an economic analysis of the effectiveness of thoroughbred...

Journal of Agricultural and Applied Economics, 3 1,3(December 1999):58 1–5920 1999 Southern Agricultural Economics Association

An Economic Analysis Of The Effectivenessof Thoroughbred Breeder/Owner IncentivePolicies

J. Shannon Neibergs and Richard Thalheimer

ABSTRACT

Thoroughbred incentive programs are subsidy policies funded from state parimutuel taxrevenue designed to promote regional race horse breeding and ownership. At issue is anongoing debate concerning the effectiveness of alternative policies. Empirical results in-dicate that incentive programs have a positive economic effect, but gains to Thoroughbredbreeders can be obtained by reallocating tax revenue to non-restricted purses. A policyallocating tax revenue to non-restricted purses shifts yearling demand and increases prices,while breeder subsidies shift only the supply function and therefore lower prices. Conse-quently, breeder revenues increase in response to a policy thatfavors non-restrictedpursesover subsidies.

Key Words: incentive programs, parimutuel horse racing, subsidy, tax,

Subsidy policies for agricultural commoditieshave long been used as a means to stabilizesupply and augment demand. Thoroughbredbreeder/owner incentive programs are state ad-ministered subsidy policies designed to pro-mote regional race horse breeding and own-ership. Currently, 28 states operate incentiveprograms that transfer one-hundred milliondollars annually to Thoroughbred breeders andowners (American Horse Council).

Breeder/owner incentive programs arefunded through a tax levied on parimutuel wa-gering pools. This share of tax revenue istransferred to owners and breeders under a va-riety of alternative subsidy programs. Thestate of Washington operated an incentive pro-gram as early as 1945, and many states initi-ated incentive programs in the 1960s and

The authors are assistant professor and associate pro-fessor, respectively, with the Equine Industry Program,College of Business and Public Administration, Uni-versity of Louisville, Louisville, Kentucky

1970s. Each state has

Thoroughbred.

different policies re-garding the administration and levels of fund-ing across the alternative incentive programs.

Limited analysis exists evaluating the ef-fectiveness of breeder/owner incentive pro-gram policies. This is an ongoing concern dueto the high levels of expenditures and the lim-ited growth in parimutuel wagering poolsacross the nation. 1The objective of this studyis to develop an economic framework to eval-uate the effectiveness of breeder/owner incen-tive policies. Effectiveness will be measuredrelative to incentive policies’ effects on thesupply of foals registered in a state, the year-ling demand as determined by average year-

1Parimutuel horse racing handle increased a mar-ginal 1.6%, $277.4 million, from 1996 to 1997. Since1982, horse racing’s average annual rate of growth hasbeen 2%. Horse racing’s market share of total gamingdeclined 0.41% from 6.80 to 6.39% from 1996 to1997, and has declined to these levels from a 22%market share in 1982 (Christianson).

582 Journal of Agricultural and Applied Economics, December 1999

Iingprice instate sales, andthe combined neteffects of supply and demand on aggregatebreeder revenue.

Background and Literature Review

Each state’s incentive program differs in thedistribution of transfer payments to the breed-ers and owners of state-bred horsesz that winor place in races. Each state has different pol-icies regarding the administration, levels offunding and distribution of payments throughsome or all five alternative incentive policies.These policies are (1) breeder awards whichtransfer money to the breeder of record of astate-bred horse, (2) stallion awards whichtransfer money to owners of stallions standingin the state, (3) restricted race purses whichtransfer money to the owner of a state-bredhorse winning/placing in a race restricted onlyto state-bred horses, (4) owner awards whichtransfer money to the owner of a state-bredhorse winning a non-restricted race open to allhorses meeting the race conditions regardlessof state of breeding. Owner awards are com-prised of “owner bonuses” where the ownerreceives incentive payments at the end of therace meet and “purse supplements” where ad-ditional purse money for state-bred horsescompeting in open races are written as part ofthe race conditions,3 (5) “other” awards whichis a miscellaneous category for state-bredstakes races, stallion stakes, and other raceshighlighting state-bred horses.

