A Fair Income for Farmers

April 26, 2000

A common definition of a fair income for a farm business is a level of income that enables the operation to pay its bills, or cover the costs of production from the revenue realized from sales. But that definition does not include a return to the operator, so a financially sound farm under that definition may generate income sufficient to cover business expenses but not provide adequate income to support a household. A new USDA study seeks to analyze a fair income for farmers.

The analysis considers three measures of farm production costs: variable costs are defined as expenses incurred in the production process that vary with the quantity and prices of inputs used such as seed, fertilizer, fuel, repairs and wages; total cash costs are defined as variable costs plus expenses for overhead items such as rent, taxes, insurance and interest payments; economic costs are total cash costs plus an allowance for depreciation along with an imputed return to management and to unpaid labor of the operator and family.

"A farm can often survive for a year if revenue covers variable costs, or even for several years if revenue covers total cash costs, particularly if the operator is able to draw on cash reserves or other liquid assets, to borrow against assets or to obtain income from non-farm sources," says the report.

"However, such remedies are only temporary. In order to sustain the business over a longer period, revenue must cover economic costs." In the short run, the allowance for depreciation – an economic cost – may be deferred and aging equipment may be repaired – a cash cost. "But in the long run, as machinery wears out or becomes obsolete, the shortage of funds for replacement may affect the farm’s ability to generate revenue."

Using a wheat farm as an example, the report notes that the characteristics of wheat farms and their financial performance "indicate diversity in the ways farmers manage their businesses and earn their livings."

So an implication of this analysis is that "there is no one fair price or fair income level, as the unit returns or revenue required for survival of the highest cost farms are well above those of the lowest cost farms." Even among farms of the same size, a cost differential exists between the lowest and the mid-range cost groups, "suggesting that cost reduction through good management decisions and adoption of better technology would be a powerful way to improve financial prospects for those whose costs exceed returns."

Without a change either in on-farm management decisions or in the approach of government policy, "earning a fair income sufficient to cover economic costs of production from the market is a dim prospect for a significant portion of wheat farmers in the U.S. today," according to this study. "However, about one-third of all wheat farmers can survive and prosper as long as they maintain their low-cost positions."

Another third or so, with very high production costs, survives because it is composed mainly of households that do not depend on farming as the main source of income and that make economic decisions that allow them to subsidize farm losses with income from other sources. The final third – the mid-range cost group – does depend on the farm business for its livelihood but experiences production costs high enough to jeopardize long-term survival.

The report is included in the May issue of Agricultural Outlook and is available here.