Farming Magazine - February, 2012
Opinion: False Profits
An agricultural forum for the progressive farmers of the Northeast.
With apologies to Matthew, in which the gospel author's verses include the 7:15 lines describing those coming "in sheep's clothing" as actually "ravening wolves," there are also false profits, typically when all the real costs of an enterprise aren't counted. When the bad old days are mined for horror stories, the lupine example was the corporate enterprise externalizing costs by dumping its wastes in the river so that downstream good guys would lose their drinking water. Now, in the good new days, it's the "food-for-people-not-for-profit" preachers who have donned the prophecy sheepskin. The quote recites the title of a very profitable 1975 book, which unintentionally illustrates the widespread urbanite mind-set: approval of profit for the in-the-shop or in-the-office wealth-generating efforts of their own kind, but not for those whose in-the-field or in-the-barn wealth-generation efforts via solar energy (a little physiocratic doctrine, there) is presumed non-entitled to any return beyond costs - and not even all of those - to the rural producers who feed them. Presently, the ovine example is the newly arrived environmentalist-exurbanite, proclaiming his love for agriculture and his desire to live amongst it, even if (a little Vanderbilt University Southern Agrarian academic/author lingo here) it's just not convenient for him to farm personally, you understand. And, he'll sue farm neighbors who operate too-noisy trucks at too-early hours. As farmers quit because their labors are without profit, urbanites, real or ex, want the farms preserved, but not at the costs of paying fully, with full profit to the producer for the products they produce. Thus the ongoing search for methods to "save the farms," but at the lowest possible cost to consumer/nonfarmers, well short of real producer profitability. One method is to redefine profitability.
That's best done by not counting all costs of production, either by providing some support services free or reduced-cost (think extension's various programs, some educational and some land-asset-creation) or by providing an accounting and tax system different from the standard for any other American industry (think asset depreciation rules) or, particularly, different from any regulated public utility, which is guaranteed a return on total shareholder investment, typically around 10 percent, including the land on which the enterprise assets sit. Not so for farming. Farmers who rent land or pay interest on a mortgage can deduct the cost as a business expense, but those who have been imprudent enough to own their land free and clear by inheritance or purchase can find no line on Schedule F for the capital investment expense it represents. And, of course, there are the urban farmers who grow their veggies on municipal land or on their own high-rise penthouse balconies and don't consider the pricey (but free) square footage as a real cost. It can be seemingly profitable to grow veggies for sale at the farmers' market when you don't count such asset costs or even your labor costs. Indeed, the "Transfer [purchase] of Development Rights" by quasi-governmental agencies has wide urbanite approval as a method of (somewhat) reducing farmer land ownership costs, a whole 'nother subject for future inspection. And, as former back-to-the-land Vermonters-from-NYC Scott and Helen Nearing did, you can grow green beans in the hills and sell them in the village and call that "The Good Life: Sixty Years of Self-Sufficient Living," while farming the mailbox for the monthly trust fund check. But what about large-scale commercial ag?
A window opening onto the official view comes from Iowa State University, which publishes a set of Crop Production Cost Budgets, which are enlightening for the items included, like "interest on preharvest variable costs," and for those not included, like land. For the typical 500-acre corn operation, with a total cash flow near $400,000 (this publication on the website uses a now-obsolete $4.50-per-bushel corn price) the owner-operator's wage for management and operation is counted in at $11.60 per hour while his hired man is in there at $11 per hour. Quick question: Name any nonfarm industry where the owner-operator of an enterprise with a $2 million investment value (U.S. average for grain farms, per the 2007 Ag Census) values his time at $11.60. Calculated another way: for the Iowa State 500-acre farm, the land is worth $3,750 per acre (2007 Ag Census) and the equipment, per the Corn and Soybean Digest, averages another $250, for the same $2 million total. A neat little pair of charts published by human resources consultants HVS (see their Web page) plots CEO pay against enterprise market value, and shows most enterprises worth $2 million paying their bosses above $1 million. Using the $11.60 per hour figure enables a seeming "profit" for corn-growing owner-operators on the balance sheet, but it's remarkably different from the norm for nonfarm enterprise. But then, the Iowa State budget does better on the land cost question, using a "cash-rent-equivalent" figure of $215 per acre to reflect the opportunity cost of capital invested in cropland and not, say, 5 percent dividend-paying utility stocks. If not "stored" in an acre of Iowa corn land, the same $3,750 could earn $190 plus inflation-based capital gains in value if invested instead in the services of Reddy Kilowatt. On the 500-acre operation, the CRE number is $107,500, and so the final net return to the grower is $20,527, or $41.05 per acre. Even that questionable profit vanishes if you budget the grower, not at the 2.85 hours per acre shown on the Iowa State budget for a total 500-acre wage of $16,530, but, say, four hours per acre or $23,200. Interestingly, the Iowa State budget shows a zero for both hired labor and for custom hire (field work) either per acre or total. One could guess that the extension view is that a $16,530 wage plus a $20,527 return on investment, totaling just over $37,000, is enough for a 500-acre corn grower, and that the ROI at 1 percent ($20,000 divided by $2 million) is equally OK, and not worthy of official notice.
