The Functional Role of Profits; A. Johnson

Arnold W. Johnson THE FUNCTIONAL ROLE OF PROFITS THAT a considerable amount of anti business sentiment exists in certain segments of our society is a fact well known. Also, well known, is the ex istence of concurrent: (a) agitation against profits and the free enter prise system and (b) agitation pro moting attempts to more heavily tax the profits earned by corporations. One of the candidates in the 1972 presidential campaign, for example, called for an 82% excess profits tax on all corporate income exceeding 1970 earnings. More recently, the government of Manitoba proposed a tax on the mining industry: 1) A basic royalty of up to 33.33% of the value of mine production. 2) An incremental royalty tax of up to 50% of the net value of produc tion above "average profits" for the five years ending with 1973. Arnold W. Johnson, Professor of Accounting (Emeri tus), New York University, now lives and writes from Boca Raton, Florida.

3) A "basic Surcharge" of up to 100% of production exceeding oper ating levels authorized by the pro vincial government. Still more recently, Prime Minis ter Trude au required Canadian cor porations to trim their profits by 5%-this action being significantly modified in 1976 when Prime Min ister Trudeau expanded his wage price control system and decided that all profit margins must be reduced 15%. In France's presidential election (May 10, 1981)(the French elector ate voted for Francois Mitterrand and his platform calling for: a) the nationalization! of banks, insurance companies, and selected major in dustries, b) mo:re social egalitarian ism via such programs as substan tial taxes on personal property, increased taxation of the incomes of the rich, a reduced work week, a higher minimum wage, and so on. 259 260 THE FREEMAN May Mitterrand's platform obviously possesses ominous overtones for the future of free enterprise in France.

What is the meaning of actions like these-actions which are pointed in the direction of harassing and pe nalizing the profits earned by cor porations? Individually and collec tively, as concerned citizens, we should be greatly disturbed. The profit-and-loss system (i.e., the free enterprise system) of the United States is our expression of freedom. Private profit cannot be extin guished without extinguishing, also, personal freedom. Profit, in the last analysis, is simply an expression of liberty-that is, the freedom to work in one's own way and to do it better than someone else. The resulting benefit (i.e., profit) redounds to the advantage of the individual and our economic society in general. Profit is the well-spring and the determinant of production-and it is also the well spring of jobs. It follows, accordingly, that all of us should be staunch defenders and expositors of the profit and loss sys tem. We should aggressively cham pion the profit-and-Ioss system and we should also be able to explain it with tutorial understanding.

To impose upon corporate busi nesses an artificial "earnings ceil ing" measured by the yardstick of "a fair amount of profit" (a term diffi cult to define) would inject into the economic fabric a debilitating force potentially powerful enough to ulti mately destroy the delicate balance which, in a capitalistic society, de termines what and how much shall be produced. The same conclusion is also the consequence of unrealistic labor-union demands. The RegUlatedEconomy? If governmental "controllers" (i.e., governmental "regulators" of Amer ican business) should become the ac tive administrators of American business, what then? Will this con sequence bring with it the sacrifice of a free market capitalistic econ omy in favor of a command or social istic economy? The system of free enterprise, the very core of which is the profit mo tive, is surely the one fundamental basis for our having achieved the highest standard of material living ever attained by any nation in the history of the world. It seems strange, indeed, that the system of free en terprise (which has shown such de monstrable social benefit) should be: 1) Challenged by individuals and organizations espousing economic systems which are not only patently inferior but, importantly, are un proven and untried as well. These advocates seem to favor a devitaliz ing system of Big Brother govern ment-a government which owns, controls, or acts as miner, manufac turer, seller, shipper-and-trans porter, banker, insuror, accountant, 1982 THE FUNCTIONAL ROLE OF PROFITS 261 taxing authority, societal decision maker, and so on.

