Jan 2018 economic and policy update (003)[31124]

& Policy Update Graphic owner: UKZN SAEES: school website

January 29, 2018 Volume 18, Issue 1 Edited by Will Snell and Phyllis Mattox

FEATURED ARTICLES USDA Confirms Record Supply of Corn & Soybeans for 2017 Marketing Year - Todd Davis Effects of the Tax Cuts and Jobs Act on Farm Businesses - Jerry Pierce The Value of Selling Steer Calves Versus Bull Calves - Kenny Burdine Tobacco Import Trends and Policy - Will Snell Following the Money - Jerry Pierce

BARNETT IS NEW CHAIR OF UK AGRICULTURAL ECONOMICS DEPARTMENT Dr. Barry Barnett has assumed the role of chair of the Department of Agricultural Economics in the University of Kentucky College of Agriculture, Food and Environment. A Woodford County native, he has earned three degrees from UK including his doctorate in agricultural economics. “I look forward to working with the outstanding faculty and staff in the department to educate our students and to develop knowledge-based solutions for the important challenges facing the commonwealth, the nation and the world,” said Barnett. “We are honored that Barnett will be taking the helm of this department,” said Nancy Cox, dean of the College of Agriculture, Food and Environment. “His background and experiences have prepared him for this role in a department that is fundamental to the agricultural economy of Kentucky and beyond.”

Barnett, who has more than 21 year of faculty experience, comes from the Department of Agricultural Economics at Mississippi State University where he was a professor. He has recently been a visiting scholar at Humboldt University in Berlin, Germany. His chief research interests are agricultural risk, insurance and public policy. Barnett has also taught at both the undergraduate and graduate levels, receiving teaching awards at both levels.

Former Chair, Dr. Leigh Maynard, continues to research and teach in the Department of Agricultural Economics, and is also involved in the University of Kentucky’s “The Food Connection,” which serves farmers, food producers, students, and consumers by developing solutions and creative strategies for a vibrant, healthy, sustainable food economy in Kentucky.

USDA CONFIRMS RECORD SUPPLY OF CORN AND SOYBEANS FOR 2017 MARKETING YEAR

n P a g e 8 o n P a g e 8

C o n t i n u e d o n P a g e 8

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The January 12th WASDE provided the grain markets USDA’s final projections on the size of the corn and soybean crops. The report lived up to the saying that “big crops get bigger.” The 2017 corn is pegged at 14.6 billion bushels (second largest), and the soybean crop is projected at a record 4.39 billion bushels. Both corn and soybeans have been rebuilding stocks since the 2012 drought, so the combined carry-in and production contributes to a record supply for the corn and soybean markets to chew through for the remainder of the marketing-year (Table 1).

The corn and soybean markets benefit from the strong demand that will help keep ending stocks from becoming burdensome like in the 1980s. USDA projects corn ending stocks to increase to 2.48 billion bushels, which would be the most massive quantity since 1987. Consider that 2.48 billion bushels of corn in 1987 would be about a 200-day supply in the bin at the end of the PAGE 2 marketing-year. Current demand for corn makes 2.48 billion bushels a 62-day supply of corn in the bin at the end of the marketing-year.

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$ 2 0 / a c r e w a s d e d u c t e d f

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EFFECTS OF THE TAX CUTS AND JOBS ACT ON FARM BUSINESSES

Table 1. Consolidated Corn, Soybean and Wheat Balance Sheets for the 2017-18 Marketing-Year.

The Tax Cuts and Jobs Act was passed December 22, 2017. The Treasury Department and the Internal Revenue Service must now Corn interpret the law and write the regulations. Most provisions will affect farm Soybeans businesses beginning this year.What Below are some of the ------------------- Million Bushels ------------------changes that affect farmers most.

Beginning Stocks

2,293

302

1,181

Employee Withholding Production 14,604 4,392 1,741 With lower tax rates Federal income tax withholding from employee paychecks have dropped. The Treasury has released new Imports 50 rates are effective immediately 25 155later than February withholding tables for employers. The new withholding and must be in use no 15, 2018.Total Supply 16,947 4,718 3,076 1031 Like-Kind Exchange Use 1,112 for sale. Thus, all Like-kindDomestic exchange is repealed for equipment and12,545 livestock. It is limited to real2,089 property that is not held primarily 975 “trades” Exports of equipment will be treated as a sale of 1,925 one asset reported on Form 2,160 4797 and purchase of another asset subject to depreciation and cost recovery.

