Capital Consumption; H. Sennholz

In the world of reality, every economic good must be produced by man and his capital in coop eration with nature. In order to consume more, man must produce more unless he is prepared to eat into the capital substance that is helping to produce the goods. Cap ital refers to the monetary net amount of all the productive assets of an enterprise, which may con sist of anything from cash to re ceivables, inventory, tools and Dr. Sennholz heads the Department of Eco nomics At Grove City College and is a noted writer and lecturer on monetary and economic affairs. 282 equipment, or even land and build ings. The amount of capital invested per head of the population basical ly determines the prod ucti vity of our labor, wage rates, and stan dards of living. We speak of a progressing economy when the per capita amount is increasing, which causes income to rise through an expansion of produc tion. And we speak of a contract ing economy when the amount of capital per person is shrinking, which reduces incomes and stan dards of living.

Every day we either accumulate capital through saving or reduce it through overconsumption. Busi nessmen either form capital through reinvestments of their earnings or dissipate it through losses or overconsumption. Every day total productive capital in the 1976 CAPITAL CONSUMPTION 283 U.S. either expands or contracts, which causes labor productivity to rise or fall, and incomes and living standards to move accordingly. The growing popularity of many government programs rests on the inability of the public to under stand the nature and importance of capital. The redistributive polI cies of the U.S. government have consumed productive capital on a massive scale. At first, these poli cies merely slowed down capital accumulation and improvement in the rates of production. But with the acceleration of government spending in recent years, it ap pears now that the U.S. has em barked 'upon net consumption of c(J)pital that was accumulated in the past. If this conclusion is cor rect, our redistributive policies have arrested further economic progress and now are reducing our wage rates and standards of living. Neither law nor regulation can prevent pernicious poverty if we choose to consume our capital substance.

We are today heirs and benefi ciaries of the capital that was formed by our forebears. We are better off than earlier generations of Americans because we are working with capital goods that they created and accumulated for us. But if, for any reason, our generation chooses to consume more than we produce, we must prepare for reduced living condi tions and all the social and polit ical consequences thereof. And our children must learn to face fur ther poverty and deprivation. The Taxing of Progress With the growing popularity of redistribution by political force, all levels of government have em barked upon specific policies of capital consumption. Their favo rite tool at first was taxation of the income and wealth of rich cap itaIists and entrepreneurs. From a modest beginning in 1913, the Federal income tax rose steadily from one per cent of per sonal incomes above $3,000, or $4,000 for married couples, plus surtaxes of 6 per cent on incomes of $500,000 or more, to a maxi mum personal income tax rate of 94 per cent in 1944. Corporate income taxes soared to 90 per cent of "excess profits." Simultane ously the Federal tax rates on larger estates rose to 77 per cent, on top of which the states may claim their shares. It is true that in recent years individual and cor porate income tax rates hav,e come down a little; but a variety of other taxes, from social security to state and local taxes, have taken even larger shares.

No matter what the motivation, this confiscation of the incom,e and wealth of millionaires must have 284 THE FREEMAN May certain economic and social con sequences. Corporate income may be distributed as dividends to owners or reinvested in business activity, that is, in capital goods that continue to render productive services. Expanding enterprises tend to reinvest most of their earnings in the business. Now, confiscatory taxation surely re duces the amount of revenue that can be reinvested in productive assets. And it curtails the divi dends paid to stockholders and thereby reduces the savings that are reinvested. Progressive income taxation has the same effects. Most successful businessmen with large incomes make large investments, that is, they convert income to productive capital which renders additional services. Confiscatory taxation ob viously curtails this creation of capital and thus prevents produc tion of goods and income. Labor productivity and living standards are debilitated as the taxing au thoritiesconsume this income.

