Economic and Policy Update UKAg

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February 27, 2018 Volume 18, Issue 2 Edited by Will Snell and Phyllis Mattox

FEATURED ARTICLES Beef Herd Continues To Grow - Kenny Burdine 2018 Revenue Protection Insurance Safety-Net Similar to Last Year - Todd Davis

BEEF HERD CONTINUES TO GROW USDA released their January 1 estimates for cattle inventory late last month and I wanted to walk through some of the high points of this report. Beef cow numbers were estimated to have grown by 1.6% from 2017, which is a little less than half the increase that was seen in the prior year.

Although growth in the US herd is clearly slowing, beef cow inventory has increased by 9% since 2014.

Anytime the beef cowherd is expanding, heifer retention is of interest. Heifer retention for beef cow replacement was estimated to be down 3.7% from 2017. Often a decrease in heifer retention is seen as evidence of future decreases in cow numbers, but that is likely not the case this time. This point is probably best made by considering beef heifer retention as a percent of the total number of beef cows in the US, as shown in figure 1. Heifer retention, as a percent of beef cow inventory, has averaged 17.3% since 1973 and is depicted by the dotted line. The solid red line shows heifer retention as a percent of beef cattle inventory by year. While this number has decreased from its high of 21% in 2016, it is still well above the long term average. So, while heifer retention is decreasing, it appears that we are still developing a sufficient number of heifers to see herd expansion continue. This really speaks to how high heifer retention was just a couple years ago.

Figure 1: Jan 1 Beef Heifer Retention as a % of Beef Cow Inventory (1973 to 2018)

Bipartisan Budget Act of 2018 Contains Changes for MPP Dairy Program - Kenny Burdine NAFTA Update and a Primer on Trade Data - Will Snell

“Surviving the Farm Economy Downturn�

Papers & Book are Available KALP is Accepting Nominations for Leadership Class XII

Source: USDA-NASS, Livestock Marketing Information Center, Author Calculations The largest change from 2017 was a 7% increase in the number of cattle on feed. Monthly reports (which survey only large feedlots) had been showing cattle on feed numbers above yearago levels since spring, but had shown especially large increases since fall. Part of this is due to the size of the calf crop, which was 2% larger in 2017, but I think a larger issue involves winter grazing.

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The annual inventory report also includes estimate of cattle grazing pasture on January 1 st in Kansas, Oklahoma, and EFFECTS OFanTHE TAX CUTS AND JOBSsmall ACT grain ON FARM BUSINESSES Texas. This estimate serves as a gauge of winter grazing, which has a significant impact on late fall and winter calf markets. USDA estimated a 13% in the number of cattle22, grazing grains this January asand compared to 2017.

I had Service an opportunity to The Tax Cuts and decrease Jobs Act was passed December 2017.small The Treasury Department the Internal Revenue must now visit with some of my colleagues in Texas and Oklahoma last week and they confirmed that fewer cattle were placed into winter interpret the law and write the regulations. Most provisions will affect farm businesses beginning this year. Below are some of the grazing programs year and some that were placed had to be sold early due to weather challenges. This would suggest that, in changes that affectthis farmers most. addition to the larger calf crop, more light cattle were placed directly on feed this winter. Cattle placed on feed at lighter weights will tend toWithholding be on feed longer and finish at slightly lower weights.

Employee With lower tax rates Federal income tax withholding from employee paychecks have dropped. The Treasury has released new Still, the combination growing cattle on feed inventories and a sizeable withholding tables for of employers.

The new withholding rates arerelatively effectiveinexpensive immediatelyfeed, and should must betranslate in use nointo later than February increase 15, 2018.in beef production for 2018. Increases are also expected for both pork and poultry. This growing supply of meat will be the largest challenge for the beef sector in 2018.

1031 Like-Kind Exchange The USDAexchange report is is summarized in equipment table 1 andand the livestock. full reportItcan be accessed Like-kind repealed for is limited to realat: property that is not held primarily for sale. Thus, all http://usda.mannlib.cornell.edu/usda/current/Catt/Catt-01-31-2018.pdf “trades” of equipment will be treated as a sale of one asset reported on Form 4797 and purchase of another asset subject to depreciation and cost recovery.