Total Use 14,470 4,248 2,087 Depreciation and Cost Recovery Ending Stocks 470 The amount of depreciation 989 allowed is Most farm property now uses the 200% declining 2,477 balance and a half-year convention.

Days of Stocks 62 40 173that original weighted to earlier years. New machinery and equipment has a shorter, five-year recovery period. New means ownership begins with taxpayer.

Used machinery $3.25 and equipment still has the longer U.S. Average Farm Price $9.30 seven-year recovery. $4.60 Source:January 2018 WASDE - USDA: WAOB.

Section 179 Expensing The maximum amount that can be deducted is $1 million. This deduction begins to phase out at $2.5 million in depreciable purchases.

Similarly, USDA also projects soybean ending stocks to increase to 470 million bushels, which would be the largest since 2006. The 2006 marketing-year Bonus Depreciation had a 68-day supply of soybeans as ending stocks. USDA’s projections imply a 40-day supply of soybeans in the bins September 1, 2018.

Business on may write off 100% of most business investments for assets placed in service through 2022. The bonus amount is reduced by 20% each year beginning 2023 until bonus depreciation is eliminated in 2027. This applies to purchases after September 27, An essential component the increasing corn and soybean is from exports. Over 50 percent of soybean use is for exports 2017.

The deduction nowofincludes used equipment, not just demand new purchases. primarily to China. Corn exports account for 13% of projected 2017-2018 demand. The importance of exports and policies that help exports is crucial to keep the corn and soybean markets from being overwhelmed with stocks.

Interest Payments Net interest expense in excess of 30% of the business’ adjusted taxable income is disallowed. Farming businesses may elect out by Wheat is to included in Table 1 to serveon asproperty a reminder ofawhat happens to aperiod commodity when export share declines.

The choosing use longer depreciation with 10-year recovery or more.

A business is exempt from theU.S. share of global wheat exports has slipped to about 15% from a 40% share in the mid-1990’s.

The 2017 wheat market benefited from the disallowance if average annual gross receipts for the prior three-tax year period exceeds $25 million. Average gross revenue for reduced planted area and below-trend yields to reduce wheat stocks.

Wheat prices are increased from last year because of 2016 commercial grain farms was $1.1 million, so most Kentucky will be exempt. reduced supply of all types of wheat except soft red winter wheat.

Net Operating Loss (NOL) The Operating March 2018 corn may futures contract is back used and to value stored corn traded lower thanThe January WASDEforward but shook-off the 2.5 Net Losses no longer bewhich carried applied to offset prior year taxes.

NOL carries indefinitely, cent decline and has traded higher to $3.56 ½ on January 24th .

The December 2018 corn contract had a similar reaction to the to 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 report as the March contract, and has traded higher $0.09/bushel since the report.

Soybeans weathered the reports with both the 80% of taxable income for that year. nearby and harvest 2018 futures contract closing higher by $0.10 ½ and $0.12 after the report with momentum continuing to close an additional $0.31 ¾ Activities and $0.24/bushel higher since January 12th.

Domestic Production Deduction (DPAD) DPAD is repealed for tax years beginning after December 31, 2017.

Where do we go from here? The markets will focus on Southern Hemisphere production and potential weather events that may improve export projections and reduce stocks. The market may also bid for 2018-planted area as soybeans have less cushion to 20% Business Deduction absorb a production or demand shocktothan the cushion availableanforentity corn or and wheat.byThe soybean market may provide A 20% Business Deduction may apply income passed through earned a sole proprietor.

The rules seemsome to be minor bidding for soybean area in 2018 if this lack of a cushion warrants some price risk premium.

Look towards North Dakota complicated. The deduction applies to Taxable Income, not Adjusted Gross, as did the DPAD. A last-minute addition to the law and South Dakota to gauge potential improvement for corn and soybeans prices.

If farmers in those states plant more spring wheat allowed the deduction to be passed through from cooperatives. However, the wording apparently gives a greater advantage to in 2018, who theresell is potential priceLawmakers improvement cornto and soybeans. those through afor co-op. arein trying address this unintended consequence.

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EFFECTS OF THE TAX CUTS AND JOBS ACT ON FARM BUSINESSES The Tax Cuts and Jobs Act was passed December 22, 2017. The Treasury Department and the Internal Revenue Service must now interpret the law and write the regulations. Most provisions will affect farm businesses beginning this year. Below are some of the changes that affect farmers most.

Employee Withholding With lower tax rates, Federal income tax withholding from employee paychecks have dropped. The Treasury has released new withholding tables for employers. The new withholding rates are effective immediately and must be in use no later than February 15, 2018.