2) Penalized by, or threatened with, punitive rates of income taxa tion, labor prices, and controls. Our economic liberty can be easily lost by choking private business with the weeds of governmental inter vention. This is but to say that pri vate business is being increasingly stifled by the massive requirements of governmental red tape.! "Govern ment is destroying the individual incentives which are the well-spring of economic growth". 2 Never should it be forgotten that it is the men and women of free enterprise who have taken the risks and created the wealth which government can only consume. Government regulation (in 1977) cost consumers $100 billion or about 25% of the entire Federal budget. About $85 billion was the cost of compliance-to-regulation. To Gen eral Motors the cost-of-compliance was $1.3 billion.-Common Cause, Vol. 6, No.4, April 1980. The defense of the profit-and-loss system, unfortunately, is somewhat complex, somewhat difficult to ex plain, and somewhat difficult for significant blocks of people to under stand. In any discussion of the profit and-loss system, it is well to recog nize certain postulates: 1) Profits are essential to our eco nomic way of life. Profits represent payment for the beneficial use of capital-and, capital, in large amounts, is needed by society for the generation of tne production3 needed for fulfillment! of the demands of consumers.

2) It is a truism that too many of our citizens d~ not really under stand the func~ional role of profits. Too many of them seem not to un derstand that a given business must earn a profit a~ justification for its very existence. I(For any given busi ness, the incurring of successive op erating losses coupled with signifi cant increases! in debt portrays a deteriorating economic position,-a position which, lin turn, points to the conclusion that the business itself will likely not ~xist for long. When the factors of deficits and debt are those of the federal government, the malaise perme~tes the entire busi ness community.)4 3) Profits mlllst be explained not only to our associates but to people generally. People must be made to understand th~t profits are a social good-that profits are the fuel which makes the wheels of industry turn efficiently, the. furnaces burn effi ciently, the assembly lines hum effi ciently-all contributing to the cre ation of profit, employment, production and, collectively, to the material betterment of society gen erally.

4) If free enterprise, highly pro ductive, efficient and profitable, should falter, the inevitable sequen262 TH~ FREEMAN May tial threat becomes-nationalization with all of its inefficiencies. England has shown that nationalization produces monopolies and deficits. Stripped of the discipline provided by competition and by the entrepre neur's zest for profit, nationalization of English industry has generated high costs, decreased production, and alarming deficits-in 1975 nation alized industry lost $2 billion of which the average worker's share was $87. 5) In and of itself government is nonproductive. 5 The only valuable money that government can dis burse is that collected or received by borrowing. In the last analysis, gov ernment can give to some people only that which it has taken from others. A corollary to this statement is: Government cannot spend money without decreasing the amount of capital which otherwise would be used by the private sector for the generation of profits and the spawn ing of jobs sequential to the process of profit pursuance. Another corol lary is the following fact: inflation (like that of the 1970s) severs the vital cord between the effort-and abili ty of businessmen and their achievement of a compensating re ward (i.e. profit).

Summary Profits in our society are impor tant as an index of the success of indi vid ual businesses and of the American economy as the composite collection of all individual busi nesses. Profits are important • to the maintenance of job secu rity. Nothing is as hurtful to jobs as the inability of a given busi ness to earn a profit. • to the process of obtaining new investments of capital. • as proof of the economic justifi cation for the existence ofa given business or industry. • because it is the pursuit of profit that spurs the production-of weal th process and the concom itant fulfillment of consumer demand. All of us should understand the functional role of profits. All of us should be ready explainers of the profit system to all who will listen. If people understand how the profit system works, they will not be fooled by anti-profit propaganda. However, as previously stated, people gener ally do not really understand the functional role of profits. And the anti-profit forces are often very vol uble.

What is our responsibility? Only those who really understand the functional role of profits are quali fied to explain them. We must as sume the responsibility of explain ing the profit system. We must make the explanation so logical and so in teresting that people will listen, make it so clear and convincing that they must and will understand.

1982 THE FUNCTIONAL ROLE OF PROFITS 263 IN a country where capital is scarce and. business leadership talent is in short supply, profits will and must command a larger s~are of the national income than in a country where both capital and talent are relatively abundant. The failure to recognize this fact is the single most important deterrent to economic growth in the underdeveloped countries of the world today. The governments of those countries, inspired in part by the anti-profits bias of both the socialists and the modern! liberals, have tried to keep profit levels low, or have punished or national!ized the high-profit firms. BENJAMIN 4. ROGGE, "Profits" In short, as participants in and beneficiaries of the system 'of free enterprise, it is our responsibility to understand the functional role of profits; and, further, it is our respon sibility to uphold, defend, and im prove the procedures of our free en terprise system and all of the freedoms resting upon it. Never should it be forgotten that the system offree enterprise is the cornerstone of our whole political structure. 6 Forfeiture by Default Never should it be forgotten, fur ther, that free enterprise (i.e., capi talism) is the only kind of economic system compatible with individual liberty. Concurrently, we should constantly remind ourselves that no freedom has ever been maintained when its advocates have been passive and apathetic in its defense.?Passiv ity is an invitation to disaster be cause failure to defend our system of free enterprise is a failure to defend economic freedom and personal liberty. Freedom i~ not free. And "fail ure to defend tee enterprise" is a non-act which forfeits (by the pro cess of default) ~he economic debate which free enterprise involves. Fur ther, it invites ·'professional critics"

