Fausti, Scott W.

Shane, Richard

English

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South Dakota State UniversityOpen PRAIRIE: Open Public Research Access InstitutionalRepository and Information ExchangeEconomics Commentator Department of Economics11-3-1994State and Local Tax Policy; Non-Trader Use ofFutures: Sell or StoreScott W. FaustiSouth Dakota State University, scott.fausti@sdstate.eduRichard ShaneSouth Dakota State University, richard.shane@sdstate.eduFollow this and additional works at: http://openprairie.sdstate.edu/econ_commPart of the Agricultural and Resource Economics Commons, and the Regional EconomicsCommonsThis Newsletter is brought to you for free and open access by the Department of Economics at Open PRAIRIE: Open Public Research AccessInstitutional Repository and Information Exchange. It has been accepted for inclusion in Economics Commentator by an authorized administrator ofOpen PRAIRIE: Open Public Research Access Institutional Repository and Information Exchange. For more information, please contactmichael.biondo@sdstate.edu.Recommended CitationFausti, Scott W. and Shane, Richard, "State and Local Tax Policy; Non-Trader Use of Futures: Sell or Store" (1994). EconomicsCommentator. Paper 310.http://openprairie.sdstate.edu/econ_comm/310ECONOMICSCOMMENTATORSTATE AND LOCAL TAX POLICYbyScott W. FaustiAssistant Professorof EconomicsThe primary purpose of a tax is to raise funds topay for government expenses. Expenditures includefunding for education, law enforcement, highwaymaintenance, and the judicial system. The governmentmay also use taxes to alter the allocation of resourcesin the private sector. For instance, if the govermnentbelieves alcohol consumption has a negative effect onsociety, it can levy a tax on alcohol to reduce bothproduction and consumption of alcohol.Underlying Principles of Tax PolicvTwo issues must be considered when govermnentselects its tax structure: 1) how much governmentrevenue is needed and 2) which groups in society willbear the economic burdens from different taxes beingconsidered. In levying specific taxes, two principlesof fairness need to be considered. First, the taxburden should be distributed according to benefitsreceived. Second, the tax burden should be distributedaccording to the ability of various groups to pay thetax.State and local officials can chose from a varietyof different taxes to raise government revenue, e.g., 1)sales tax, 2) income tax, 3) property tax, 4) excise tax,5) severance tax, and 6) user fees. Each of these taxalternatives distributes the tax burden differently acrosssociety. Variation in tax burdens among taxinstruments can generate a tax shifting problem asindividual interest groups try to influence governmentto select taxes that minimize their respective taxburdens.With regard to taxes levied on specific goods andservices, "who pays the tax?" depends on whetherbuyers and sellers are more sensitive to tax-induced(Continued on next page)SOUTH DAKOTA STATE UNIVERSITYNo. 341 November 3, 1994NON-TRADER USE OF FUTURES:SELL OR STOREbyRichard ShaneExtension GrainMarketing SpecialistMarket analysts have all been talking about therecord row crop harvest this fall. Com yields mayaverage 140 bushels per acre in the United States and100 bushels per acre in South Dakota. Soybean andsunflower yields have been phenomenal. All thesefundamental facts have pushed cash and futuresmarkets to relatively low prices. Farmers are askingwhether to store or sell at these low prices. Twofutures market concepts can be used to help make thisdecision—basis and carry.Basis is the relationship between your local cashmarket and the futures market price. In most areas ofSouth Dakota, futures price is higher than cash priceby a predictable amount and we say the basis is somany cents under (the futures market). If the actualbasis is different from this predictable amount(normal), it may suggest selling or storing. If thebasis is more than normal, storing is encouraged. Ifthe basis is less than normal, selling is encouraged.In one southeast South Dakota town picked atrandom, the cash corn price is $1.74 per bushel andthe Chicago futures price is $2.16 per bushel. Thebasis is $.42 under. A study of basis tables from pastyears reveals that normal basis for this location at thistime of the year is $.34 under, and by March the basisshould decline to $.25 under. This basis improvementindicates a potential payment to storage until March of$.17 per bushel. For soybeans at the same location,normal basis is $.47 under and current basis is $.63under, with expected improvement by March to $.35under. The expected payoff to storage from basisimprovement is $.28 per bushel.Carry is the change in futures price from onecontract month to the next. If the change is positive, a(Continued on page 3)Page 1changes in price. If buyers are more sensitive thansellers to a change in price, sellers pay the greatestproportion of the tax. If sellers are more sensitive to achange in price than buyers, then buyers pay thegreatest proportion of the tax.Consider the South Dakota twenty-three centexcise tax on cigarettes. Seller response to a changein the price received for cigarettes due to the tax ismore