1031 Like-Kind Exchange Like-kind exchange is repealed for equipment and livestock. It is limited to real property that is not held primarily for sale. Thus, all “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.

Depreciation and Cost Recovery Most farm property now uses the 200% declining balance and a half-year convention. The amount of depreciation allowed is weighted to earlier years. New machinery and equipment has a shorter, five-year recovery period. New means that original ownership begins with taxpayer. Used machinery and equipment still has the longer seven-year recovery.

Section 179 Expensing The maximum amount that can be deducted is $1 million. This deduction begins to phase out at $2.5 million in depreciable purchases.

Bonus Depreciation Business may write off 100% of most business investments for assets placed in service through 2022. The bonus amount is reduced by 20% each year beginning 2023 until bonus depreciation is eliminated in 2027. This applies to purchases after September 27, 2017. The deduction now includes used equipment, not just new purchases.

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 longer depreciation on property with a 10-year recovery period or more. A business is exempt from the disallowance if average annual gross receipts for the prior three-tax year period exceeds $25 million. Average gross revenue for 2016 commercial grain farms was $1.1 million, so most Kentucky will be exempt.

Net Operating Loss (NOL) Net Operating Losses may no longer be carried back and applied to offset prior year taxes. The NOL carries forward indefinitely, 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.

Domestic Production Activities Deduction (DPAD) DPAD is repealed for tax years beginning after December 31, 2017.

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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THE VALUE OF SELLING STEER CALVES VS BULL CALVES One of the more common questions that I get as I travel the state involves the magnitude of the price premium for steers over bulls. Most agree that steers will outsell bulls of similar weight, but it is also well established that castrating bulls requires time and some expense. Further, it is generally accepted that bulls will outgain steers, which further complicates the discussion.

While there is no way that this short article can completely address this topic, it should help provide a framework to help producers make this basic management decision.

We will start with the basic notion of price differentials, and even this is not completely without question. I will occasionally get a call or email asking why bulls are outselling steers at a given time or location. The first thing to understand is that there are thousands of cattle sold at Kentucky markets every single day. Inevitably, a group of bulls will outsell a group of steers on occasion. Sometimes this may be due to quality factors, other times it might be a lot size issue, and it can sometimes be due to the needs of individual buyers at a given time. However, these instances are the exception, rather than the rule. This can be best shown by examining actual price data collected by Kentucky market reporters.

Figure 1 shows prices for 550 lb. steers and bulls in Kentucky auction markets from 2010 to 2017, by month. To compile this data, I averaged the 500 to 550 lb. weight range with the 550 to 600 lb. weight range for all state auctions. This excluded cattle that market reporters identified as value-added, fancy, thin, fleshy, or otherwise noted as falling outside the norm. Utilizing the eight years of data available allows us to take a longer term view on this question. Note that over the 8-year period depicted in figure 1, steers outsold bulls by a little over $11 per cwt. It may also be worth noting that the 550# steer price exceeded the 550# bull price in each of the 96 months analyzed. Again, that doesn’t mean that every single steer lot outsold every single bull lot, but it does mean that on-average, steers consistently outsold bulls.

Figure 1. 550# Medium & Large frame #1-2 Steer and Bull Prices KY Auction Prices 2010 to 2017 ($ per cwt)

Source: USDA-AMS, Livestock Marketing Information Center, Author Calculations

Now, one limitation of comparing prices, as in Figure 1, is that it compares steers and bulls of the same weight. For example, an $11 per cwt price differential on a 550 lb. calf is over $60 per head. Clearly, this ignores potential weight differences between the two. So, how much more would that bull calf have to weigh to bring as much per head? This answer is not as simple as one might think because of price slides. As calves gain weight, their value per cwt decreases. This is a key concept in cattle marketing that impacts most all decisions that producers make. Let’s walk through it step-by-step.

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PAGE 5 The average value of a 550 lb. bull calf from 2010 to 2017 in Kentucky auction markets was $853 (550 lb. @ $155 per cwt). A price slide of $15 per cwt would mean that for each 100 lb. increase in the bull’s weight, his price decreases by $15 per cwt. So if a bull weighed 600 lbs., rather than 550, his price would have most likely been $147.50 per cwt ($7.50 per cwt less). This would place the value of the 600 lb. bull at $885 (600 lbs. @ $147.50). This is $32 more dollars than the 550 lb. bull, but only about half of the additional $60 needed to make him as valuable as the 550 lb. steer calf. So, an additional 50 lbs. of weight is not likely to be enough to make up for the price discount that bulls see relative to steers, assuming a pride slide of $15 per cwt.