That's not the typical grower view, and their opinion of the returns to farming shows up in their embrace of off-farm employment, not only for weekender veggie growers, but also for large-scale commodity producers, as discussed at length in earlier columns in this space. It's not the view of the beyond-the-farmgate food sector, either. Consider, for example, the gross profit at the corn-using chipotle fast-food outlet, where each corn-based hand-held burrito retails for more than the corn grower gets for a bushel of the kernels. A recent laudatory review by food columnist Jonathan Gold describes CEO Steve Ells as "bringing sustainable agriculture to the masses" and doing it with "25 percent profit margins." And without visible urban/consumer resistance: a Bureau of Labor Statistics study includes a neat little chart showing the decline in "food at home" spending through the '90s, to less than 8 percent of total household spending, while "food away from home" grew to nearly 6 percent. More recent BLS stats and studies show the trend continuing and projected to continue further.
Since the Iowa State corn-following-corn budget was set up corn prices have increased to over $6, land values in Iowa have increased from $2,900 to $3,900 per acre, (a capital gain, but also a higher cost of ownership for owners) and current cropland rental costs are (close to the alternative 5 percent from Reddy Kilowatt) $176 per acre, not the $215 used by Iowa State, an August 2010 USDA study says. Input costs, from fertilizer to equipment, have increased as well, but all the new data aren't yet published. Nevertheless, land being the single largest cost in grain production, it's a safe guess that it now costs at least as much to produce $6 corn as it did in late 2010, when the crop last crossed the $4.50 mark. None of the above really explains why the probably most interesting to most observers tax aspect of commercial land cost, depreciation, remains by government decree different for commodities like corn or milk than for commodities like coal or oil. It's a tax-deductible event to remove solar-energy-origin valuables like fossil fuels and lumber, because they can't be annually replaced, and so there's a "depletion allowance" line on the tax return for owners, drillers and miners benefiting from mineral extraction. Nearest comparison: the allowable deduction for fertilizer, lime, etc., for non-depreciable farmland. Years ago, there were some elaborate math exercises published, seeking to demonstrate the inequality of the comparison based on the higher value for land compared to the costs of fertilizer and soil amendments to replace those depleted by crop production. However, the really interesting comparison (humble scribe opinion) is farming versus utilities.
It's been argued in these columns that, measured by direct government involvement in production, pricing and sales, agriculture is just as much a regulated public utility (RPU) as Ma Bell or her multiple offspring. However, the RPUs are guaranteed a real profit and can price their output accordingly. The profit is phrased in terms of return on investment, after costs, in physical assets, as represented by book value of the common stock, and that includes land cost. Typically it's in the 10 percent range. The Iowa State 500-acre corn-growing example, with assets (including land) worth $2 million, if treated similarly, would be guaranteed a net profit of $200,000, not the $20,527 described above. Underlying (easy) question: Why can utilities expense the land under their physical plant as a shareholder investment, but growers can't do likewise for the soil supporting their physical plants?
The answer, of course, is that the real cost and value of corn are higher than urban consumers are willing to recognize, and so they've instructed government to offer, over the decades, not the full price (as needed when dealing with heavyweight corporations), but a range of supposed parity programs, deficiency payments, TDR programs, even soil bank and manure pit subsidies, to convince growers to keep on growing, because, as today's Iowa State sample balance sheet shows, a 1 percent ROI including a $12 CEO wage should been seen as an adequate and honest profit. Some might call it false, but there are 98 urban consumer votes for every two farm votes.
The author is an architect and former farmer.