Table 1: USDA January 1, 2018 Cattle Inventory Report Depreciation and Cost Recovery 2017 2018 2018 as % Most farm property now uses the 200% declining balance and a half-year convention.

The amount of 2017 depreciation allowed is (1,000 hd.) (1,000 hd.) of weighted to earlier years. New machinery and equipment has a shorter, five-year recovery period. New means that original All Cattle and Calves 93,704.6 94,399.0 101 ownership begins with taxpayer. Used machinery and equipment still has the longer seven-year recovery.

Section 179 ExpensingCows and Heifers That Have Calved 40,559.2 41,122.6 101 The maximum amount that can be deducted is $1 million.

This deduction begins to phase out at $2.5 million Beef Cows 31,213.2 31,723.0 102in depreciable purchases.

Milk Cows

9,346.0

9,399.6

101

Bonus Depreciation and Over Business may write offHeifers 100% of500 mostPounds business investments for assets placed in service through 2022. The101 bonus amount is reduced 20,132.0 20,244.8 by 20% each year beginning 2023 until bonus depreciation is eliminated in 2027.

This applies to purchases after For Beef Cow Replacement 6,368.2 6,131.2 96 September 27, 2017. The deduction now includes used equipment, not just new purchases.

For Milk Cow Replacement Other Heifers

4,754.0 9,009.8

4,781.3 9,332.3

101 104

14,386.3

14,427.2

100

Interest Payments Net interest expense in excess of 30% of the business’ adjusted taxable income is disallowed. Farming businesses may elect out by choosing to use longerSteers depreciation on property with a 10-year recovery period or 16,352.2 more. A business is exempt 500 Pounds and Over 16,383.5 100 from the disallowance if averageBulls annual gross receipts for the prior three-tax year period exceeds $25 million.

Average 500 Pounds and Over 2,243.6 2,252.2 100 gross revenue for 2016 commercial grain farms was $1.1 million, so most Kentucky will be exempt.

Calves Under 500 Pounds

Net Operating Loss (NOL) Net Operating Losses may no on longer be carried back and applied to 13,067.0 offset prior year14,006.4 taxes. The NOL carries forward indefinitely, Cattle Feed 107 rather than the old 20-year rule. A farm NOL may qualify for a two-year carryback. Any NOL deduction during the year is limited to 80% of taxable income for that year.

2016

2017

2017 as % of 2016 102

Domestic Production Activities Deduction (DPAD) DPAD is repealed for tax years beginning after December 31, 2017. 35,092.7 Calf Crop 35,808.2 Source: NASS, USDA 20% Business Deduction A 20% Business Deduction may apply to income passed through an entity or earned by a sole proprietor. The rules seem to be complicated. The deduction applies to Taxable Income, not Adjusted Gross, as did the DPAD. A last-minute addition to the law allowed the deduction to be passed through from cooperatives. However, the wording apparently gives a greater advantage to those who sell through a co-op. Lawmakers are trying to address this unintended consequence.

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2018 REVENUE PROTECTION INSURANCE SAFETY-NET FOR CORN AND SOYBEANS SIMILAR TO LAST YEAR Yogi Berra famously said, “It’s déjà vu all over again.” He probably was not referring to the 2018 revenue protection (RP) crop insurance projected prices; however, the sentiment is appropriate. The closing prices of the December 2018 corn and November 2018 soybeans futures contract during February provide the initial price guarantee used in crop insurance. As of February 20, 2018, the projected prices for corn and soybeans are $3.95 and $10.11 per bushel, respectively. If realized, the 2018 price guarantees are $0.01 and $0.08 lower from the 2017 price guarantees for corn and soybeans, respectively.

Figure 1 compares the expected crop insurance guarantees for corn and soybeans compared to the budgeted total variable costs and cash rent for corn and soybeans. As in 2017, soybeans will likely have a better safety net than corn. Given the budget assumptions, soybean RP insurance guarantee at the 75% coverage would have a deficit of $106/acre. The RP guarantee for corn at the 80% coverage level would be $150/acre below budgeted variable costs and cash rent.