Inheritance taxa tion to a large extent is an outright confiscation of productive capital. The wealth of a multimillionaire mainly con sists of business assets that are producing goods for millions of customers and giving employment to thousands of workers. What the wealthy person holds to consume, such as his housing and clothing, usually constitutes a tiny fraction of his total wealth. Confiscatory estate taxation is bound to fall preponderantly on his productive assets, which means that the tax ing authorities directly consume productive capital, and thus limit living standards and employment. And finally, the taxpayers are influenced by the fear of such tax rates. Instead of making more productive investments - the prof its of which are destined to be seized, or worse yet, the substance of 'which will some day be claimed by estate tax collectors - the indi vidual may prefer to consume and enjoy the wealth himself. Why strive and struggle if the fruits will be reaped by tax collectors?

Why preserve his capital for the benefit of politicians and their beneficiaries? Deficit Spending When the public demand for government services and benefits grows beyond the ability of busi ness and weal thy .taxpayers to pay, budgetary deficits become un avoidable. After all, the popularity of redistribution by political force tends to grow with every dollar of "free" service rendered. The clamor finally becomes so intense that, in order to be heard, every new call is presented as an "emer gency" that must be met immedi ately before all others. R,edistribu1976 CAPITAL CONSUMPTION 285 tive government then rushes from one emergency to another trying to meet the most noisy and polit ically potent demands. As no one wants to pay for the new expen ditures, least of all the benefi ciaries, the transfer administra tion is bound to suffer budgetary deficits. When a corporation suffers losses for long periods of time, it inevitably comes to the end of its capital substance and ceases to op erate. Any remaining assets will be distributed to its creditors.

While government deficits may not throw the government into bank ruptcy, they nevertheless have economic consequences. They des troy productive capital. Indeed, the deficits of the U.S. govern ment have consumed, and continue to consume, capital substance on a seale far greater than all losing enterpris'es combined. In the dec ade of the 1950's total U.S. gov ernment deficits amounted to a mere $17.7 billion. During the 1960's the total was $56.9 billion. Deficits during the first half of the 1970's soared to $71.4 billion, and, as if they were following an exponential curve, in fiscal 1976 alone are expected to exceed $74 billion. It is difficult to estimate the number of f'actories and stores that were not built, the tools and dies that were not cast, the jobs not created, the wages not paid, the food, clothing and shelter not produced on account of this mas sive consumption of capital. This generation of Americans and countless others to come will be poorer by the productive capacity that could have been, but was not created.

Of course, the beneficiarlies of the redistribution process may have enjoyed every moment of it. Among m'en lacking vision, to day's enjoyment is always more pleasurable than saving for to morrow. They may applaud the very favors and handouts that are destroying their jobs and the wages they could have earned, and costly emergency programs may be hailed as progress -though they yield the opposite. The bank or insurance company that is invest ing the people's savings in Trea sury bonds, notes, or bills may be enjoying "safety" for its invest ments. What is significant is the fact that it is channelling poten tially productive saving,s into the maelstrom of government con sumption. The returns it seeks from its investments will not come from new production but from taxes to be collected in the future. In dim awareness of the im portance of capital, some social spenders are quick to maintain that government spending is mere286 THE FREEMAN May ly another form of investing.

Therefor,e, they want government to "invest" in a greater society that is to be built by political force and redistribution of prop erty. Their judgment of what is most urgent and important is to prevail over that of all others. All such planners are would-be dictators. No matter what the ob jective, government expenditures always constitute economic costs that are borne by taxpayers, len ders, or inflation victims. Even when the government builds roads or canals, utility plants or air ports, the expenditures invariably flunk the tests of the market. De manded by voters, authorized by politicians, and administered by bureaucrats, public works consti tute huge malinvestments that waste scarce resources and con sume productive capital. Inflation Destroys Capital When the redistributive society has exhausted its favorite vic tims - wealthy taxpayers and lenders - it can be expected to resort to inflation as a desperate method of fund-raising. The infla tion then taps the savings of the middle class whose material wealth mainly consists of monetary assets and claims. It destroys the capital markets that provide the neces sary savings for the expansion and modernization of productive enterprises. And above all, it causes businessmen to overesti mate their earnings, overpay their taxes, and consume their fictitious profits.