Table 1 shows the distribution of incentiveaward payments, averaged from 1989 through1995 for all states operating incentive pro-grams. Restricted race owner awards accountfor 53 percent of the distribution of incentive

2Generally, to be classified as a state-bred, the foalmust be conceived in the state and the mare must givebirth in the state,

3Owner bonuses are paid directly to owners, whoare not obligated to share the award with the winninghorse’s jockey or trainer, and bonuses do not accu-mulate as part of the horse’s race earnings record.Purse supplements are shared with the trainer and jock-ey, in the same manner as traditional purses, and areincluded in the horse’s race earnings record. Purse sup-plements are included in purse distribution statisticsreported by race tracks and in aggregate state totals,

Table 1. Alternative Breeder Incentive Pro-gram Options

U.S. AverageIncentivePayment

Program Option Distribution

Breeder Awards 22%Owner Awards 18%Stallion Owner Awards 5~oRestricted Purses 53~oOther Awards/Funding 270

Source: American Horse Council, 1989–1 995, average

over time and 28 states operating incentive programs. The

most current year available for aggregate incentive pro-

gram data is 1995.

award payments. Breeder and stallion awardsaccount for 22 and 5 percent of the distribu-tion of incentive program payments, respec-tively. Owner awards account for 18 percentof the payment distribution, and “other”awards account for 2 percent.

Of particular interest is the wide range inincentive program expenditure per registeredfoal across the 28 states operating incentiveprograms (see Table 2). New York and NewJersey rank first and second in incentive pro-gram transfer payments, at $11,364 and$11,100, followed by Illinois at $9,660 perfoal. Ohio ranks fourth with $5,653 incentivepayments per foal. In comparison, Marylandand Washington rank twelfth and fourteenth inexpenditures at $2,191 and $1,486 per foal.Kentucky, which ranks first in foal crop, rankstwenty-fifth in incentive payment transfers at

$525 per foal. The majority of states, 64 per-cent, provide $2,208 or less in incentive pay-ment transfers per foal.

Incentive program payments in the Thor-oughbred industry work differently than tra-ditional agricultural support programs whichtransfer payments to eligible producers. Gen-erally, agricultural commodity support pro-grams provide subsidy payments as the differ-ence between the market price and agovernment support price relative to a farm’sproduction level subject to maximum paymentrestrictions. Program benefits are not linked toquality or production efficiency targets, Incomparison, Thoroughbred incentive pro-

Neibergs and Thalheimer: Effectiveness of Thoroughbred Breeder/Owner Incentive Policies 583

Table 2. Breeder Incentive Expenditures PerRegistered Foal

AveragePer

Foal FoalFoal Crop Incen-

Rank State Crop Rank tivesi

12345678910111213141516171819202122232425262728

New YorkNew JerseyIllinoisOhioLouisianaWest VirginiaCaliforniaPennsylvaniaNebraskaMichiganNew MexicoMarylandArkansasWashingtonArizonaOregonOklahomaFloridaMinnesotaMassachusettsIowaKansasWyomingSouth DakotaKentuckyIdahoColoradoTexas

1,579 9581 14

1,468 101,010 111,711 6

442 193,946 2

872 12546 15509 16636 13

1,581 8457 18

1,610 7413 20289 22

1,723 53,784 3

505 17125 26192 25243 24

46 2881 27

7,274 1347 21252 23

2,294 4

11,36411,1009,6605,6535,1884,1884,0313,6673,6263,0932,2082,1911,6861,4861,4731,4621,4491,3811,2541,0881,049

658635632525414282220

1Average annual total incentive program transfer pay-

ments per registered foal, 1989 to 1995.

grams are only paid to breeders/owners ofhorses that win races, thereby directly incor-porating market-based and clearly definedquality targets. Also, government expenditureson farm commodity support programs are af-fected by stochastic yields and differences be-tween market prices and target prices. This ex-poses the government to budget risk. Incontrast, Thoroughbred breeder/owner incen-tive transfer payments are directly linked to arevenue source through the tax levied on pari-mutuel wagering pools. Breeder and stallionawards are calculated and paid at yezn-end, af-

ter tax revenues are known with certainty.Purses for restricted races and owner awardsare set throughout the year and can be adjustedrelative to the growth or decline in parimutuelpools. Any carry-over or short-fall in the in-centive program funding is recovered in thenext calender year, thus eliminating govern-ment budget risk.

While there exist a number of studies ex-amining agricultural commodity supply poli-cies (Shumway, Smith, and Richardson; Sun,Kaiser, and Forker) and demand policies (Al-ston, Carter, and Smith; Halliburton and Hen-nebery), there is limited analysis of the effec-tiveness of Thoroughbred breeder/ownersubsidies.

Degennaro examined the role of sire stakeson the volume of wagering (handle) for har-ness racing at Scioto Downs racetrack nearColumbus, Ohio. Degennaro did not find a di-rect relationship between parimutuel handleand sire stakes, indicating that the state-bredsire stakes program had no economic impacton wagering.

