedy to a successful WTO legal challenge of a subsidy program depends on
the nature of the subsidy — prohibited versus actionable — and on the recommendation
of the panel hearing the case. Prohibited subsidies must be withdrawn without delay
(SCM Article 4.7) according to a time period specified by the panel in its
recommendation. If withdrawal is not accomplished within the specified time frame, then
the Dispute Settlement Body (DSB) shall grant authorization to the complaining member
to take appropriate retaliatory countermeasures (SCM Article 4.10).
With respect to actionable subsidies, the remedy is to remove the subsidy’s adverse
effects or withdraw the subsidy (SCM Article 7.8). The subsidizing party is given some
leeway in deciding how to remove the adverse effect. Options could include eliminating
the subsidy program, reducing the subsidy amounts, reducing the linkage between the
subsidy and the adverse effects (e.g., decoupling), or making some sort of mutually
acceptable compensatory payment. Furthermore, if the recommendation is not followed
within six months of the adoption of the panel report (or the Appellate Body report on
appeal), then the DSB shall grant the complaining member authority to take appropriate
retaliatory countermeasures commensurate with the degree and nature of the adverse
effects determined to exist (SCM Article 7.9). An arbitrator may be asked to determine
whether proposed countermeasures are commensurate.
Conclusions
When measured against WTO criteria, all major U.S. subsidized crops (both
“covered commodities” and “loan commodities”) appear potentially vulnerable to WTO
legal challenges. Furthermore, several commodities may be more vulnerable to
challenges because of impacts in specific export markets (rather than on a global basis)
or in sub-product domestic and export markets. Another important concern is the
potential for certain U.S. farm programs (e.g., foreign market development programs) to
be ruled prohibited subsidies when subject to detailed analysis by a WTO Panel.
A review of recent economic analyses suggests that a partial U.S. policy reform (such
as the U.S. Doha-Round Proposal to reduce U.S. amber box spending by 60%) would
provide only a modest reduction in adverse effects in international markets. This happens
because the United States plays such a large role in world commodity markets. As a
result, U.S. subsidy programs would appear vulnerable to WTO challenge under SCM
Article 5 and 6.3 following even such a policy reform.
The most clear method for decreasing exposure to WTO legal challenges is through
extensive decoupling — i.e., remove the linkage between payments and producer or
consumer behavior. Such decoupling would sever the causality linkage necessary to
accomplish a successful WTO challenge. Several options for decoupling have been
considered or discussed as part of the ongoing 2007 farm bill debate. These include fully
decoupled direct payments, whole-farm revenue-insurance-type programs, and
conservation or “green” payments. The attraction of these alternatives is their likely
qualification as green box programs. The costs thus would fall outside the WTO’s
aggregate measures of support (AMS) spending limits.

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