As managers consider the coverage levels purchased for 2018, managers should take stock of the farm business’s financial strength and the availability of working capital to absorb a loss. If the farm’s working capital is limited, managers may want to consider increasing coverage to protect the farm’s ability to cash flow this fall if there is a yield loss or lower prices. Managers planning to sell grain at harvest should consider risk management tools to lock in prices before harvest. Another large corn and soybean crop in 2018 will contribute to lower fall prices and create profitability and cash flow challenges.

The 2014 Farm Bill made crop insurance the foundation of the corn and soybean safety net. As Congress begins discussing the next farm bill, changes to the crop insurance program may be proposed to find cost savings. Reducing the crop insurance premium subsidy or eliminating the harvest price option for RP insurance will increase the farm’s risk and lower the safety net for farms already facing tight, or negative, profit margins.

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BIPARTISAN BUDGET ACT OF 2018 CONTAINS CHANGES FOR MPP-DAIRY PROGRAM The Margin Protection Program for Dairy (MPP-Dairy) was established as part of the 2014 Farm Bill. Overall, the program has been very unpopular as few producers have received payments from participation and many have questioned whether the program provides an adequate safety net for the dairy sector. There were some pretty significant changes made to the MPPDairy program as part of the Bipartisan Budget Act of 2018 and I wanted to quickly highlight some of those.

Changes to MPP-Dairy Program for 2018  The lower Tier I premium rates now apply to the first 5 million lbs. of coverage, rather than the first 4 million lbs. So, more lbs. can be covered at the lower rate.  Premium rates have been significantly lowered for Tier I. There is now no premium cost for coverage up to $5 per cwt and major premium reductions were made across all coverage levels. Previous and modified premium levels can be seen in Table 1.  Margin calculations and payments are now made monthly, rather than bi-monthly.  Enrollment in the program now occurs on an annual basis.  Limited resource, beginning, veteran, and socially disadvantaged farmers are now exempt from the administrative fee.  Dairy producers have until 90 days after passage of the act to enroll for 2018.

These changes to the program are significant and I do think it will make the program somewhat more attractive to dairy producers. However, it is important to understand that available coverage levels ($4 to $8) have not changed. So, with the exception of moving to monthly payments, the general magnitude and frequency of payments will not change. There continues to be discussion of dairy policy that will pertain to the next farm bill.

The changes in premiums are likely to have the most significant impact on dairy producers, especially those that operate smaller dairies. As can be seen in Table 1, the reductions in premium are very significant. For the highest $8 coverage level, premium levels were reduced by roughly 70%. Additionally, there is no premium for the $5 coverage level and the $6.50 coverage level can now be purchased for $0.04 per cwt. So, it is going to cost much less to purchase buy-up coverage for 2018.

Finally, I wanted to quickly speak to the changes in enrollment. For 2018, producers have until 90 days after passage of the act to enroll. This means that producer can wait until well into 2018 to make enrollment and coverage decisions. By that time, we should know the MPP-Dairy margin for January through March. So, producers will have a lot of price information when they make this decision. Similarly, the movement towards annual enrollment should allow producers to utilize the program when it is attractive and use other strategies when it is not. This added flexibility is an advantage that is worth taking note of.

Table 1: Margin Premiums by Coverage Level on First 5 million lbs. Covered Coverage Level $4.00 $4.50 $5.00 $5.50 $6.00 $6.50 $7.00 $7.50 $8.00

Premium per CWT (Previous) None $0.010 $0.025 $0.040 $0.055 $0.090 $0.217 $0.300 $0.475

Premium per CWT (Modified for 2018) None None None $0.009 $0.016 $0.040 $0.063 $0.087 $0.142

*Premiums for Tier II, which now apply to pounds covered exceeding 5 million, remain unchanged

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NAFTA UPDATE AND A PRIMER ON TRADE DATA

The North American Free Trade Agreement (NAFTA), went into effect on January 1, 1994. This trilateral agreement between the United States, Mexico, and Canada, effectively reduced most agricultural tariffs to zero over time. Since the implementation of NAFTA, U.S. agricultural exports have increased from less than $9 billion in 1993 to nearly $40 billion in recent years.

Collectively, NAFTA is the largest export market for U.S. corn, wheat, beef, poultry and pork and accounts for approximately 28% of total U.S. agricultural exports.

U.S. consumers are also an important market for Canadian and Mexican farmers and food companies. In fact, despite the dramatic growth in U.S. trade to Canada and Mexico, the U.S. has actually run an agricultural trade deficit with NAFTA markets over the past four years.