Model Specification

The hypothesis to be tested is that breeder/owner incentive programs positively affect thesupply and demand of Thoroughbred blood-stock. The empirical specification is based ona structural Thoroughbred yearling supply anddemand model of inter-temporal equilibriumwith price expectations (Neibergs and Thal-heimer) augmented to include breeder/ownersubsidy programs. The proposed model is a setof state-level Thoroughbred market models asspecified by the following three equation sys-tem:

Supply of Registered Foals

(1) RFOAL,, = a, + alRFOAL,t_, + a2P,(_2

+ a~BA1t.2 + @A,,_2

+ Ix~MTBit_z+ IxbFCI,t_2

+ aTSFEE,,_z + p,,.

Foal to Yearling Transfer


(2) YRL,, = RFOAL,, -I.

Inverse Demand For Yearlings

(3) P,, = PO+ ~ ,YRL,, + (3ZPRSE,,+ ~~RPRSE,t

+ 1340A,t + 135YTF% + (3JWp,

+ &EXR, + ~8PCI,, + v,,

where i= l... n represents an index of statelevel variables.

A working description of the model is pro-vided herein. For a complete model definitionand justification of breeder price expectationssee Neibergs and Thalheimer. Equation (1)represents a supply model of registered Thor-oughbred foals, RFOALIV The model is basedon the hypothesis that breeding decisions aredependent on expected yearling price and oth-er supply factors. The decision to breed a mareis made early in year t, which is followed byan 11-month gestation period, to produce andregister a foal in year t + 1. The foal maturesfor a year and is sold as a yearling in year t+ 2. Therefore supply decisions are based inpart on breeders’ price expectations two yearsin the future.

The Supply Model

Supply response is modeled where RFOAL,,responds to state average price for Thorough-bred yearlings lagged two years, P1,-2, to rep-resent price expectations and reproductiveconstraints associated with breeding decisions.Due to the high asset fixity associated withThoroughbred breeding investments and thelong biological lag associated with breedingdecisions, the supply of Thoroughbred year-lings changes gradually over time. The stick-iness in supply response is in part attributableto the large fixed capital investment associatedwith horse production that is not easily liqui-dated, the small difference in marginal costbetween a bred mare versus a non-productivebarren mare, and the biological constraints ofreproduction. Also, many breeders may not beprice responsive due to their willingness tosubsidize their Thoroughbred investment

through periods of non-profitability. A partialadjustment process is represented by a one-period lag of the endogenous variable,RFOAL,,.

Breeder awards, BA,,.Z, and stallionawards, SA1t-2, are transfer payments to Thor-oughbred breeders and are measured in aggre-gate state totals. They impact the expected re-turns of breeding decisions and are includedin the supply side of the model. Tax benefitsare a primary consideration in Thoroughbredinvestment decisions. Tax benefits are a betterindication than tax costs of federal tax policyimpacts on the yearling market, because taxbenefits apply equally to profitable and non-profitable Thoroughbred investment decisions.The effects of changes in federal tax policycan be captured through an index that mea-sures the present value of tax benefits from acapital investment in a Thoroughbred brood-mare (Hall and Jorgenson). The mare tax ben-efit index, MTB~-2, represents the present val-ue of the tax benefits generated from a fixedcapital investment in a Thoroughbred mare.4A farm cost index, FCI,-Z, represents inputcosts of production, and SFEE,~-z, representsthe state average advertised stud fee paid tobreed a mare. A stochastic error term is rep-resented by p,,t.

Foal To Yearling Transfer

Thoroughbred foals are registered with theJockey Club as weanlings shortly after they

4 MTB, and YTBt are calculated for each year, t, in

the time series 1964–1 995 as the present value of ex-

pected maximum tax benefits from a fixed capital in-vestment in a Thoroughbred breeding mare or yearling,

projected over its tax recovery period. For example,MTB, is calculated as follows:

N TcnD,,, ctNMTB, =~— —

.=, (1 + r)n + (1 + r)N

for t = 1964 . . . 1995

where: n is an annual index relative to year t, and N

is the tax recovery period of a mare which is seven

years and for a yearling its five years. Tn is the highest

personal marginal tax rate, Dn is annual depreciation

expense, C~ is the capital gains tax benefit when allowedand O otherwise, and the discount rate, r, is fixed at 8percent. Each tax policy variable is projected over theseven-year tax planning horizon as expeeted in year t.

Neibergs and Thalheimer: Effectiveness of Thoroughbred Breeder/Owner Incentive Policies 585

are born and become yearlings on the first Jan-uary 1 after they are foaled. Equation (2) is anidentity that transfers RFOAL,, to the supplyof marketable yearlings, YRL,~. Once a foal isregistered, only death prevents it from becom-ing a yearling. Since death loss rates are un-available and presumed negligible and invari-ant over time, an identity is used to transferfoals to yearlings.

