el is a function of what policy makers consider Afair.@ If the value of quota disappears some farm groups and legislators argue that since the tobacco is permanent legislation, quota owners should be compensated for all potential future lost income from quota where quota is assumed to generate income into perpetuity. This is how the $8 per pound of quota figure was arrived at during the tobacco settlement debate of 1998. Others argue that compensation should only be for a set time horizon of lost quota income or that market values of quota should be used. Finally, some groups may argue that market prices paid for quota reflect the risk of program elimination and consequently no compensation for quota is warranted.
Market values of quota are determined by buyers and sellers based on several criteria. The first factor is the expected annual income from owning one pound of quota. In the past this annual income has been the difference between the expected market price for one pound of tobacco and the cost of producing and selling one pound of tobacco (less the cost of the quota). This difference or expected income is represented by the rental rate. Expectations concerning future Phase II payments or potential government payments associated with quota ownership have caused much uncertainty in the quota market and have inflated quota values. Currently, expectations of annual income from quota seem to include future rental value plus some expectation of Phase II or other payments.
The second factor is how much, if any (and when), the quota is expected to decline or increase in quantity in the future. When the national quota is set each year, the quantity of quota owned by an individual will increase or decrease by the same percentage as does the national quota. Thus, in a situation of expected decreased demand for tobacco (for example, due to a tobacco settlement or increase in cigarette taxes) future quantities of quota would be expected to decline having a negative effect on current quota values.
The third factor influencing the value of quota is how long the tobacco program is expected to last (i.e. how long farmers can expect an income stream from the quota). This factor is influenced heavily by the content and tone of any policy debate about the tobacco program at the time the market values are observed. Finally, the uncertainty surrounding the forecasts for the first three factors affects the discount rate used to calculate the current value of the expected stream of income from a pound of quota. (A discount rate is similar to an interest rate and accounts for the effects of inflation on the purchasing power of future earnings and the risk or uncertainty of achieving the expected outcomes for the first three factors.)
Since current market values of quota likely are distorted by expectations of payments associated with quota ownership, calculation of quota values may be useful. This can be done by determining some annual income level for the quota and some discount rate that reflects the risk associated with the future of the tobacco program. Current rental rates likely are also distorted in most states by expectations that growers will receive Phase II payments based on the quantity of quota grown. Thus, it may be reasonable to use a range of rental rates. Determination of the appropriate discount rate is also very speculative, so a range of discount rates should be used. A higher discount rate indicates greater risk of a reduction or loss of future income from quota (e.g. due to program elimination). Table 1 gives quota compensation values using rental rates of $0.40, $0.50 and $0.60 and discount rates ranging from 5 to 20 percent.
Table 1. Present value of annual quota income
If tobacco price is reduced to a level greater than the free market price, then quota income would not fall to zero. In other words rental rates would still be positive. If compensation were paid under such a scenario smaller payments could be justified since quota would still have value, albeit lower.
If the tobacco program were eliminated, then m