- 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.
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?