When the purchasing power of money depreciates, all claims de preciate at the inflation rate. Cred itors los'e and debtors gain. Now the creditors - for instance, phy sicians, dentists, attorneys, busi ness executives, and all others holding savings bonds, life insur ance, pension funds, and the like - may, in spite of their inflation losses, endeavor to maintain the levels of consumption to which they have grown accustomed. The physician whose Keough fund has lost half or more of its purchasing power, will not sell his home or automobile or postpone his vaca tion because of his inflation losses. On the contrary, in reaction to his losses, he may save less and consume more because of the ap parent "futility" of saving. Or, he may want to hedge against further lossles by investing in dur able goods, which do not enhance the capital supply. On the other hand, the debtors who are gaining from the debt depreciation may immediately raise their consumption. The gov ernment whose real debt, let us say, is cut in half will surely in crease its spending. In fact, it may be tempted to add more debt 1976 CAPITAL CONSUMPTION 287 until its old level of real debt is restored. Most individuals t,end to react the same way. The house owner whose mortgage debt has diminished to insignificant month ly payments may buy new furni ture or appliances. His consump tion rises as his debt decreases.

Corporate Losses Corporations, which as a class are the largest debtor, lose most of their inflation gains to tax col lectors, labor unions, and their customers, all of whom are eager to boost their consumption. As prices rise taxes rise at progres sive rates. When corporate income doubles on account of the inflation, the multiplicity of corporate taxes will surely more than double. La bor unions will make massive de mands that are to compensate them for past losses and antici pated losses during the life of the contract. And finally, customers may reap inflation gains as corporations tend to pass their gains from debt depreciation on to their customers. After all, when a bank loan falls in value or a corporate bond loses in purchasing power, a corpora tion usually does not raise the prices it charges its customers. On the contrary, facing the com petition of many other enterprises reaping similar gains, the corpo ration may keep its own prices lower than it otherwise would.

This means that customers pay prices that do not fully cover the rising costs of capital. Only grad ually, when the inflation raises interest rates and corporations faee higher interest charges on new loans, do business costs rise and ultimately the prices of goods. Thus, corporate customers are reaping gains at the expense of corporate creditors, gains that may find their way into additional consumption. Only a small fraction of the capital lost by creditors may be retained as productive capital by the corporation. Capital Markets Disappear Inflation destroys the capital markets. Surely, there are always debtors eager to borrow money at "low" interest rate~, that is, at rates that do not fully compensate the lender for the anticipated in flation losses. But the number of credi tors willing to lend their funds at such rat.es tends to shrink with progressing inflation. Instead of suffering losses, the would-be lenders may prefer to consume their funds, or invest them in dur able goods that may rise in price rather than depreciate in purchas ing power.

Thus, the capital market tends to wane and economic expansion is checked for lack of capital. In fact, there may not even be enough 288 THE FREEMAN May capital to maintain the apparatus of production if business should fail to earn sufficient profits to re build and replace the capital goods that were used in the production process. In countries that are plagued by chronic inflation, as in Asia and South America, long-term capital markets have long ceased to exist. Consequently, new plants and en terprises requiring large invest ments of capital cannot be built, labor productivity cannot rise and living conditions are destined to remain at misery levels. Inflation makes economic calcu lation nearly impossible, which in variably causes businessmen to overestimate their earnings and overpay their taxes. Both account ing convention and tax legislation permi t businessmen to treat as costs only those costs of capital that were expended in the pas,t.

But economic action always aims at future provision of goods and services; the past is significant only as it provides the m'eans for future action. The fact that a cer tain item of capital equipment cost $1 million five years ago is irrele vant for business decisions if it costs $2 million today. If only $1 million were set aside for its re placement the production process cannot continue. But tax account ing only depreciates past capital costs and thus during inflation understates present costs and over states business earnings. Earnings Overestimated, Taxes Overpaid The overestimation of American corporate earnings in ree-ent years runs into tens of billions of dol lars. Capital intensive industries, especially, are badly air ected by this delusion, leading to massive capital consumption. To illustrate the point, let's take a chemical company with capital facilities of one billion dollars earning 20 per cent before taxes, but after taxes only 10 per cent or $100 million per year. If the facilities need to be replaced on the average of every five years, our company will depreciate $200 million per year.