for the average cooperative elevator. On an after-income-tax basis, the cooperatives not paying a tax, the comparison is even more striking. In 1956 and 1957 on a before-income-tax basis, the average return of the private elevators was only about one-third of that of their co-op competitors. Some other important conclusions were also developed in the surveyAlthough the average business transacted per cooperative elevator was only twice that of its private elevator counterpart, its net earnings were almost four times as great. It is believed that this shows two things: First, in a business such as the grain business where expenses per unit decrease as total volume increases, the cooperatives have a substantial advantage directly related to size and business volume. Second, the figures indicate that the private elevators are willing, and as a matter of necessity, must operate on a substantially lower net margin than their co-op competitors. Substantial benefits are obtained by cooperative corporations in plowing back tax-free earnings into their businesses. Earnings increase in proportion to the increase in gross assets, a fact to be expected. On the other hand, expansion of facilities by the private elevators subject to income tax was possible only out of wholly inadequate depreciation reserves and the plowback of tax retained earnings. Any greater retention of earnings than actually existed during the period studied could have been accomplished only at the expense of the owners of these private elevators whose return on investment during the period was already completely inadequate. The North Dakota comparison is a good example of the difficulties encountered by private grain elevators in competing with their relatively tax-free cooperative grain elevator competitors. The growth pattern of a typical cooperative country grain business which had a small beginning and grew large and powerful is portrayed by the Farmers Cooperative Co. at Britt, Iowa. The growth of this cooperative, which is partially subject to income tax, is shown in the following statement appearing in their 1956 report: NOTE.-A part of the patronage refunds allocated in earlier years have been retired by cash payments. Such payments are made, however, entirely within the discretion of the cooperative's board of directors. The balance sheet and other financial statements of this cooperative are also interesting because they indicate some of the features of typical cooperative financing methods: Grain purchased from members: (including CCC grain deliv ered) 675,404 bushels at 2.4 cents__. Grain sold to members: 153,932 bushels at 1.0 cents---. Total----- 68,049. 68 $16,209. 70 1, 539. 32 31, 268. 92 49, 017. 94 This cooperative is of the nonexempt kind, paying an income tax only on earnings used for dividends on capital stock and otherwise not allocated on the books of the corporation. All allocated patronage refunds, even though not paid in cash and payable at an indeterminate future date at the discretion of the board of directors, are excluded from income. The financing of the growth of this cooperative has been accomplished largely through retention of tax-free earnings kept in the business through use of the noncash patronage refund device. Several interesting facts should be noted: Uniform dividends are paid on all grain purchases from members, including grain not actually purchased but hauled to the elevator for the account of the Commodity Credit Corporation in connection with defaulted commodity loans under the farm program. In the latter case, the earning was the direct result of charges paid by CCC to the cooperative. No effort seems to have been made to allocate earnings to particular grains even though the margins with respect to such grains undoubtedly varied considerably. Uniform patronage dividends are paid on all merchandise sold even though the type of merchandise varies considerably. The cooperative has included in income but has not paid a tax thereon, patronage refunds earned from other cooperatives. It also carries in its investment account a little more than $90,000, representing patronage refunds it has received over a period of years from regional and other cooperatives. ably, it has allocated these dividends to its members and patrons. Presum The North Dakota and Britt, Iowa, situations are intended only to describe cooperative grain elevator operations which are typical of those in many areas. Multiply these situations by several thousand and the aggregate competitive effect of cooperative country grain elevators can be determined. IV. WHY COOPERATIVES GROW AND HAVE COMPETITIVE ADVANTAGE Cooperatives in the grain and feed business have grown. The next step is to show the contribution of income tax exemption and treatment to such growth and how competitive advantage is gained thereby. This can be done by the use of examples which are typical and which compare the cooperative method of doing business with that of private grain elevator competitors. (A) How grain elevators function The business function of an ordinary country grain elevator is to receive grain from producers, such grain to be (1) purchased and sold; or (2) to be handled, stored for a period of time, and then either bought and sold or delivered to someone at the direction of the customer depositing the grain in such elevator. Prior to the Government's commodity loan program, the bulk of all grains received by country elevators was purchased from farmers and subsequently sold. Under the commodity loan program, however, grain may be pledged or mortgaged to Commodity Credit Corporation as security for a nonrecourse loan. If such grain is stored in a country grain elevator and the loan is defaulted CCC becomes the owner of the warehouse receipt pledged as collateral. As owner of such warehouse receipts, CCC ordinarily