and demagogue$ to press their claims for the substitqtion of uncontrolled spending and cpmpassionate rheto ric in place of economic common sense. They seem not to understand ' for example, that government can not borrow or spend its way to pros perity or solveqcy. They seem, also, not to underst~nd that a declining economy which gives increasing ac ceptabili ty to the practice of taking from the productive in order to sup port the willing1y nonproductive can have one result bnly: a poorer United States of Ameliica because of a de cline in the amount of material pro duction per capita. 8 All of us sho~Ild be staunch and well-qualified· u\nderstanders of our profit-and-Ioss!economy and, also, should be equally staunch and well264 THE· FREEMAN qualified expositors, defenders, and improvers of the free enterprise sys tem-the system under which this nation lives. This action is obligatory-if we wish a third century of capitalism to materialize. We must accelerate our efforts to understand, preserve, and improve the most productive eco nomic system ever generated in all of the history of mankind. ® -FOOTNOTES1"... There are now no fewer than 87 Federal entities that regulate U.S. business, and to complete the 4,400 different forms they dis pense requires 143 million man-hours of exec utive and clerical effort each year. The regula tors are proposing so many new rules that the Federal Register has ballooned in size to nearly 70,000 pages annually ... Economist Murray L. Weidenbaum of the Center for the Study of American Business at Washington University, has estimated the total annual bill at $103 bil lion... " Newsweek, June 12, 1978, p. 86.

See also: Time to Control Runaway Regula tion by Murray L. Weidenbaum, Reader's Di gest, June 1979, pp. 98-102. "There are 88,200,000 Americans supported by government ... yet there are only 71,900,000 Americans (employed by the private sector) to foot the bill by paying taxes on their productive earnings."-Tax Target, Washington by Gary Allen, p. 19. 2policy paper, Center for Research in Gov ernmental Policy and Business, The University of Rochester, May 1976. 3When a business fails to earn a profit, "there are no dividends for stockholders. There are no quality products or services for customers. There are no jobs for employees.And there are no taxes to support the increasing number \)fthings our citizens now take for granted: educational facil ities for our children and ourselves, protection against fire, protection against crime, protec tion against illness, to name but a few of the public services paid for by corporate taxes as well as the individual income taxes that you and I pay."-Dimension, May 1968, p. 12.

4According to a report of the National Tax payers' Union, 1980, each citizen's share of the federal debt ($9.03 trillion) was over $112,000. 5"The Department of Energy '" will cost taxpayers $10.6 billion in its first year (and more in succeeding years)." This cost "is greater than the total amount of money that will be spent this year by all of the oil and natural gas producers in the United States for drilling and exploration. And it will not produce one drop of oil or natural gas."-American Cause, Vol. III, No.9, October 1977. 6" •••We in this country in the past half cen tury have been moving from a free society and toward an increasing degree of slavery. Not the kind of slavery that Lincoln talked about, but a kind that is no less destructive of the basic greatness and freedom of this country, a slav ery in the form of an increasing role of govern ment in our country, of an increasing extent to which we are the subjects and the government the master, instead of the other way around.

"If we continue the trend to a collective econ omy, a society controlled by government, we shall lose not only our economic advantage but also our political freedom ... " Milton Friedman: Address: National Association of Manufactur ers Congress of Industry, 1978. 7''Allthat is necessary for the forces of evil to win the world is for enough good men to do nothing." Edmund Burke, 1739-1797. 8"1fthe road to serfdom-government control and economic decline-is paved with ever-in creasing proportions of the earnings of individ uals taken by government, then the road to freedom and economic prosperity is paved with savings. It is the lifeblood of investment and economic growth." American Economic Foun dation, National and Informational Report, Vol. I, No.4, April 1980.