The Functional Role of Profits

Arnold W. Johnson, Professor of Accounting (Emeritus), New York University, now lives and writes from Boca Raton, Florida.

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 existence of concurrent: (a) agitation against profits and the free enterprise system and (b) agitation pro-rooting 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 production above “average profits” for the five years ending with 1973.

3) A “basic surcharge” of up to 100% of production exceeding operating levels authorized by the provincial government.

Still more recently, Prime Minister Trudeau required Canadian corporations to trim their profits by 5%—this action being significantly modified in 1976 when Prime Minister 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 electorate voted for Francois Mitterrand—and his platform calling for: a) the nationalization of banks, insurance companies, and selected major industries, b) more social egalitarianism via such programs as substantial taxes on personal property, increased taxation of the incomes of the rich, a reduced work week, a higher minimum wage, and so on. 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 penalizing the profits earned by corporations? Individually and collectively, 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 extinguished 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 wellspring of jobs.

It follows, accordingly, that all of us should be staunch defenders and expositors of the profit and loss system. We should aggressively champion the profit-and-loss system and we should also be able to explain it with tutorial understanding.

To impose upon corporate businesses an artificial “earnings ceiling” measured by the yardstick of”a fair amount of profit” (a term difficult to define) would inject into the economic fabric a debilitating force potentially powerful enough to ultimately destroy the delicate balance which, in a capitalistic society, determines what and how much shall be produced. The same conclusion is also the consequence of unrealistic labor-union demands.

The Regulated Economy?

If governmental “controllers” (i.e., governmental “regulators” of American business) should become the active administrators of American business, what then? Will this consequence bring with it the sacrifice of a free market capitalistic economy in favor of a command or socialistic economy?

The system of free enterprise, the very core of which is the profit motive, 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 enterprise (which has shown such demonstrable social benefit) should be:

1) Challenged by individuals and organizations espousing economic systems which are not only patently inferior but, importantly, are unproven and untried as well. These advocates seem to favor a devitalizing system of Big Brother government—a government which owns, controls, or acts as miner, manufacturer, seller, shipper-and-trans-porter, banker, insuror, accountant, taxing authority, societal decision-maker, and so on.

2) Penalized by, or threatened with, punitive rates of income taxation, labor prices, and controls.

Our economic liberty can be easily lost by choking private business with the weeds of governmental intervention. This is but to say that private business is being increasingly stifled by the massive requirements of governmental red tape.[1] “Government 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 General 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 explain, and somewhat difficult for significant blocks of people to understand. In any discussion of the profit-and-loss system, it is well to recognize certain postulates:

1) Profits are essential to our economic 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 the production[3] needed for fulfillment of the demands of consumers.

2) It is a truism that too many of our citizens do not really understand the functional role of profits. Too many of them seem not to understand that a given business must earn a profit as justification for its very existence. (For any given business, the incurring of successive operating losses coupled with significant increases in debt portrays a deteriorating economic position,—a position which, in turn, points to the Conclusion that the business itself will likely not exist for long. When the factors of deficits and debt are those of the federal government, the malaise permeates the entire business community.)[4]

3) Profits must be explained not only to our associates but to people generally. People must be made to understand that profits are a social good—that profits are the fuel which makes the wheels of industry turn efficiently, the furnaces burn efficiently, the assembly lines hum efficiently—all contributing to the creation of profit, employment, production and, collectively, to the material betterment of society generally.

4) If free enterprise, highly productive, efficient and profitable, should falter, the inevitable sequential 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 entrepreneur’s zest for profit, nationalization of English industry has generated high costs, decreased production, and alarming deficits—in 1975 nationalized 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 disburse is that collected or received by borrowing. In the last analysis, government 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 spawning of jobs sequential to the process of profit pursuance. Another corollary is the following fact: inflation (like that of the 1970s) severs the vital cord between the effort-and-ability of businessmen and their achievement of a compensating reward (i.e. profit).


Profits in our society are important as an index of the success of individual businesses and of the American economy as the composite collection of all individual businesses. Profits are important

•       to the maintenance of job security. Nothing is as hurtful to jobs as the inability of a given business to earn a profit.

•       to the process of obtaining new investments of capital.

•       as proof of the economic justification for the existence of a given business or industry.

•       because it is the pursuit of profit that spurs the production-of-wealth process and the concomitant 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 generally do not really understand the functional role of profits. And the anti-profit forces are often very voluble.

What is our responsibility? Only those who really understand the functional role of profits are qualified to explain them. We must assume the responsibility of explaining the profit system. We must make the explanation so logical and so interesting that people will listen, make it so clear and convincing that they must and will understand.

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 responsibility to uphold, defend, and improve the procedures of our free enterprise system and all of the freedoms resting upon it. Never should it be forgotten that the system of free enterprise is the cornerstone of our whole political structure.[6]

Forfeiture by Default

Never should it be forgotten, further, that free enterprise (i.e., capitalism) 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.[7] Passivity is an invitation to disaster because failure to defend our system of free enterprise is a failure to defend economic freedom and personal liberty. Freedom is not flee. And “failure to defend free enterprise” is a non-act which forfeits (by the process of default) the economic debate which free enterprise involves. Further, it invites “professional critics” and demagogues to press their claims for the substitution of uncontrolled spending and compassionate rhetoric in place of economic common sense. They seem not to understand for example, that government cannot borrow or spend its way to prosperity or solvency. They seem, also, not to understand that a declining economy which gives increasing acceptability to the practice of taking from the productive in order to support the willingly nonproductive can have one result only: a poorer United States of America because of a decline in the amount of material production per capita.[8]

All of us should be staunch and well-qualified understanders of our profit-and-loss economy and, also, should be equally staunch and well qualified expositors, defenders, and improvers of the free enterprise system—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 economic system ever generated in all of the history of mankind. []

1.   ". . . There are now no fewer than 87 Federal entities that regulate U.S. business, and to complete the 4,400 different forms they dispense requires 143 million man-hours of executive and clerical effort each year. The regulators 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 billion . . .” Newsweek, June 12, 1978, p. 86.
      See also: Time to Control Runaway Regulation by Murray L. Weidenbaum, Reader’s Digest, 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.

2.   Policy paper, Center for Research in Governmental Policy and Business, The University of Rochester, May 1976.

3.   When 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 of things our citizens now take for granted: educational facilities for our children and ourselves, protection against fire, protection against crime, protection 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.

4.   According to a report of the National Taxpayers’ 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 century 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 slavery in the form of an increasing role of government 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 economy, a society controlled by government, we shall lose not only our economic advantage but also our political freedom . . .” Milton Friedman: Address: National Association of Manufacturers Congress of Industry, 1978.

7.   "All that is necessary for the forces of evil to win the world is for enough good men to do nothing.” Edmund Burke, 1739-1797.

8.   "If the road to serfdom—government control and economic decline—is paved with ever-in- creasing proportions of the earnings of individuals 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 Foundation, National and Informational Report, Vol. I, No. 4, April 1980.

In a country where capital is scarce and business leadership talent is in short supply, profits will and must command a larger share 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 under-developed 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 nationalized the high-profit firms.

Benjamin A. Rogge, “Profits”