Will the New Tax Bill Really Harm Privately-Owned Grain Handlers?

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Key insights:

  • The Hoeven-Thune Amendment allows farmers to claim a 20% deduction on income associated with delivering to a cooperative.
  • Numerous outlets are reporting that this could hurt privately-owned grain handling facilities because more farmers will deliver to cooperatives due to the tax benefit.
  • Competitive agricultural markets will most likely eliminate any advantage to producers via the pricing mechanism.
  • Cooperatives are likely to offer a lower price than privately-owned facilities, and the difference in the prices will approximately equal the 20% deduction benefit.

In the past several days, I’ve seen a number of articles that have discussed the potential impacts of the Hoeven-Thune amendment. The amendment language is a bit convoluted, but for farm businesses, the most direct benefit is that they can claim a 20% deduction on sales income, if those sales were made to a cooperative. For example, if a farmer makes $100,000 in grain sales to a cooperative, they can claim a $20,000 deduction on their business income. On the surface, that’s a big deal.

[Update: Here’s a great semi-non technical summary of the new provisions.]

The articles that I’ve seen about this amendment—from the Wall Street Journal and World Grain are two examples—have indicated that this is not only a big win for cooperatives, but perhaps a big loss for privately-owned facilities such as Cargill or ADM. The rationale is that farmers are more likely to deliver to cooperatives because they can gain the 20% deduction advantage and are, thus, less likely to deliver to the privately-owned facility.

But, as is typically the case, this is actually not very likely to happen. Why? Markets!

Consider this very simple scenario. There are ten farmers, each producing 100,000 bushels of wheat. Before the tax law change, each farmer delivers 50,000 bushels to a cooperative and 50,000 bushels to a privately-owned facility. Then, the tax law changes. All ten farmers are profit-maximizers and, therefore, they all decide to deliver all 100,000 bushels of wheat to the cooperative in order to claim the 20% income deduction.

This works in theory, but in reality, the cooperative is likely unable to handle all of the extra grain. In some recent research with a colleague at Kansas State University, we looked at elevator characteristics for facilities in Kansas and Montana. In both states, the storage and handling capacity of cooperatives was smaller than that of privately-owned facilities. In Kansas, privately-owned facilities are, on average, 2.71 times larger, and in Montana, they are 1.67 times larger. And while I don’t have data for other states, my educated guess is that the general relationship between capacity of cooperative and privately-owned facilities is similar.

So, what happens when a large influx of grain begins to flow to a smaller facility (an increase in supply)? The facility will begin lowering its price to manage the amount of delivered grain. This is exactly what happens during years of larger-than-average harvests: prices go down.

Prices at cooperatives will continue to fall until farmers no longer see a net benefit of delivering to the cooperative. Let’s return to our example above and assume that before tax law change, both the cooperative and privately-owned facility offered a $5.00 per bushel price for wheat. After the tax law change, the $5.00/bu at the cooperative is a lot more attractive because now farmers can claim a 20% deduction on the sales income. But to avoid the excessive influx of wheat, the cooperative will lower its price to approximately $4.17 per bushel. At this price, a farmer will see no net benefit by delivering either to the cooperative (selling at $4.17/bu and obtaining a 20% deduction) or to the privately-owned facility (selling at $5.00/bu and receiving no tax benefit). At the end of the day, the farmers will deliver exactly the same amount of wheat to each facility as they had delivered before the tax law change.

So, while some temporary market adjustments may take place, the long-run implications of the tax law change for privately-owned facilities are likely not as dire as some may think. The Hoeven-Thune amendment does provide several additional benefits to cooperatives, but the manifestation of those benefits on farm business profitability is more complex to assess and may not become evident for a while.

What are your thoughts about the Hoeven-Thune amendment?

(Photo by amtrak_russ is licensed under CC BY 4.0)

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About Author

Dr. Anton Bekkerman is an associate professor in the Department of Agricultural Economics and Economics at Montana State University, joining the faculty in 2009 after completing his PhD at North Carolina State University. Bekkerman's primary areas of research are grain marketing, basis and price forecast modeling, understanding how grain prices are affected by changes in supply chain infrastructures and quality demands, and analyzing the economic trade-offs of adopting alternative dryland cropping systems in Montana. One of his current projects is an investigation of how new grain loading technologies are affecting prices that Montana farmers receive for their wheat. Bekkerman is also examining the economic impacts that Montana's rapidly expanding dry pulse industry will have on the state's crop industry. Although Bekkerman grew up on the east coast, he has recently made a small step toward production agricultural after acquiring three backyard chickens.

9 Comments

  1. Country elevator business has been in a slump for a few years. There appears to be an excess of capacity in that industry. Producer operations getting larger and more direct marketing exacerbates the situation. Giving one competitor a government sponsored advantage in that situation will have dire consequences on the disadvantaged businesses. The competition factors you cite will have very little influence.

    It will not be the large multinational grain companies that suffer. It will be the small independent owned country elevator that supports many local communities.

