The Influence of IRS Tax Policy on Use of Livestock Cattle Futures and the Effectiveness of the Price Discovery Process

Current IRS policy on deductibility of losses on futures trades discourages cattle feeders from being fully involved in the price discovery process. Analysis suggests the policy hurts the effectiveness of price discovery and imposes a cost on society at large. Cattle feeders are forced to make all adjustments in the cash side of their business by changing placements, and when negative margins are being offered, they must function as cash market speculators or allow unused capacity and absorb the costs of investment. There is no economically rational way cattle feeders can participate in the price discovery process under current IRS policy when the margins being offered are negative. A change in policy is proposed that would allow feeders to be long in cash cattle and/or distant live cattle futures up to feedlot capacity with losses in futures trades being treated as a deduction for tax purposes. The change should improve the price discovery process, produce a significant consumer surplus, increase market share for the beef sector, and it could increase revenues to the IRS. Conceptual and empirical support for a change in policy is presented. Research results that show the impact of different trader groups, including cattle feeders, on the effectiveness of price discovery are presented in support of the proposed change. More research on the impact of IRS revenues, where the results of a policy change are less definitive, and the related implications of the elasticity of demand for slaughter cattle is needed.