Selected Ag Commodity Beef Pork Poultry Corn Wheat U.S. Ag

% of U.S. Ag Exports to Canada/Mexico 27% 41% 26% 28% 12% 28%

U.S. President Donald Trump has repeatedly threatened to withdraw from NAFTA, blaming the trade agreement for job losses and contributing to the U.S. trade deficit.

Last year, the U.S. trade deficit in all goods and services totaled $566 billion, its highest level since 2008. The trade deficit in goods alone swelled to more than $800 billion with U.S. trade deficits totaling $71.1 billion with Mexico and $17.6 billion with Canada. Currently the three nations are in negotiations to “modernize” NAFTA which includes addressing digital commerce and intellectual property rights, while also focusing on labor/environmental issues and settling trade disputes.

U.S. agriculture has been very involved in the NAFTA renegotiations (labeled as NAFTA 2.0) given the importance of Canada and Mexico to the U.S. farm economy – our second and third largest ag trading partners. Most of the trade dispute over agriculture in the NAFTA negotiations has centered on dairy policy, with the U.S. claiming that Canadian dairy pricing policies are undercutting U.S. dairy exports to Canada. In addition, U.S. ag concerns have escalated in response to Canada and Mexico seeking alternative suppliers and signing/pursuing other trade agreements with other important U.S. ag export markets.

Trade negotiators between the three NAFTA nations wrapped up the sixth round in Montreal late last month, with the seventh round currently proceeding in Mexico City. The talks are scheduled to finish by the end of March to avoid clashing with Mexico’s presidential election in July. However, it appears likely that negotiations will continue beyond March, assuming the parties observe progress in a revised agreement. While much uncertainty exists on the fate of NAFTA, U.S. Secretary of Agriculture, Sonny Purdue stated before the House Ag Committee earlier this month that he remains optimistic an agreement can evolve by late in 2018, but others claim that the negotiations may linger into 2019.

If the United States withdraws from NAFTA, tariffs on U.S. agricultural products to Canada and Mexico would be allowed to increase according to trade rules established by the World Trade Organization (WTO). Acceptable tariff levels vary depending on the commodity/product. For example, the tariff for some U.S. meat exported into Canada could be as high as 75%. U.S. corn exports to Mexico could become 20% higher for Mexican buyers. According to the Congressional Research Service (CRS), the average tariff across all U.S. agricultural products imported into Canada would be 23% and 32% for U.S. agricultural products transported to Mexico versus duty free status on most U.S. agricultural products currently entering Canada and Mexico under NAFTA . (See the appendix in the CRS report (https://fas.org/sgp/crs/row/R45018.pdf) for allowable tariff levels facing U.S. agriculture if the U.S. withdraws from NAFTA).

Higher tariffs facing U.S. exporters would give competitive advantages to U.S. competitors, leading to loss of U.S. ag exports and likely reducing already depressed U.S. commodity prices. In addition, tariffs would have a modest positive impact on U.S food prices due to increased costs of food products imported into the U.S. from Canada and Mexico along with disrupting supply chains and adversely impacting trade-related jobs.

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The Foreign Ag Service (FAS) at USDA indicates that Kentucky ag and ag-related exports to NAFTA markets have averaged around $300 million annually over the past 5 years, accounting for Kentucky Ag and Ag-Related Exports over 22.5% of Kentucky’s global ag exports. Canada is the to Canada and Mexico (2017) largest foreign purchaser of Kentucky ag and ag-related Canada Mexico Selected Categories products (primarily processed foods, forest products, and (mil $) (mil $) distilled beverages), representing around one-fifth of the Processed Foods/Beverages 96.8 14.7 Commonwealth’s global ag sales and comprising 80% of Forest Products 52.5 4.4 Kentucky’s NAFTA ag trade. FAS trade data indicate very Distilled Spirits 46.3 14.1 limited Kentucky bulk (ag commodity) exports to Canada Live Animals 18.7 except for a relatively large shipment of canola in 2017 ($5 Feed 6.3 3.0 million). Mexican ag imports from Kentucky are comprised Bulk Agricultural 5.5 1.9 primarily of meat and dairy products, along with corn and Totals for all Categories 264.7 47.0 periodically wheat.