sensitive than consumer demand to a change inprice paid. In this situation, cigarette retailers are ableto shift the majority of the tax burden to the consumerof cigarettes.Another question that arises in a discussion overtax policy is the distribution of the tax burden acrossincome groups: what proportions of income are paidout for any particular tax by people from differentincome groups? Economists categorize tax alternativesinto three groups with respect to sharing tax burdensacross income groups: 1) proportional tax - taxpayerspay the same percentage of income in taxesirrespective of their income level; 2) progressive tax -the higher the income, the larger is the percentage ofincome paid in taxes; and 3) regressive tax - thehigher the income, the smaller the percentage ofincome paid in taxes.An example of a regressive tax is a general salestax. The larger the number of household necessitiessubject to the tax (e.g., food, clothing), the moreregressive the tax. This is true because lower incomehouseholds spend larger proportions of their incomeson necessities than higher income households.An example of a proportional tax would be thesocial security tax. For all individuals who earn lessthan $60,600, the social security tax is 6.2% of grossincome, i.e., tax payments are proportional to income.However, if one includes all tax payers the socialsecurity tax becomes extremely regressive.An example of a progressive tax is an incrementalincome tax. The higher one's personal income, themore one pays in taxes as a percentage of one'sincome. Or, the higher a corporation's income, thelarger percentage of income paid as a corporateincome tax.Concerning the tax equity (ability to pay) issue, aproportional tax scheme provides an equi tax burdenacross income groups. However, higher incomegroups have higher percentages of discretionaryincome (i.e., income not required for food, clothing,and other household necessities) to total income.Therefore, higher income groups can better afford topay higher percentages of their income in taxes.Viewed from this standpoint, most people wouldconclude that a progressive tax scheme is moreequitable than a regressive or proportional tax.South Dakota's Current Tax StructureThe State of South Dakota is required by law tomaintain a balanced budget. The State's total projectedcontinuing General Fund Receipts for FY1994 are$563,872,488. The State does not raise revenues fromtaxes on real or household property. The State's salesand use tax is estimated to generate 52.9% of totalcontinuing receipts or $298,020,860 in FY1994. A"use tax" is a tax on rental transactions, etc. Videolottery would have been the next largest contributor,accounting for approximately 10% of total receipts.The remaining revenues are generated by a host ofother fees and excise taxes levied by the State.Because South Dakota's sales tax coversnecessities such as food and clothing, it is especiallybroad-based. The broad-based approach makes thistax mechanism regressive, since lower incomehouseholds spend larger proportions of their incomeson necessities than higher income households. Theother instruments of taxation used by the State arespecific in nature. The tax burden of these specifictaxes falls upon the buyers and sellers of the specificgood or service taxed. The distribution of the burdendepends on which group is more sensitive to pricechanges.The primary revenue raising mechanism at thelocal level is the real estate property tax. In 1992,local governments in South Dakota raised$457,042,759 through property taxes. Approximately2/3 of property tax funds went to schools and the other1/3 was used to fund local services. With regard tothe fairness issue, property taxes in South Dakota arelevied at the local level. These fiinds remain withinthe community to fmance local services. Thus, thelocal tax burden for the entire conununity equals thebenefits received by the community.The property tax is considered a regressive formof taxation. However, one could argue that since theproperty tax rate is set at a fixed percentage of theproperty's value, it is proportional to income. Forexample, poor people do not own property.Page 2JTherefore, they do not pay property taxes. However,as an individu^'s income increases there is apropensity to become a property owner and propertytax payer.Considerations for the FutureAt this time, the South Dakota economy is healthyand expanding. In the current economic climate, stateand local governments should not be experiencingfiscal crises. The current financial crisis at the statelevel is the result of the demise of video lottery. Theimminent financial crisis at the local level arises fromthe possible passage of the property tax cap onNovember 8.Obviously, these difficulties are not the result ofdeclining economic activity in the state. Rather, theyare the result of the perceived unfairness of the currenttax structure at the state and local level by particularcoalitions within the state. These perceived inequitiesare the result of the heavy dependence of governmenttax revenues being raised through taxes on the specificeconomic areas of property and gambling.On the other hand, broad-based taxes, such assales or income taxes, provide