The Demand Model

Demand for Thoroughbred yearlings can bestbe represented as a capital investment func-tion. Equation (3) represents an inverse de-mand function where the state average priceof yearlings, Pl~,is a function of the predeter-mined supply of yearlings, YRL,,, and a set ofcurrent exogenous variables. The price of acapital asset, a Thoroughbred yearling beingno exception, is related to its earning potential.For Thoroughbred yearlings those earnings arethe purses for which they compete plus incen-tive program transfer payments targetingThoroughbred yearling/race-horse owners.The state average purse per race, PRSEi~, re-stricted race purses, RPRSE1,, and ownerawards, OA,~, represent yearling earning po-tential.

The yearling tax benefit, YTB,, representsthe present value of the tax benefits from acapital investment in a Thoroughbred yearling,and is calculated in the same manner as MTB~.Foreign investment influences the Thorough-bred yearling market. The gross amount offoreign purchases of Thoroughbred yearlings,GFP,, and the exchange rate of United King-dom pounds for U.S. dollars, EXR,, capturethe export influences of demand on the Thor-oughbred market. Buyers from the UnitedKingdom led foreign purchasers for manyyears of the study. State per-capita income,PCIiL,represents regional economic conditions.The stochastic error term is v,,.

Because the feedback from the demandequation to the supply equation is a laggedresponse, the specified model is recursive. Ina recursive system, each endogenous variablescan be determined sequentially. Given valuesfor P,,-,, one can solve directly for RFOALi,

in the supply equation. Then, knowingRFOAL1,, the value of Pit can be solved recur-sively in the demand equation.

Data

Data availability constrained the scope of

states included in the model. A number ofstates failed to maintain an archive of incen-tive program transfer payments. Other statesdid not conduct yearling auction sales, so dataon P,~ is unavailable in those states. Threestates are included in the model based on thecomparability of their Thoroughbred indus-tries. Annual data from 1964 to 1995 forWashington, Maryland and Ohio were ana-lyzed. These states represent a geographicaldispersion of Thoroughbred production, andrank seventh, ninth and twelfth in foal cropsize in the United States. Over the study pe-riod, Washington’s incentive program consist-ed of restricted race purses, owner awards andbreeder awards. Maryland’s incentive programconsisted of restricted race purses, ownerawards, breeder awards, and stallion awards.Ohio’s incentive program consisted of restrict-ed race purses, owner awards, breeder awards,and stallion awards.

Data on RFOAL1, were obtained from The

Jockey Club Fact Book. Data on P,, and GFPi,were collected from Annual Auction Review

(The Blood-Horse) and represent an annualsummary of yearling auctions in North Amer-ica. Data on GFP, are available only from1973 to 1995. Prior to 1973 foreign purchaseswere relatively insignificant and were not re-ported separately. Essentially GFP, is a vari-able with a constant value of O assumed foryears prior to 1973 and actual data used whenGFP, rose to a level of significance to be re-ported separately. Data on PRSE,, were col-lected from The American Racing Manual.

Data on RPRSEit, OAi~, BA,,, and SA,, werecollected from individual states’ annual racingcommission reports. MTBt_2 and YTBt werecalculated using data from Standard Federal

Tax Reports: Depreciation Guide and the In-ternal Revenue Code (Commerce ClearingHouse). Data on FCIt were collected from Ag-ricultural Statistics (USDA). Data on SFEE1~-a


were collected from the annual Stallion Reg-ister (The Blood-Horse). An annual averagestud fee was calculated by averaging all ad-vertised stud fees in the register per year foreach state in the study. Data on PCI,, were ob-tained from the Statistical Abstract of the

United States. Data on EXR,, and the consum-er price index used to deflate data expressedin monetary units were obtained from the Ci-tibase Data Base. The sources of data for eachof these data series are, respectively, Board ofGovernors of the Federal Reserve System,Foreign Exchange Rates; and U.S. Departmentof Labor, Bureau of Labor Statistics, Consum-er Price Index. Descriptive statistics are pre-sented in the Appendix.

Results and Discussion

The specified state level Thoroughbred year-ling market model was estimated using Kmen-ta’s method of pooling cross-section time-se-ries data, which assumes autocorrelation andheteroskedasticity (Kmenta). Shazam 8.0econometrics software was used to estimatemodel parameters. Due to problems of multi-collinearity in the supply model betweenBA1,.2 and SAI,.2, the relatively small distri-bution of incentive transfer payments throughSAlt.2, and since these awards largely targetthe same Thoroughbred breeder, they werecombined into one variable, BASAi~.z, by add-ing them together, A dummy variable forMaryland, MADUM, was included in themodel, because of an extraordinary price dropwhich occurred in 1974 to the present. Thisreflects the export of Maryland’s higher qual-ity horses to more lucrative markets in Ken-tucky and New York through the Fasig-Tiptonauction house (Finney). A squared per-capita-income variable, SQPCI, was introduced tobetter reflect the high disposable income de-mographic characteristic of yearling investors.Estimated results are presented in Table 3.Overall model results support the suggestedmodel specification, based on the consistencyof estimated parameters with what is expectedfrom economic theory, and statistical mea-sures of significance and goodness of fit.