Probably the most valuable use of this approach is to use it as a way to value additional lbs. In the previous scenario, an additional 50 lbs. added $32 of value to the bull on a per head basis using a $15 per cwt price slide. This means that those additional pounds were worth roughly $0.64 each. At that rate, the bull’s weight would need to exceed the weight of the steer by 94 lbs. for their values to be similar. Using a smaller price slide of $10 per cwt, would make the value of those additional lbs. worth about $0.94, which would mean that the bull would need to outweigh the steer by roughly 64 lbs. for his value to be comparable. This discussion is quickly summarized in Table 1.

Table 1: Price Slides and Value of Additional Weight $10 / cwt price slide $15 / cwt price slide Value of 550 lb. bull, initial price of $853 per head $853 per head $155 per cwt Value of 600 lb. bull $900 per head $885 per head Value of additional 50 lbs. $47 $32 Value of each additional lb. $0.94 per lb. $0.64 per lb.

Lbs. needed to add $60 of value per 64 lbs.

94 lbs. head

The final point that needs to be made here involves implants. Implanted steers have the potential to gain as efficiently as bulls, especially if castrated early. This may allow for comparable sale weights at steer prices. Again, I am fully aware that working calves takes time and facilities, but if a producer does choose to castrate their bulls, implanting does provide another option for producers that are not targeting a market that prohibits their use.

The purpose of the previous discussion was primarily to make two points. First, there is solid evidence that bulls will sell at a considerable discount to steers in Kentucky auctions. Second, it would require significantly higher sale weights for bulls to offset this price discount. Still, there may be reasons such as time limitations, working facilities, or other factors that may result in a producer choosing not to castrate bulls. However, one should also understand that there are individuals in the market place who make money by purchasing bulls, castrating them, backgrounding them for a period of time, and re-selling them. Producers who typically sell bulls may want to consider the potential value that can be added to their calves through this practice as they look for ways to increase profitability in the future.

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Tobacco Import Trends and Policy Declining global cigarette production coupled with the introduction of new tobacco products and technologies requiring less tobacco leaf continues to reduce demand for U.S. tobacco. Domestically, another factor that is currently eroding the demand for U.S burley tobacco has been the increasing use of imported leaf. In recent years, U.S. tobacco manufacturers have been importing around 120 million pounds of foreign burley annually – close to the size of a typical U.S. burley crop and accounting for approximately 2/3 of total burley use in the U.S. market. Slumping U.S. burley exports totaling around 60 million pounds annually in 2016 and 2017 has resulted in a U.S. burley trade deficit averaging 60 million pounds annually for the past two years.

While ample supplies of foreign burley have affected this trend, a growing price differential between U.S. and foreign burley likely contributed to the trade imbalance. In 2013, the differential between the average price of burley tobacco imported into the U.S. and the average price of U.S. burley exported was close to $1.00/lb., with the trade price differential between U.S. burley and our closest competitor, Brazil, only a 25 cents/lb. difference. This past year, the overall trade price difference swelled to nearly $1.40/lb, with the U.S. burley export/Brazilian import price differential approaching $1.00/lb. Consequently, utilization of imported burley versus using U.S. burley this past year resulted in a cost savings of approximately $170 million (120 million lbs. x $ 1.40/lb.) for U.S. cigarette manufacturers or around 1.4 cents/pack of cigarettes (0.3% of the average U.S. retail price).

The U.S. adopted import restrictions on tobacco in 1993, which required U.S. cigarette manufacturers to use at least 75% U.S. tobacco in their blends. However, this legislation was ruled to violate international trading rules and thus was replaced by an acceptable tariff rate quota (TRQ) system in 1995. Under the TRQ, cigarette leaf imports that exceed predetermined quota levels for specified countries are subject to an import duty of 350%. Collectively the annual TRQ was set at 150,700 metric tons (332.2 million pounds) in 1995 when U.S. cigarette production totaled 755 billion pieces. The annual TRQ level remains at 150,700 metric tons today with annual U.S. cigarette production levels close to 250 billion pieces. However, U.S. tobacco imports under the TRQ have rarely approached the maximum level and have generally only been around 50% utilized in recent years.

Tariff Rate Quota Level Argentina Brazil Chile EU Guatemala Malawi Philippines Thailand Zimbabwe Others TOTALS

10,750,000 80,200,000 2,750,000 10,000,000 10,000,000 12,000,000 3,000,000 7,000,000 12,000,000 3,000,000 150,700,000

% of TRQ Used 2013-2017 40% 69% 0% 51% 62% 64% 49% 16% 6% 100% 55%

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FOLLOWING THE MONEY A cash flow statement is commonly used by farm managers and lenders to reveal where monies came in and went out of the farm business account. The Statement of Cash Flow groups cash flow by activities: operating, investment, and financing. Look at the statement for the 2016 average KFBM* grain farm.

