The Forward Contract’s Income Shifting Option and Implications on the Forward Basis

Previous studies have documented a cost of forward contracting grain relative to hedging in the futures markets. Our study quantifies the value of the income shifting option to forward contracting. An income shifting option refers to the fact that at harvest-time, a farmer can chose to sell uncontracted bushels of corn in the spot market or forward contract to sell after the first of the year. This option has non-trivial tax implications under a progressive tax system. By shifting income to the next tax year, a farmer can reduce the current year’s income level and avoid a higher marginal income tax rate. Further, if country elevators have market power, they can capture some of the value of this income shifting option by offering a weak forward delivery January basis bid. In a sufficiently captive draw area, an elevator knows that a farmer will be willing to accept a weak January forward basis bid so long as he still receives some income tax benefits from deferring sales to the next tax year. br br This option is most valuable during years when farmer income is high. Therefore, in this study we posited that during years of high farmer income we would see forward basis bids which are abnormally lower and appreciate at a slower rate than the harvest-time immediate delivery bids. We measure this effect using basis bids from elevators in seven regions in Illinois from 1980 to 2009. We find that a 1% increase in yield above trend level decreases the January delivery forward basis bids by 3 cents per bushel; we also find that the January delivery forward basis bids appreciate at 44% the rate of the immediate harvest-time delivery basis bids.