How inflation and taxes impact Nebraska farms and factories

Inflation is the top concern for families heading into midterm elections. Americans largely see federal government actions as hurting their households, and they’re right. As a result of the federal inflationary whirlwind, real wages have fallen 3.6% over the last year.

Inflation and supply chain disruptions hurt all household budgets. But they also impact different states in different ways.

Fortunately, Nebraska has enjoyed bright spots in its economy because of strong global demand for its agricultural commodities and manufactured food products. The strong demand has resulted in high prices for Nebraska’s major exports. Such demand helps boost Nebraska’s state income, which in turn drives strong state tax revenues.

Yet on the other hand, inflation hits farmers and manufacturers when they make input purchases and can also bite when they depreciate the cost of capital investments like machinery and equipment. So even the industries that benefit from selling at high prices also have to make purchases at high prices.

In the first quarter of 2022, personal income grew at a 6.5% annualized rate in Nebraska compared to a 4.8% average across states. That placed Nebraska 10^th for personal income growth. The top four states for income growth were South Dakota, North Dakota, Iowa, and Idaho, all states that produce and export agricultural commodities. For these states, the U.S. Bureau of Economic Analysis describes how “an increase in farm earnings was the leading contributor to the increase in personal income in the first quarter.”

Farm earnings have also been a major driver in Nebraska’s income growth, which has factored into surprising strength in state tax revenues. Nebraska farm earnings, which are leveraged to commodity prices, increased from an annual rate of $1.8 billion in the first quarter of 2018 to an annual rate of $7.5 billion in the first quarter of 2022, representing a fourfold increase over four years. Nebraska’s strong tax revenues, in turn, have allowed policymakers to reduce tax rates.

As Nebraska’s economic pie has expanded over the last four years, farm earnings have become a bigger slice of that pie. Farm earnings have grown from 1.8% to 6.1% of Nebraska’s total income over the last four years. Nebraska state income was $100 billion at the start of 2018, and farm earnings made up $1.8 billion of that amount. By the start of 2022, Nebraska state income was $123 billion, and farm earnings made up $7.5 billion of that amount.

Even though farms and food manufacturing have seen strong growth, policymakers should remember that purchasing prices are going up for farms and factories. For example, processed fuels and lubricants are up 43% for manufacturing industries and 66% for non-manufacturing industries over the last year. Prices for manufacturing capital equipment are up 12.2% year over year, and agricultural machinery and equipment prices are up 17.6% year over year.

The cost of capital equipment will increase even more if policymakers fail to protect full expensing in Nebraska’s tax code. Full expensing is a policy that allows a business to immediately write off the cost of machinery and equipment, and is current law in Nebraska through the end of 2022. Nebraska adopts this policy by conforming with a similar provision of the federal tax code. Yet full expensing will phase out from the federal tax code over upcoming years, effectively raising the cost of capital equipment for Nebraska’s farmers and manufacturers.

Nebraska policymakers can prevent this from happening at the state level by making the option to use full expensing permanent in the state’s tax code. This is especially important during times of high inflation because inflation eats away at the value of tax deductions that are used for capital cost recovery over a depreciation schedule of 5-20 years. Under the assumption of 5% annual inflation, a Nebraska farmer or manufacturer would lose half the value of capital cost recovery by depreciating an asset over 20 years rather than writing it off immediately.

Farming and manufacturing have helped Nebraska weather the economic storm of the last several years by producing strong growth while other sectors were under duress. This growth shouldn’t be taken for granted, and Nebraska’s tax code should be adjusted to alleviate a bias against capital-intensive industries.