BRUCE CHAPMAN. Drought Policy: A Different Way

It is said that little is certain in life except death and taxes. In contemporary Australian public policy debate we can add another inevitability: that during terrible droughts governments will spend large amounts of taxpayer resources to address farmers’ legitimate anxieties concerning the effects.

While the next tranche of the government’s further response to drought has yet to be announced there will be several unsurprising components for drought affected farmers: additional handouts in the form of grants, and the maintenance or extension of existing concessional loans. It can be demonstrated that for reasons of both equity and farm welfare neither aspect is desirable nor sound economic policy.

A fresh approach – if considerable research going back over 18 years now can be described as “fresh” – is to offer farmers financial relief through what are known as income contingent loans (ICL). These are quite unlike the “normal” loans now available because they have the unique and highly desirable characteristic of needing to be repaid when a farm borrower has the financial capacity to do so. That is, with this type of loan, when the farm is doing poorly in the future only small loan repayments are required, and if the farm is doing well it repays a lot more.

The best known example of an ICL is HECS, Australia’s innovative student loan scheme which is being copied all over the world. Some commentators and farmers are now promoting the notion of there being “HECS-style loans” available in times of drought.

To understand why this is the right way to go, let’s start with the economics This begins with the recognition that farming is an uncertain, perhaps the most uncertain, business. Significant year-to-year differences in a farm’s finances are typical. This happens for a range of reasons as well as drought: exchange rate vicissitudes; floods; international unrest affecting food production; and the agricultural policies of other countries.

The high variance in farm financial circumstances is undesirable for planning and other reasons, and this promotes the use of policies which smooth incomes across the agricultural cycle. Australian governments have recognised the benefits of income smoothing through the adoption and extension of the successful Farm Management Deposits Scheme (FMDs).

FMD rewards farmers through tax subsidies if they put away finances in good years to be used in future poor years. It is motivated by the benefits of “saving for a rainy day”, even if in a drought context it is more accurately about saving for a non-rainy day. FMDs have been used across Australia in recent years to mitigate the trauma of drought.

An ICL is essentially a mirror image of this scheme, because it essentially allows farmers to borrow from future good years in order to meet the needs of the present bad years. ICL have three critical features:

  • Compared to a normal loan in which repayments have to occur on a regular basis (what the existing government concessional loans scheme requires) there is default protection, with an ICL the farm is not at risk of repossession due to an inability to meet repayment obligations;
  • They make life easier for farmers because just about all the loan repayment obligations will be met when farm financial circumstances are propitious, so there are no repayment hardships; and
  • Unlike grants or loan interest rate subsidies given to farmers ICLs don’t have involve significant subsidies from taxpayers, with the vast majority of citizens paying for them being in far less healthy financial circumstances over their lifetimes than the farmers benefitting from these gifts.

And we should not forget that the current concessional loans have to be repaid no matter what the circumstances facing the farmer are. This has to contribute to anxiety and poor psychological experiences for many farmers.

An astute farmer, Alison McLean, has invited the Federal Government to consider the suggestions and modelling of ICL research, and last week her suggestions for the government to consider this was rejected by the Federal Minister. However, the grounds given for this rejection to Ms McLean were, to be polite, curious.

For example, the argument given by the Minister for the rejection of her idea was argued that using income as a basis for repayment would not work. This is true and this is something the plethora of research on this topic has long recognised.

In the many papers on this issue, Linda Botterill and I – with considerable advice and guidance from farmers and rural accountants – have argued that indeed income is the wrong basis for repayment for these types of loans, and we have instead suggested that farm annual revenues as the basis of collection is the simple and correct way to go.

If government officials had read our work before advising the Minister the response to Ms McLean would have been much better. Our many papers have always pointed out that farmers’ income is wrong, and that using farm’s annual revenue as a basis for loan collection is the right way to go. This is not only simple administratively, but would be both fair and cost the Government’s budget close to nothing.

Fears with “over-borrowing” with such loans, raised also by the government in its response to Ms McLean, are easily handled by putting a cap on each farm’s debt level; this is a simple solution to this alleged problem.

Revenue contingent loans (RCL) to support farmers in hard times are a good and equitable solution for governments and farmers. We note also that collection complications are not going to be an important part of the administrative requirements of a RCL. How this can be achieved is addressed comprehensively in all out research.

It is perplexing that these ideas continue to be ignored by governments and oppositions. And it is a major frustration that when RCL is suggested the responses are often uninformed and poorly researched.

So where are we now in the debate for the use of RCL for drought relief? Well, clearly not in the right public policy debate space. The modelling and results, published in the best journals and provided at many times to government enquiries, suggests that RCL can provide a realistic alternative to interest rate subsidies, concessional loans and the plainly regressive use of grants for farmers.

In an era of tight budgets and mutual obligation in many areas of government support, it would seem appropriate that drought relief is subjected to further scrutiny. Particularly when there is available a viable and well-researched alternative that makes life easier for farmers, saves government resources and is more equitable for taxpayers.

Bruce Chapman, College of Business and Economics and Sustainable Farms, Australian National University.

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