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Got Produce? Will The Money Really Be There?

As we have been analyzing the proposed Generic Promotion Board for produce, we haven’t paid much attention to the details of who will be assessed, how people will be assessed, and how the board will be constituted, etc., etc.

Mostly this is because we think discussion of these matters is putting the cart before the horse. First you establish need, then you establish efficacy and only then do you start looking at mechanics.

In the context of a larger issue, we did mention our concerns that assessing based on sales had the effect of making the high quality end of the industry subsidize marketing for the low caliber guys.

Now we thought it worth mentioning that we are not convinced that when all is said and done, the board will actually raise the $30 million a year the USDA says it will.

The way the money is supposed to be raised is that so-called “first handlers” will pay an assessment on their sales, not counting freight.

But you can’t assume that business will be conducted in the same way when what are, economically speaking, “new taxes” are imposed.

In other words, right now a fresh-cut processor/juicer/canner/freezer, etc., will buy raw produce and gain margin by cutting, blending, packing, promoting and providing services. The final product may sell for many times the price of the raw material.

It is this processed/juiced/canned/frozen price that the USDA seems to have used for its revenue estimates.

Yet the minute the board passes, companies would look to change the way they do business so as to avoid or minimize this “tax.” So they may set up separate procurement subsidiaries that would resell product to the parent company for the equivalent of a small brokerage.

Or they could insist vendors grade the product, which transforms the vendors into “first handlers,” or they may make other arrangements with buying co-ops and similar organizations.

In other words processors, including fresh-cut produce processors, will change the way they procure to make sure the assessment falls against a few pennies of raw materials not the finished product.

The transportation exemption is another big question mark. If a company is buying both produce and transportation services from the same parent corporation, this proposal would provide an incentive to charge more in transport and less in product.

In fact, the proposal encourages the break-out of a lot of expenses. If a company is now selling a product with a pledge to advertise and promote that product to consumers and provide transportation services, merchandising assistance and consulting on marketing, it probably just groups all that in one price for the product.

This proposed plan would create an incentive to sell these various things under separate contracts and thus dramatically reduce the “tax.”

Of course, the consequence of all this is that the money may not be there. The USDA numbers reflect a history that was established in an environment without a national “tax” on the sale price. But the assessment will change behavior.

In this year’s annual letter from Berkshire Hathaway, famed investor and Berkshire Hathaway CEO Warren Buffet warned about the danger of assuming the future will be like the past when you are, in fact, changing the conditions. He wrote in the context of Berkshire Hathaway getting into the business of municipal bond insurance:

The rationale behind very low premium rates for insuring tax-exempts has been that defaults have historically been few. But that record largely reflects the experience of entities that issued uninsured bonds. Insurance of tax-exempt bonds didn’t exist before 1971, and even after that most bonds remained uninsured.

A universe of tax-exempts fully covered by insurance would be certain to have a somewhat different loss experience from a group of uninsured, but otherwise similar bonds, the only question being how different. To understand why, let’s go back to 1975 when New York City was on the edge of bankruptcy. At the time its bonds — virtually all uninsured — were heavily held by the city’s wealthier residents as well as by New York banks and other institutions. These local bondholders deeply desired to solve the city’s fiscal problems. So before long, concessions and cooperation from a host of involved constituencies produced a solution. Without one, it was apparent to all that New York’s citizens and businesses would have experienced widespread and severe financial losses from their bond holdings.

Now, imagine that all of the city’s bonds had instead been insured by Berkshire. Would similar belt-tightening, tax increases, labor concessions, etc. have been forthcoming? Of course not. At a minimum, Berkshire would have been asked to “share” in the required sacrifices. And, considering our deep pockets, the required contribution would most certainly have been substantial.

Local governments are going to face far tougher fiscal problems in the future than they have to date. The pension liabilities I talked about in last year’s report will be a huge contributor to these woes. Many cities and states were surely horrified when they inspected the status of their funding at yearend 2008. The gap between assets and a realistic actuarial valuation of present liabilities is simply staggering.

When faced with large revenue shortfalls, communities that have all of their bonds insured will be more prone to develop “solutions” less favorable to bondholders than those communities that have uninsured bonds held by local banks and residents. Losses in the tax-exempt arena, when they come, are also likely to be highly correlated among issuers. If a few communities stiff their creditors and get away with it, the chance that others will follow in their footsteps will grow. What mayor or city council is going to choose pain to local citizens in the form of major tax increases over pain to a far-away bond insurer?

We’ve had some questions about that $30 million number from the beginning; in fact, at first we thought the processed sector, especially juice, was being wildly underestimated. We furnished these inquiries to PBH and understand they are awaiting additional information from USDA.

If, however, we accept that the base USDA statistics are correct, then we can expect a significant decline in the amount of money actually raised for the generic promotion board as companies legally adjust their behavior to minimize their “tax” payments.

This means the board won’t actually have a $30 million budget. What does that imply for its ability to fund a program adequate to actually raise consumption?

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