Understanding NAFTA/Global Trade Data Trade data can be measured in different ways, leading to different totals and different conclusions. USDA’s Foreign Ag Service (FAS) measures trade data by state based upon the final origin of movement of the product to the export market. Thus, a calf born and backgrounded in Kentucky, but finished out in the Midwest and shipped as beef to Mexico would not be reflected as a Kentucky ag export according to the FAS database. Likewise, Kentucky would not receive export credit for tobacco produced in Kentucky, comingled, processed, and exported out of Virginia, or Kentucky-produced soybeans shipped out of the port in New Orleans.

Consequently, FAS export data will generally understate the importance of ag exports of inland states, like Kentucky that do not possess ports and that do not process a lot of agricultural products.

Alternatively, USDA’s Economic Research Service (ERS) of USDA measures trade data by state based on the location of original production. Thus, if Kentucky produces 25% of the nation’s tobacco cash receipts, Kentucky would receive 25% of the nation’s tobacco exports. ERS’s methodology does not allow one to track state ag exports to specific countries (as is the case with FAS data).

According to the ERS database, Kentucky ag exports have averaged $2.2 billion over the past five years (2012-2016) versus only $724 million under FAS methodology measuring ag product exports only and $1.4 billion if you add in ag-related trade (such as ethanol, distilled spirits, and forest products.). Looking at specific ag commodities, the ERS reports $161.8 million of Kentucky corn exports in 2016 vs only $2.9 million from the FAS database. Similarly, 2016 ERS data reveal $73 million of Kentucky beef exports versus $1.6 million recorded by FAS. The chart below shows total KY ag exports to all markets using the different methodologies.

Kentucky Ag Exports (FAS vs ERS methodology) Calendar Year

2012 2013 2014 2015 2016 2017

FAS (mil $) Ag Products Only 1/

FAS (mil $) Ag and Ag-Related Products 1/

775.1 776.4 750.6 664.5 652.1 667.6

1,306.4 1,331.5 1,386.1 1,338.8 1,277.0 1,442.6

ERS (mil $) Ag and Crop/Livestock Products 2/ 1,824.0 2,437.2 2,499.2 2,120.2 2,117.7 na

1/ For details and data see Global Agricultural Trading System (GATS), https://apps.fas.usda.gov/gats/ 2/ For details and data see State Ag Exports, https://www.ers.usda.gov/data-products/state-export-data/

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“SURVIVING THE FARM ECONOMY DOWNTURN” PAPERS AND BOOK ARE AVAILABLE Todd Davis, Jordan Shockley, and Kenny Burdine, Agricultural Economists at the University of Todd Davis, Shockley, KennyExtension Burdine, Agricultural Economists are at the University Kentucky andJordan members of the and Southern Economics Committee, co-authors onofa series and members of the Southern Economics Committee, are co-authors onaaseries series ofKentucky papers helping managers in this periodExtension of tight profit margins.

The committee has written of papers helping managers in this period of tight profit margins.

The committee has written a series of papers titled “Surviving the Farm Economy Downturn.” The nineteen papers provide an overview of papers titled “Surviving the Farm Economy Downturn.”

The nineteen papers provide an overview of the Southern agricultural lending and farm credit conditions, management considerations when of the Southern lending and farm creditwith conditions, management when changing crop or agricultural livestock enterprises, how to work your lender in difficultconsiderations times, crop insurance changing crop or livestock enterprises, how to work with your lender in difficult times, crop and government program payments outlook, and helping loved ones that are coping with the stress and government program payments outlook, andbehelping loved ones that arefrom coping ofinsurance this economy.

Individual papers and the entire book can downloaded as PDF files thewith the stress of this economy.

Individual papers and the entire book can be downloaded as PDF files Texas A&M Agricultural and Food Policy Center’s website at https://afpc.tamu.edu/. from the Texas A&M Agricultural and Food Policy Center’s website at https://afpc.tamu.edu/.

KENTUCKY AGRICULTURAL LEADERSHIP PROGRAM IS ACCEPTING NOMINATIONS FOR CLASS XII The Kentucky Agricultural Leadership Program (KALP) is accepting nominations for Class XII. KALP, housed in the University of Kentucky College of Agriculture, Food and Environment, is an intensive two-year program designed for young agricultural producers and agribusiness individuals from Kentucky and Tennessee.