All variables in the supply model are sta-

tistically significant and have a Buse R2 of0.97. Although SFEE,,-Z is a production costand its anticipated sign is negative, the sign onthe estimated parameter is positive and insig-nificant. The incorrect sign is due to the rela-tionship between stud fees and yearling prices.Stud fees are set relative to the strength of theyearling market. This is evidenced by a posi-tive and statistically significant correlation co-efficient between P,,., and SFEE,,, of .333 (p= 0.002). Breeders are willing to pay in-creased stud fees as they expect the marginalvalue product of YRL1[ to increase as shownby a positive correlation coefficient of. 197 (p= 0.063) between SFEE,,-2 and P,,.

The Buse R2 in the demand model is 0.84.All model variables except for variables mea-suring export influences of the market are sta-tistically significant. The states included in thestudy are regional markets, and typically donot have the quality of horses to attract inter-national buyers. The estimated parameters ofPCI,, and SQPCI,, are negative and positive re-spectively, These nonlinear results representthe large disposable income demographiccharacteristics of yearling investors. The keymodel variables of PRSE~, RPRSE~ and OA,are statistically significant at a 1-percent levelof significance, and BASA~.2 is significant ata 2-percent level of significance. All breeder/owner incentive program variables are positiveand statistically significant, indicating a posi-tive economic impact. Their elasticities arecalculated to evaluate their effectiveness.

Supply and Demand Parameter Elasticities

The short-run supply elasticities and priceflexibilities presented in Table 4 are all inelas-tic, with the exception of PRSE, which has aprice flexibility of 1.108, and PCI,. The priceflexibility of owner award programs OA, andRPRSE, are similar at 0.111 and 0.101. Supplyresponse is price inelastic, 0.086, and breederawards, BASA~ is also inelastic, 0.079. Theseresults are consistent with the elasticities es-timated by Neibergs and Thalheimer. Theprice flexibility of PRSE, of 1.108 in this studyis lower than the purse flexibility of 2.606 es-timated in Neibergs and Thalheimer. Two rea-

Neibergs and Thalheimer: Effectiveness of Thoroughbred Breeder/Owner Incentive Policies 58’7

Table 3. Thoroughbred Breeder/Owner Model Empirical Results

Supply (RFOALJ Demand (P,)

Signifi- Signifi-Estimated cance Estimated cance

Variable Parameter Levelz Variable Parameter Levelz

Intercept

RFOAL,_ ,

Pt_2

BASA,.2

MTB,_2

FCI,_2

SFEE,_2

MADUM

nBuse R*

–283.71(61.48)

0.837(0.035)0.167E-i

(0.408E-2)0.134E-3

(0.565E-4)0.993

(0.028)–0,238(0.101)0.176

(0.035)–60.56(38.82)

900.97

0.000

0.000

0.000

0.020

0.001

0.021

0,000

0.123

Intercept

YRL,

PRSE,

RPRSE,

OA,

YTB,

GFP,

EXR,

PCI,

SQPCI,

MADUM

nBuse R2

4779.3

(2191.0)

–1.218

(0.659)

0.993

(o. 109)

0.389E-3

(0.102E-3)

0.105 E-2

(0.505E-3)

1.284(0.218)

0.619E-S

(0.399E-5)

–5.217

(4.714)

–111.62

(23.23)

0.236

(o. 120)

–4489.2

(1032.0)

90

0.84

0.032

0.068

0.000

0.000

0.040

0.000

0.126

0.272

0.000

0.053

0.000

1The top number is the estimated parameter and the bottom number in parentheses is the standard error.

2 Exact probability of rejecting HO: ~, = O.

Variable Definitions: RFOAL = supply of registered foals, P = yearling price, BASA = breeder and stallion awards

combined, MTB = mare tax benefit, FCI = farm cost index, SFEE = stud fee, MADUM = dummy variable repre-senting Maryland, YRL = the supply of yearlings, PRSE = purses, RPRSE = restricted purses, OA = owner awards,

YTB = yearling tax benefit, GFP = gross foreign purchases, EXR = exchange rate, PCI = per-capita income, SQPCI

= PCI squared, t = annuaI time frame with appropriate lags.

sons may account for the lower response, InNeibergs and Thalheimer the purse variablewas an aggregate of purses, restricted pursesand owner awards. Second, data was aggre-gated to a national level in comparison to thestate-level data used in this study.