orders the grain delivered to some other location. For this the elevator is paid a storage and handling charge. Much of the grain upon which commodity loans are obtained is also stored on farms and in the event of a loan default title to this grain is acquired by Commodity Credit. This agency then uses the facilities of the country elevators for handling and storage of such grains and compensates such country elevator under the terms of a so-called uniform grain storage agreement. In addition to assembling grain for sale and storage, the normal country elevator does many other things. It sells feed, seed, fertilizer, and many farm supplies; it grinds, mixes, and manufactures feed; it sells lumber and fuel; and in general usually does a rather complete farm supply business. The facilities employed by a country elevator in its business consist of buildings designed for the handling and storage of grains and the necessary equip ment to do the grain-handling job. In addition, buildings are owned for whatever feed and farm supply business is conducted. Grain is received at country elevators from farmers who ordinarily deliver in truckload quantities. The grain is weighed on receipt and carefully graded according to Government grain standards. After this has been done, the grain is dumped into a pit and then elevated and conveyed to a selected bin within the elevator. As a general rule, grain of common quality is commingled and no effort is made to preserve the identity of any particular lot of grain nor is that legally required. Farmers delivering grain in this manner either sell the grain immediately or if it is not sold but stored the farmer receives a warehouse receipt reciting the grade and quality of the grain. When the grain stored in the elevator is sold, it is loaded out either into railroad boxcars or into trucks. Grain from the common lots within the elevator are so delivered, the elevator operator conducting his business so that sales and deliveries on such sales are made to the best advantage. If the grain is not sold but is redelivered on warehouse receipts, grain of the grade and quality called for by such receipt is delivered. Delivery in this case may also be made into railroad cars or into trucks. The buying policies of country grain elevators are quite standard whether the elevator is cooperative or otherwise. As described in University of Minnesota Agricultural Station Bulletin 407, "the prevailing method of buying grain by cooperative associations is outright purchase and the producer receives the current price at the time of delivery." The determination of the buying price is the manager's responsibility. Over a period of time this price is such that the difference between the buying and selling price is sufficiently large to cover operating and other costs, and to provide for reasonable net returns. It is the general policy for country elevators to change their buying prices during the day, depending upon changes in price at the appropriate terminal grain market. The method of pricing grain by local cooperative grain elevators in Kansas is described in bulletin 66 of the Farm Credit Administration. This explains that grain is handled by local farmers' cooperative elevators on a purchaseand-sale basis. Under that plan of cooperative marketing the title to grain is transferred to the local country elevator when the contract of sale is consummated. Usually upon delivering the grain or tranferring title, the patrons are paid the current market price, grade and quality considered, less a nominal amount per bushel as an operating margin. Incoming price offers or bids are numerous and frequent, and the margin the local elevator takes is generally the difference between the best bid price it has received from buyers and the price it pays to its patrons. The price difference is the margin that the association hopes to realize and on which it expects to operate. This price difference is the initial charge for services and possible risks. Buying margins vary in amount from year to year and season to season. Buying margins for individual customers also vary, depending upon market conditions and grade and quality of grain. Accounting policies and methods followed by country grain elevator operators are quite standard. Except for terminology, the practices followed are the same whether the country elevator operation is cooperative or otherwise. Country grain elevators, as is typical of any business, may be owned in any one of several different ways. A relatively few country elevators are now owned by persons as individuals or in partnership with others. Cooperative country grain elevators are owned by cooperative associations incorporated as corporations under appropriate State laws. Most privately owned country grain elevators are operated as corporations. The legal effects of these various methods of ownership are all well known. Terminal grain elevators are similar to large country elevators in many respects, but are, of course, much larger and are located at terminal marketing points. They receive grain by rail or truck, ordinarily from country elevators and not directly from producers. The grain so received is either purchased and sold or received for storage. In this latter event, it may eventually be redelivered for the account of the person storing it or it may be subsequently purchased and sold as any other grain. The facilities used and the mechanics followed in handling grain at the terminal market level follow the country elevator pattern except on a much larger scale. All grain elevators whether cooperative or otherwise, are organized for profit. The business of the private elevators is for the profit of the owners-usually the stockholders of the corporation. A cooperative grain elevator business also is conducted for profit-that of its members