more stable sources ofrevenue than specific taxes. Broad-based taxes are alsoless politically controversial because no single interestgroup is being singled out to bear the tax burden. Forexample, the property tax cap measure is the result ofthe belief of property owners in South Dakota thatthey are bearing an unfair share of the tax burden atthe local level. If the measure is successfiil, thenproperty owners will have successfully shifted the taxburden away from their interest group.South Dakota ranks 47^ in the nation with respectto state and local taxes paid per capita. However,South Dakota is 50^ in the nation with respect toincome per capita. The implication is that SouthDakota has a moderate tax burden and a largeproportion of South Dakota's households earn lowincomes relative to the rest of the nation. However,South Dakota's current regressive tax structure isplacing a heavier tax burden upon the shoulders of lowincome households, than upon the shoulders of upperincome households.Given the regressive nature and instabilitiesassociated with South Dakota's current tax structure, itmay be time for South Dakota to consider a newapproach for government financing. It seems thatSouth Dakota has been playing the "don't tax me.don't tax you, tax that guy behind the tree" game toolong. Tax revenues pay for government services. Theless tax revenue generated, the fewer governmentservices provided. Total tax revenues raised from allsources in South Dakota sum to approximately onebillion dollars. If a property tax cap of one percent isimposed and video lottery fails, then total tax revenueswill decline by approximately 37%. The implicationis that government services will also have to declineby 37%, with the greatest decline in the level ofgovernment services at the local level. The magnitudeof this impending fiscal crisis indicates that it is timefor a broad based tax scheme. Without a stable taxsystem. South Dakota will continue to endure theeconomic hardships associated with unstable taxrevenue sources.(Shane . . . cont'd from page 1)higher price is expected which, in effect, represents apayment for storage. If the change is negative, alower price is expected ~ based on current marketinformation. In the following table, com carry fromDecember to March is $.09 per bushel and soybeancarry from November to March is $.23.Combining the basis improvement and carry in themarket yields a potential payment to storage for comuntil March of $.26 per bushel and for soybeans of$.51 per bushel. Both of these payments exceed thecost of storing the commodities until March.Therefore, the futures market is encouraging farmersto store corn and soybeans at this time. Mostlocations in eastern South Dakota currently havesimilar storage analysis results ~ with storageencouraged. Producers should evaluate their ownsituations to take advantage of this type of analysis.FUTURES PRICEMon. Corn Mon. Soybean Mon. Soyoil($ Per Bushel") f$Per Cwt)DEC 2.16 NOV 5.42 DEC 25.75MAR 2.27 JAN 5.54 JAN 24.85MAY 2.35 MAR 5.65 MAR 24.36JLY 2.40 MAY 5.73 MAY 24.14SEP 2.45 JLY 5.80 JLY 23.95With sunflowers, the futures-cash relationship(basis) is less predictable because there is no sunflowerPage 3SOUTH DAKOTA STATE UNIVERSITYEconomics DepartmentBox 504ABrookings, SD 57007Address Correction Requestedfutures market and they are cross-hedged on thesoybean oil market. TTie sunflower price at majormarkets traditionally runs around 42% of soyoilfutures price. This relationship is used today inmaking cash bids to farmers and local elevators.However, since the initiation of the federalgovernment's Sun Oil Assistance Program (SOAP),which began in 1988, the relationship has been around50%. Pricing has followed the traditional relationshipbecause of uncertainties surrounding governmentprograms.On Nov. 1, 1994, the Enderlin ND price forsunseed is $9.40 per cwt and the price of nearbysoyoil futures is $25.75 per cwt. Sunseed price is36.5% of sunoil price. If the relationship becomesmore "normal" at 42%, one could expect the basis tonarrow by up to $1.40 per cwt and maybe more if thegovernment continues to use SOAP. Tliis relationshipencourages storage.The carry in the soyoil market contradicts thebasis answer to encourage storage of sunseed (see theprevious table). The price of successive soyoilcontracts is decreasing, suggesting lower prices ahead.In this situation, up to three mondis storage is prudentfor at least part of the sunseed crop in order to takeadvantage of basis improvement. Long term storage isquestionable at this time because of the inverted carryin the soyoil market. Producers with sunseed instorage should watch these relationships very closelyand be ready to sell more of their sunseed.ECONOMICSCOMMENTATOREDITOR: DonaldC. Taylor, AgriculturalEconomistECONOMICS DEPARTMENTSouth Dakota State University .Box 504ABrooldngs, SD'57007Phone: (605) 688 - 4141475 copies of this newsletter were produced at a costof less than $100Page 4

State and Local Tax Policy; Non-Trader Use of Futures: Sell or Store

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State and Local Tax Policy; Non-Trader Use of Futures: Sell or Store

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