    • Thanks, Brett. An important aspect that will likely influence the extent to which market and price adjustments depend on the level of spatial competition among elevators. Most grain (about 60% of grain that an elevator receives) is delivered within a 10-mile radius of a farm business, and 85% of delivered grain comes from operations within a 20-mile radius. So, the largest market implications would likely occur if elevators are within 10-20 miles of each other and are competing for the same grain. If smaller country elevators are not within a highly competitive area (especially if there aren’t cooperative elevators nearby), the impacts on them may not be as significant.

      I agree that the past several years have resulted in profitability slumps for smaller elevators. However, I recently recorded a podcast with Will Secor of CoBank (http://ageconmt.com/podcast-episode-025-grain-elevator-markets-2018/) who analyzed the 2017/18 market for grain elevators, and provides persuasive arguments and data that indicate a likely strengthening of profit margins for US grain elevators.

  2. As a loan officer I really think farmers are more than likely going to deliver to the higher priced venue as they can manage taxes by deferring grain if they have to and that helps them to maximize their revenue to create cash flow in general. Some that have tax issues the coop 20% deduction will be of big benefit, however, if the coop lowers their price too much the farmer would rather deal with the tax issue later and maximize revenue especially in the low net income environment that we are in now where they can manage taxes.

    • It is definitely going to be interesting to watch the market play out. I agree that there may be some type of psychological/behavioral component of marketing in which, even though you know that you will get a tax reduction later in the year, you’re still not willing to deliver to an elevator that isn’t within a ballpark of a competing elevator. The flip-side to the story is the potential that privately-owned elevators will raise their prices in order to remain competitive with co-ops. That is, the co-ops and privately-owned elevators may “split the difference”: co-ops prices drop by a bit while privately-owned corporations pass down some of their profits to farmers in the form of higher prices. The next 6-12 months will be really interesting to observe how all the dynamics play out.

  3. Additional possibilities:
    1. Co-ops will buy farm production and immediately resell to ADM, Cargill, etc. and earn enough margin to cover licensing and transaction costs. Deliveries could be direct from farm to non-coop companies.
    2. Non-coop companies could form alliances with current or newly formed coops to be the intermediators between them and farmers.

  4. I question your rational that the cooperative will drop their price. In my opinion in NE MT there is a lot of excess capacity in the grain handling business. If the Co-op has excess capacity I see no need for them to initially drop their offered price. If your assumption is correct that they do indeed drop their price offered to the farmer because of the added volume I again see a flaw in this rational as the co-op should then make larger profits on the sales which should in a properly functioning co-op turn lead to larger co-op dividends to the farmer. The elevator rationing volume by lowering their price will have no impact on the price they sell the grain out the back door to their customers as the total supply in the country is the same.

    • Agree. Ultimately, the amount of capacity flexibility and nearby competition will determine the extent of price-setting responsiveness. Here’s another, related issue to consider that someone else brought: why wouldn’t co-ops simply respond by building additional capacity to increase throughput. That’s definitely a rational, profit-maximizing response, but here are my two concerns.

      First, as currently implemented, many of the tax cuts and advantages are set to expire in 2025, and it’s unclear whether they will be extended by Congress. This is actually a pretty big deal for farmers and others in the ag industry, because modern ag requires so much capital investment. So, if co-ops invest in expanding their operation, for example, as a response to the more favorable tax laws, will they get hung out to dry if the tax bill doesn’t get extended past 2025? I think there are many farm and industry groups that may be quite nervous about this uncertainty.

      Second, from the data that I’ve seen, co-ops are slower to expand facilities than private companies. Now, obviously, CHS and some of the other bigger co-ops are excluded from this statement, but there are still many smaller co-ops that simply don’t have the liquid assets to quickly respond to such policy changes. What’s more, because of the relative short time before the new tax law might expire (7-years), it may be too short for those smaller co-ops to take the plunge and invest a lot of funds in expanding capacity. If in the next few years we see signals of the tax laws becoming permanent or extending significantly past 2025, then we could see a changing landscape.

  5. Has anyone analyzed the impact of the tax law on a landlord whose rents are based on a a share of the crop? If the operator gets a 20% exclusion from selling to a co-op, the he might take a lower per bushel price. however, the landlord, not qualifying as a farmer, will have to take a lesser price without receiving any exclusion. The landlord usually is at the mercy of the operator as to where his (the landlord) share is sold.

    • That’s a really great question, Jack! I’m not aware of any studies to which one could look to get at least some insights, but it is definitely conceivable that there would be potential changes in leasing agreements between land owners and tenants. Such dynamics have been observed in real estate markets. For example, suppose that there are two communities that are right next to each and in most things quite similar, except that the two are located on a state border. Community A is in a state that has lower property taxes and Community B is in a state that has higher property taxes. Well, if home prices were identical in both communities, then many in Community B may want to buy a home in Community A. That would result in an increased demand and home prices in Community A relative to Community B. Home prices in Community A would rise until most benefits from living in a state with lower property taxes are arbitraged away.

      Something similar could potentially be observed in the medium- to long-run to land rental values. Especially in communities where price differentials between co-ops and private elevators are significant. The degree to which land leasing agreements change would not be known for a few years (because rental contracts do not adjust very quickly), and may not happen at all if the Section 199A is repealed or changed.

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