Operating includes net cash farm and non-farm income less money withdrawn by the owners. Net cash income was $390,616.

Operators took out $205,473 for partner draw or family living and $54,207 for taxes. The $130,936 remaining is available for investing and loan repayment.

Investment includes buying and selling capital items used on the farm, like buildings, equipment, and breeding stock... The farm sold $34,087 of capital assets and purchased $185,827 – a net $151,740 outflow. There was another $151,923 net outflow for non-farm investments and transferred funds. Investing in capital assets and other things reduced net cash by $303,662.

Financing involves loan activity as well as gifts and inheritance. The average grain farm borrowed over $1 million for operating and another $367,127 for capital purchases.

Principal payments totaled $1,358,028. The farm received $100,254 from gifts, inheritance, and other sources. Financing activities increased net cash by $181,405.

The average farm began 2016 with $107,930 in cash. Total inflow was $3,820,713 and total outflow was $3,812,034. There was a $7,844 net increase, so ending bank balance was $115,774.

Interpreting the Statement Close review of the Statement of Cash Flow suggests some areas where the average grain farmer could try to improve cash flow.

Drastically reduced net cash income from farming is the direct problem. Managers will try to increase revenue and decrease expense to produce more net cash income. Some may seek off-farm employment to supplement income.

But low revenue reveals other underlying problems.

The statement of Cash Flow reveals a large net outflow for investment and funds transferred. Much of this has little to do with the farm operation. Look carefully to see if these expenditures can be stopped or delayed until more profitable times.

Replace buildings and equipment only as needed. This may increase taxes, but tax was only about 4% of total outflow. On the other hand, principal payments totaled about 36% of total outflow. The average KFBM grain farm cut non-farm transfers by $68,556 and capital purchases by $40,285, reducing total outflow from financing about $100,000 from the year before.

Finally, consider reducing family living or partner draw. These expenses tend to increase in profitable times. It may be reasonable to reduce them in less profitable times.

Replacing Capital Assets Every farm will have to replace buildings, equipment, and breeding stock at some point. These things wear out, get used up, or die. Just how much can the farm pay for from cash generated by the operation? *Kentucky Farm Business Management program http://www.uky.edu/Ag/KFBM/

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Capital replacement is calculated by combining operating income and net non-farm income from wages and other business with depreciation. The amounts taken out for taxes and owner draw are subtracted. The average grain farm generated $121,106 for capital payments and replacement.

Subtract the next year’s scheduled payments on term debt to find the debt repayment margin. This is the amount available for new spending or debt servicing. The average grain farm did not generate enough cash to meet scheduled term debt. It was short $61,675. There is no capacity to purchase or finance new capital assets, and the owner will use up equity to make ends meet.

CENSUS OF AGRICULTURE Every five years, the USDA National Agricultural Statistics Service (NASS) conducts the Census of Agriculture, which is the only source of uniform, comprehensive and impartial agricultural data for every county in the nation. It is a complete count of U.S. farms and the people who operate them. From small plots of urban and rural land to large farms with thousands of acres, the Census counts them all, plus looks at land use and ownership, operator characteristics, production practices, and income and expenditures. USDA is currently collecting data for the 2017 Census of Agriculture, with a February 5, 2018 deadline.

Why is data like this good to have?  Farmers have an opportunity to decide if they’d like to expand or diversify their operations to fill a gap that may show in trends.  Universities can identify a need in the county/state, build programs and workshops for farmers to learn about best practices and strategies, use data to analyze the farm/rural economy, evaluate farm programs, develop extension programs to improve rural areas, and write grant proposals to benefit farmers looking to diversify and grow their operations.  Commodity associations use the data to implement programs, educate producers and consumers, and successfully market their products here and abroad, ensuring more market stability for farmers.  Agribusinesses have insight to where particular farm machinery or processing facilities are needed to address farmers’ needs.

There is no other source for detailed agricultural data, and NASS needs all farmers to respond to the Census, and all surveys, in order to provide accurate, timely data to the ag community.

Submitted by the U.S. Department of Agriculture, National Agricultural Statistics Service, Eastern Mountain Regional Field Office Serving Kentucky, North Carolina, Tennessee, Virginia, West Virginia

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.