Long-Run Comparative Statics

The derivation of the final form of the modelby substituting the supply model, equation (1),into equation (3) takes into account the inter-action of supply and demand simultaneously.If a disequilibrating change occurs in the form

of a variation in an exogenous variable, theinitial equilibrium will be upset. Endogenousvariables (RFOAL and P) adjust relative to thenew value of the exogenous variable, plus therecursive adjustments between RFOAL and Puntil long-run equilibrium is reached. Long-run supply elasticities and price flexibilities ofkey model variables are presented in Table 5.The long-run elasticities determine the relativeeffectiveness of the alternative breeder incen-tive programs.

The policy in question is how to effectivelyallocate state tax revenue from parimutuel tax-es to best promote Thoroughbred breeding


Table 4. Short-Run Supply Elasticities and Demand Flexibilities at the Mean

Supply (RFOAL,) Demand (P,)

Variable Elasticity Variable Flexibility

RFOAL,_ , 0.828*** YRL, –0.236*P,_, 0.086*** PRSE, 1.108**13ASA,., 0.079** RPRSE, O.1O1***MTB,-, O.21O*** OA, O.111**FCI,.2 –0.131** YTB, 0.686***SFEE,-2 0.259*** GFP, 0.035

EXR, –0.171PcIt – 1.490***SQPCI, 0.306**

Notes: One, two and three asterisks indicate statistical significance at the 10%, 5% and I% level, respectively.

Variable Defimtions: RFOAL = supply of registered foals, P = yearling price, BASA = breeder and stallion awards

combined, MTB = mare tax benefit, FCI = farm cost index, SFEE = stud fee, YRL = the supply of yearlings, PRSE

= purses, RPRSE = restricted purses, OA = owner awards, YTB = yearling tax benefit, GFP = gross foreign purchases,

EXR = exchange rate, PCI = per-capita income, SQPCI = PCI squared, t = annual time frame with appropriate lags.

within a state. Each state has the authority to

allocate funds to the non-restricted purse ac-

count, PRSE,t, across its breeder award pro-

grams, BASAL,, or to the owner award pro-

grams, RPRSE,, and OA,,. Relative to the

objective of promoting regional Thoroughbred

breeding, the long-run elasticities indicate that

PRSE has the greatest effect on RFOAL with

a long-run elasticity of 0.521, followed by

BASA with a long-run elasticity of 0.432.

BASA is a direct transfer payment to breederswhich stimulates foal supply. However, theBASA policy works against itself by decreas-ing price, since there is a long-run increase insupply without a commensurate increase indemand.

The market intervention effects from a pol-icy decision to introduce or increase BASAare illustrated in Figure 1. Starting at a pointof long-run equilibrium, the short-run foal

Table 5. Long-Run Comparative Statics of Key Model Variables

Long-Run Supply (RFOAL) Long-Run Demand (P)

Comparative supply Long-Run Comparative Long-RunStatic Responsel Elasticityz Static Price Responsel Flexibllityz

dRFOAL

dPRSE0.090

JRFOAL3.540E-5

dRPRSE

6’RFOAL0.961 E-4

dOA

JRFOAL

dBASA7.308 E-4

0.521

0.048

0.052

0.432

f3P

dPRSE0.883

8P

dRPRSE3.455 E-4

tlOA

dP

8BASA

0.938E-3

–0.891E-3

0.985

0.090

0.098

–0.102

] The result is the evaluation of the comparative static using the estimated coefficients from the supply and demand

equations.

2 Elasticity and flexibility estimates are calculated at the mean.

Variable definitions: RFOAL = supply of registered foals, PRSE = purses, RPRSE = restricted purses, OA = owner

awards, BASA = breeder and stallion awards combined, P = yearling price.

Neibergs and Thalheimer: Electiveness of Thoroughbred Breeder/Owner Incentive Policies 589

‘1I RFOAL ,,

D,.RFOAL ,,

P,+ Pw- brmiers r.,.

1% n c~~n$.,?r., w.. .