“Anyone who wants to be on the cutting edge of decisions that affect agriculture, rural communities and society in the 21 st century will benefit greatly from going through this program,” said Will Snell, KALP Co-Director. “Graduates of the program have gone on to become active leaders in legislative bodies, farm and commodity organizations, agribusinesses and their local communities, which is vital for the future of agriculture in today’s challenging marketplace and policy arena.”

Applicants must be U.S. citizens, residents of Kentucky or Tennessee, be involved in some phase of agriculture, and be willing and able to commit around 50 days over the two-year period to participate in this premier leadership program. The program dates back to the mid-1980s and was originally called the Philip Morris Agricultural Leadership Development Program, though it was never commodity specific. Philip Morris fully funded the first seven classes. Now nearly 200 financial supporters provide funding, including the Kentucky Agricultural Development Board, Kentucky agribusinesses, farm organizations, program alumni and participant fees. Participants will be responsible for tuition of $2,500 payable in two installments to help offset the $15,000 individual program costs.

The program consists of 10 domestic seminars devoted to important agricultural issues. Sessions also focus on improving participants’ communication, leadership and management skills. Class members will visit a variety of Kentucky agribusinesses, Frankfort and Washington D.C., and will travel to other states and nations to explore agriculture in different settings. The previous 11 classes have yielded 291 graduates, many who subsequently have taken on leadership positions in agriculture.

“This program is about more than farming,” KALP Co-Director Steve Isaacs said. “Participants will polish essential leadership skills, identify common rural and urban concerns, understand current public policy issues and establish a basis for lifelong learning and development.”

Interest is expected to run high for the 22 seats available in Class XII. Snell and Isaacs, both from the UK Department of Agricultural Economics, said they generally receive around 100 nominations for each class. Candidates may self-nominate or be nominated by county extension agents, farm organizations, trade associations, alumni of previous leadership programs or other interested individuals. Nominations are due no later than May 31, 2018. All nominees will receive information about the program and procedures for submitting the required application and three letters of recommendation, which will be due no later than July 15, 2018. Interviews to select class members will be in mid-August, with the first seminar tentatively scheduled for October 29-31, 2018 in Lexington, Ky. The nomination form is on the next page. Please email the completed form to KALP-L@LSV.UKY.EDU, or mail the form to

KALP, UK Dept. of Ag Economics, 321 C. E. Barnhart Building, Lexington, KY 40546-0276 before May 31, 2018.

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Kentucky Agricultural Leadership Program

NOMINATION FORM for Class XII I nominate this individual as a candidate for Class XII of the Kentucky Agricultural Leadership Program.

Nominee __________________________________________________________________________ ___ Address ______________________________________________________________________________ City

State

Zip code___________

County ______________________________________________________________________________ Email _______________________________________________________________________________ Telephone: Home

Cell ___________________________________

●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●●

I have discussed this with the nominee and he/she is willing to be considered as a candidate.

Nominator ___________________________________________________________________________ Nominator contact information (email or phone) ______________________________

______________

Submit by e‐ mail to KALP‐ L@LSV.UKY.EDU, or return via mail

by MAY 31, 2018 to: KALP – Kentucky Agricultural Leadership Program University of Kentucky 321 C. E. Barnhart Building Lexington, KY 40546-0276

For more information on KALP, visit our website: http://www.uky.edu/Ag/KALP/ Educational programs of Kentucky Cooperative Extension serve all people regardless of race, color, age, sex, religion, disability, or national origin.

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College of Agriculture, Food and Environment Department of Agricultural Economics 315 Charles E. Barnhart Bldg. Lexington, KY 40546-0276 Phone: 859-257-7288 Fax: 859-257-7290

Economic & Policy Update View all issues online at http://www.uky.edu/Ag/AgEcon/extbluesheet.php

Educational programs of Kentucky Cooperative Extension serve all people regardless of race, color, age, sex, religion, disability, or national origin.

UNIVERSITY OF KENTUCKY, KENTUCKY STATE UNIVERSITY, U.S. DEPARTMENT OF AGRICULTURE & KENTUCKY COUNTIES COOPERATING.