and/or patrons. Here are a few general conclusions applicable to both country and terminal elevator grain operations: As the volume of grain handled increases, the cost per bushel decreases. This is a fact disclosed by many elevator surveys conducted by the Farm Credit Administration as well as various agricultural experiment stations. It is a fact well known in the grain and feed trade. A large grain elevator operated near its maximum practical volume level has an important competitive advantage over a smaller elevator similarly operated. In other words, size of the facility is important provided the elevator is used efficiently. The foregoing conclusions apply to the storage of grain as well as to the merchandising or handling of grain. It may be concluded that as both country and terminal grain elevators increase the volume of grain handled and their size, they decrease their unit costs per bushel of grain handled and improve their competitive position. This creates an endless chain of events. Volume and size breed greater efficiency and lower costs per unit. These, in turn, create greater volume and larger total profits. (B) Effect of tax advantage The Federal income tax advantages which grain cooperatives enjoy are: (1) All cooperatives, whether exempt or nonexempt under the code, are permitted under administrative practices to exclude from gross income the amounts allocated to patrons as patronage dividends. (2) Cooperatives exempt under sections 521 and 522 of the Internal Revenue Code are allowed a statutory deduction for their dividends on capital stock and for allocations of incidental nonpatronage receipts to patrons on a patronage basis, and may attribute to a taxable year patronage receipts allocated to patrons within 91⁄2 months after the close of the taxable year. (3) The ability to exclude patronage dividends from gross income occurs whether the dividends are paid in cash or noncash form. The fact that these tax advantages influence growth and competitive position would seem to be too obvious to require explanation. Cooperative proponents, however, deny that they have any particular advantage; say that competitive position is not really influenced; that favorable tax treatment is actually necessary to permit them to compete effectively, and that any corporation can do the same by paying patronage dividends. The facts indicate that exactly the opposite is true, unless of course the cooperative competitor wishes to conduct his business on a nonprofit basis. In this connection, it should be explained that very little investment capital can be attracted to a business, the operation of which is conducted on a nonprofit basis. If it is the desire and belief of the Congress that business can best be conducted without profit, then it can easily grant a tax subsidy to all business which foregoes the profit motive. By the same token, however, Congress will have to look elsewhere for the support of Government. Tax advantage does have a direct bearing on growth and competitive position for many reasons. These are best explained by a few specific examples. A typical average Minnesota cooperative grain elevator in 1952, according to a study conducted by the University of Minnesota Department of Agricultural Economics (Mimeo. Report No. 502), had earnings (before taxes) of about $16,000 based on total sales of $700,000 (grain $600,000 and merchandise $100,000). The net worth of this average cooperative amounted to a little more than $100,000, consisting of about $40,000 of stock and the balance members and patrons equities of one kind or another. The return of slightly more than 2 percent on sales is quite typical, according to similar studies conducted in Kansas (Farm Credit Administration Bulletin 66, May 1951), Illinois (University of Illinois Department of Agricultural Economics, AERR-17, February 1957), and Ohio (Ohio State University Department of Agricultural Economics, Mimeo. Bulletin No. AE 247, 1953). The cooperative elevator earnings in this example would have permitted it to pay 6 percent on all of its stock and make a similar allowance on all members' equity (a practice seldom followed) and yet pay a $10,000 patronage dividend or approximately 1% percent on sales. In the case of wheat at $2 per bushel, this would have equaled a 3 cent per bushel dividend. With other grains at normal price relationships, this would have meant about 2 cents per bushel on corn and 1 cent per bushel on oats. If the cooperative had been required to pay a tax on all of these earnings, as is true of the non-co-op private competitors, it would have had about $5,000 less to distribute. This is not a large amount, but it is still the equivalent of 3/4 percent on sales. In the case of $2 wheat, this would have meant 11⁄2 cents per bushel, and with normal price relationships in effect about 1 cent per bushel on corn and a half cent per bushel on oats. In considering these amounts paid as patronage dividends, it is most important to realize, as has been previously stated, that the grain business is normally conducted on a very low gross margin on grain. Two cents per bushel on wheat, for example, is a substantial amount in the eyes of a farmer customer and is enough to influence his decision about the elevator where his grain is to be marketed. A substantial competitive advantage results from the payment of these cash patronage dividends, and a large part of that advantage arises from the distribution of a tax subsidy. The advantage pyramids. As growth results, costs are decreased and margins increased. Larger patronage dividends follow, and this, in turn, leads to more business. This is the way co-op corporations grow. An equally interesting situation arises when all earnings except for dividends on capital are retained for use in the business. The growth in physical assets |