P . . . . . . . . . . . . . . . . . . . . . ,

RIKIAL ,,. RF’OAL . . . RFOAL

/00/ Wrplu%

Figure 1. Economic Effects of BASA PolicyIntroduction

supply, RFOALs~, the long-run foal supply,RFOAL~~, and long-run yearling demand, D~~are at equilibrium, resulting in an equilibriumprice of P~. The expansion in BASA transferpayments can be expressed on a per-foal basisas P~A~~.The intervention of the BASA ex-pansion policy creates an upward biased pricesignal of PB plus P~AsA. In the short run,RFOAL~~ is perfectly inelastic due to the two-year biological production constraint. Breedersbenefit by receiving the equilibrium price plusthe breeder awards. The short-run breedergain, identified in Figure 1 as the darkly shad-ed rectangle area, is shared among existingbreeders based on established BASA distri-bution policy. In the short run, there is no ef-fect on consumers, or in this case yearlingbuyers, due to the inelastic supply of foals. Inthe long run, breeders respond to the upwardbiased price signal of P~ plus P~~~Aby increas-ing the foal supply to RFOAL~A~A. The long-run supply elasticity of BASA is 0.432. Theexpanded supply in turn forces a market clear-ing price decrease to P~c. The long-run priceflexibility of BASA is –O. 102 (see Table 5).A consumer gain occurs in the long run assupply expands and price decreases, and isidentified in Figure 1 as the lightly shadedarea. In effect, a foal surplus is created by thenon-market intervention of BASA as the dif-ference between RFOAL~A~A and the supplyof foals relative to P~c of RFOAL~c. Netbreeder gain in the long run depends on the

Table 6. Breeder Revenue From a 109o In-crease in Non-Restricted Purses Versus Breed-er Awards.

10% Increase in Non- 10% Increase inRestricted Purses Breeder/Stallion

(PRSE) Awards (BASA)

Year Thousands ($)

o12

3

4

5

6

7

8

9

101112131415

8,4919,6379,6379,6999,7279,7509,7699,7839,7959,8049,8119,8179,8239,8269,8309,832

8,4918,5608,5608,6048,6238,6388,6508,6598,6678,6738,6788,6818,6848,6878,6898,691

Breeder’ revenue is YRL,*P, + BASA,. BASAC = O when

analyzing the policy to increase purses.

YRL = the supply of yearlings, P = yearling price, BASA

= breeder and stallion awards combined, t = annual time

frame.

magnitude of the price flexibility and supplyelasticity of BASA. There is no additionallong-run breeder gain from BASA. BASA isa target transfer payment based on the level ofparimutuel handle, and it is independent offoal supply and price. Therefore as foal supplyexpands, there is increased competition be-tween breeders for the relatively fixed level ofbreeder awards.5

The breeding sector’s marginal revenuewould increase by allocating revenue to PRSE,over BASAL, because PRSEt provides a posi-tive stimulus to both supply and price. Thelong-run supply elasticity of PRSE is 0.521,and its price flexibility is 0.985. Table 6 illus-

5Breeder awards are relatively fixed once a policyis enacted, because parimutuel handle levels are rela-tively stagnant. An increase in breeder awards requiresa policy change to increase its share of parimutuel taxrevenue.


trates the change in total breeder revenuec inresponse to alternative policy scenarios thatincreases PRSE~ or BASA~ by 10 percent. Theanalysis is based on using the average for eachvariable in the model to calculate the initiallong-run equilibrium. Starting from a point oflong-run equilibrium, year O, breeder revenueis $8.49 million. Both policy options are ini-tiated in year 1. Considering the policy optionto increase PRSE,, P, responds immediately tothe increase in PRSEL, and breeder revenue in-creases to $9.64 million in year 1. Breederrevenue stays at this level for the two-yeartime lag required for breeders to adjust supplyrelative to an exogenous shock. From years 3to 15, breeder revenue increases to $9.83 mil-lion as the market adjusts to a new long-runequilibrium. Under the PRSE, policy option, ittakes 10 years to achieve 95 percent of theadjustment to long-run equilibrium. In con-trast, the policy option of increasing BASA,increases breeder revenue to $8.56 million inyears 1 and 2, reflecting the increase in BASA,transfer payments. Starting in year 3, breederrevenue increases as supply responds to theincrease in BASA~, and increases to $8.69 mil-lion by year 15. This policy option takes thefull 15 years illustrated in the table to achieve95 percent of the adjustment to the new long-run equilibrium.

