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Abstract

Financial reserves are an important component of farms’ risk management. A tax incentive for the establishment of reserves in agriculture is demanded by various parties, particularly against the background of an increase of extreme weather events. The proposals differ considerably. This report provides an updated and comparative assessment of different design options, and takes a closer look at models that build on the Forest Damage Compensation Act, the proposal of the German Farmers’ Association, as well as the reserve formation from direct payments. The analysis of the situation and the objectives shows that the hypothesis of reserves in agriculture being generally and systematically too low cannot be substantiated on the basis of the available data. The discussion of tax issues highlights a number of challenges that tax-based promotion of the establishment of reserves must meet in order to comply with tax and competition law requirements. These include, in particular, the commitment of the funds to a special reserve account, the limitation of interest income resulting from a longer or indefinite duration of the reserve and the limitation of the tax-based compensation to agricultural risks through appropriate provisions for the establishment and liquidation of the reserve. For all examined models, tax advantages and thus the incentive for additional reserve formation are low on average due to existing, partly agricultural-specific, tax regimes that smooth the income tax burden. However, there are big differences between the farms. Above all successful farms, which even without the benefits from the tax regulation have free financial resources for the establishment of a reserve, as well as farmers with high non-agricultural income, will benefit. The incentive effect created by a fiscal support measure to build up liquidity reserves is likely to be largely ineffective for low-income farms. In the case of restrictive conditions for the establishment and liquidation of a tax-privileged reserve, which is characteristic for models designed according to the Forest Damage Compensation Act, the tax incentive for additional reserves comes at the price of restricted access to the farm's own liquidity and lost benefits from alternative investments. This limits the acceptance of such a risk reserve. The waiver of a specific reserve account and the broad, non-specific list of occasions justifying a favoured liquidation of reserves in the proposal of the German Farmers’ Association do not meet the requirements for a goal-oriented, effective and efficient promotion of a liquidity reserve. Channelling part of the direct payments to a reserve account in economically good years can in principle increase the contribution of direct payments to risk management. However, even with this approach, the contribution to improving liquidity in times of crisis is low in many farms, as significant subsidized reserves can only be created in farms that manage large land areas and therefore receive high direct payments.

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