The total revenue generated over the 15-year simulation period further illustrates dif-ferences between the two policy options. Thesum of breeder revenue over the 15-year sim-ulation period is $146.5 million and $129.7million for the PRSE~ and BASA~ policies, re-spectively. Comparing the present value of therevenue streams between the two policy op-tions shows additional strength in the PRSE,policy option. Using a real discount rate of 2percent, the present value of the stream ofbreeder revenue over the 15-year simulationperiod is $125.5 and $111.1 million for thePRSE, and BASA, policies respectively. The$14.4 million difference in present value re-flects the PRSE, policy’s higher annual reve-

nue, immediate revenue increases, and a fasteradjustment to the new long-run equilibrium.7

There are additional indirect effects of theBASA policy on breeders. The direct effectsare the revenue benefits to breeders when theBASA policy was initiated. However, revenuebenefits of price support policies are largelycapitalized into the values of land and spe-cialized production resources (Pasour), and theincreased capitalized values impede entry intothe business by reducing investment profit-ability. The economic gains to breeders froma policy to increase BASA funding are likelyto be short term or transitional as breedergains are capitalized into higher specializedproduction input costs: land, broodmares, andstud fees, for example. The distribution ofgains between breeders and the owners of spe-cialized production inputs depends on howquickly the expected benefits of policy chang-es in BASA are incorporated into asset values.The more quickly asset values rise when pro-gram benefits are increased, the more assetowners benefit from the gain. Thus the BASApolicy results in a transitional gains trap. Oncea price support program is in operation, itselimination imposes losses on owners of spe-cialized resources regardless of whether theybenefitted from the original windfall.

Conclusions

At issue is an ongoing debate concerning theeffectiveness of alternative breeder/owner in-centive programs. This study developed anempirical tool to measure the relative effec-tiveness of alternative Thoroughbred incentiveprograms to promote the breeding sector. Em-pirical results indicate that breeder/ownerawards have a positive economic effect, butgains in foal supply, yearling demand andbreeder revenue can be obtained by allocatingrevenue to non-restricted purses. Allocatingrevenue to non-restricted purses shifts demandand increases price, while breeder subsidies

c Totat revenue to breeders is YRL,.P, + BASA,.BASA, = Owhen analyzing the policy to increase purs-es.

7The $14.4 million real (base = 1982–1984) totalpresent value breeder revenue difference between pol-icy options corresponds to a $21,8 million differencein 1995 nominal terms.

Neibergs and Thalheimer: Effec~ivenessof Thoroughbred Breeder/Owner Incentive Policies 591

shift only the supply function and thereforelower price. Consequently, breeder revenuesincrease in response to a policy that favorsnon-restricted purses over subsidies. This pol-icy may have further benefits outside of thoseidentified by this model. Increased purses im-prove the quality of horses running in a raceand may increase the field size of the race,both of which have been shown to increaseparimutuel handle (Thalheimer and Ali).

Implementing the policy recommendationof transferring the BASA funding to non-re-stricted purses will be met with resistance.First, breeder and stallion awards are directtransfer payments to breeders, and they pro-vide a competitive ranking of merit based onthe amount of breeder awards received. Theseutility enhancing aspects of breeder awards arenot provided by a policy that increases purses.Second, a policy recommendation to eliminateBASA imposes losses on breeders because ofthe loss in expected earnings and the loss ofcapitalizing BASA benefits into the value ofspecialized resources used in foal production.Policies that redistribute wealth are difficult tochange if they adversely affect the interests ofwell-organized interest groups, such as breed-er associations. The results from this study in-dicate that market-based policies of non-re-stricted purses, and the resulting competitionbetween horses, is the most effective policyfor Thoroughbred breeding.

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Appendix Table. Summary Statistics of Variables in Model System (1966-1995)1

StandardVariable Mean Deviation Minimum Maximum

RFOAL[ 1,159 440 362 2,020

RFOAL.I 1,146 452 291 2,020

P, 5,987 3,138 1,048 13,194

P,.2 5,999 3,149 1,048 13,194

BA,_z 579,930 323,570 0 1,260,900SA,-, 104,890 133,960 0 446,440FCI,.2 640 267 270 1,000YTB, 3,195 797 1,837 4,569MTB,., 2,452 662 1,453 3,732SFEE,-2 1,887 421 1,123 2,555PRSE, 6,677 3,182 3,565 15,546RPRSE, 1,555,000 1,673,800 0 6,542,000OA, 627,910 759,100 0 2,186,000GFP~ 33,951,000 35,438,000 0 118,400,000EXR, 197 42 130 279PCI, 80 38 30 161SQPCI, 7,775 6,856 912 25,921

I All monetary data have been deflated by the consumer price index where 1984 = 100.

2 Mean, median and standard deviation are calculated using non-zero data from 1973–95.

Variable Definitions: RFOAL = supply of registered foals, P = yearling price, BA = breeder awards, SA = stallion

awards, FCI = farm cost index, YTB = yearling tax benefit, MTB = mare tax benefit, SFEE = stud fee, PRSE =

purses, RPRSE = restricted purses, OA = owner awards, GFP = gross foreign purchases, EXR = exchange rate, PCI

= per capita income, SQPCI = PCI squared, t = annual time frame with appropriate lags.

an economic analysis of the effectiveness of thoroughbred...

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