A Public Service Message from the American Indome Life Insurance CompanyExecutive offices, Waco, TexasBernard Rapoport, Pres. The dirty six-letter word. ‘profit’ By Martin Stone One of the fallacies which has been most damaging to our nation’s economy and which has unfortunately been constantly publicized by irresponsible politicians is that corporatiohs’ profits have been climbing outrageously. Nothing could be further from the truth. The fact is that, when factored for inflation, the profits of non-financial corporations for the ten years through 1974 declined by 20%. In terms of share of national income, corporate profits have declined from 13.3% of national income in 1956 to 9.2% in 1974. By contrast, during the same period employee compensation has gone from 70.2% to 75.1% of national income. After adjusting for inflation, corporate profits have declined from a 10% return on investment in 1966 to approximately 5% in 1974. With interest rates as high as they presently are, corporations have no incentive to borrow additional funds with which to expand or even to maintain their level of operations. Operating a business involves the risk of loss as well as the prospect of profit. When business cannot earn significantly higher levels of return than the cost of borrowed money it is foolish to take the risks of borrowing to finance operations. Today more and more people are going on welfare, into all forms of government employment, and into other areas that do not produce goods for public consumption. Thus, fewer and fewer people in producing industries are being asked to produce the goods and services for ever-increasing numbers of “non-productive” people. At the same time, industry is being starved for liquid capital with which to modernize and expand productive capacities. With the high levels of inflation and constant erosion of profits, it takes a higher percentage of earnings simply to replace existing inventory and capital levels. If the inventories and capital facilities needed to produce higher levels of goods are added in, corporations are caught in a capital squeeze. If industry does not have the capital to purchase the higher levels of inventories and capital facilities, it cannot create the jobs or produce the goods needed to meet the expanding needs of society. In the past as the economy expanded ‘corporations avoided excessive accumulations of debt because profits increased rapidly,, dividends were increased, new equity capital was attracted, and corporate financial health was preserved. Furtherinore, those companies that required debt financing.had a much easier time of it since they did’ not have to compete with massive federal borrowing requirements caused by huge government deficits. What is happening today is that there are constant pressures to reduce corporate profits and increase corporate taxes . with little understanding of the effect inflation has had on real corporate profits and the dangers imposed by the rapid accumulations of corporate debt. One unfortunate aspect of the tax laws which has compounded the problem is that interest paid on debt is tax deductible while dividends are not. As a result, since corporations facing shortages of liquidity were not able to pay out high enough levels of dividends to attract additional equity capital they were forced into borrowing. Another unfortunate political tax decision was the enactment of the “investment tax credit” in lieu of an across-the-board corporate tax cut. The investment credit largely benefits the giant corporations with heavy investments in fixed assets. It discriminates against the generally smaller firms that haven’t yet accumulated large capital bases and are primarily assemblers and Stone is chairman of the board of Monogram Industries. merchandisers. The investment credit is also inappropriate in this era of high unemployment and shortages of energy. Many decisions on whether to install labor saving, energy intensive equipment are marginal and often the difference that causes management to opt for the new equipment is the tax saving afforded by the investment credit. Today, internal generation of capital through profits and depreciation provides far less of a corporation’s needs than it did ten years ago. As Henry Kaufman of Salomon Brothers, one of the nation’s largest underwriters and dealers in public and private debt securities, pointed out: external financing requirements of American business were up from approximately $17 billion in 1964 to approximately $78 billion in 1974. Total capital requirements increased from $25 billion per year to $125 billion per year in the same period. Of this $100 billion increase, approximately $80 billion resulted from the effects of inflation. Thus it is clear that inflation has been the primary cause for the fact that corporations have been forced deeper and deeper in debt to finance their capital needs. While the need for external sources of capital was increasing, the sale of equity securities, the traditional form of external financing, declined dramatically. Part of the reason for this was the increased attractiveness of high interest rates on debt securities which dividends were unable to match because of the difference in tax treatment. The other primary reason was the steep decline of the stock market to the point that most of the stocks traded on the Exchanges or “Over the Counter” were selling at extremely low price/earnings multiples and at prices below existing per share asset values. For a company to have sold equity securities under these circumstances would have been to reduce existing levels of earnings per share and dilute the,per share asset value of existing shares. The change in the form of external financing can be seen in the fact that in the 1960-1964 period, capital raised by non-financial corporations through equity additions exceeded debt increases by $10 billion. In 1965-1974 the additions to debt exceeded the increases in equity \(consisting of retained It is this crushing combination of reduced corporate profits, continuous inflation and the diminished liquidity of corporate balance sheets that makes it an absolute certainty that corporations will be forced to seek substantial amounts of capital in the capital markets over the next few years. In fact, the present remedies for overcoming the recession appear to be exactly the opposite of what we should be doing to overcome the shortage of capital. We must reverse the pattern of increased consumption and reduced savings. Until a balance is restored, governmentally established tax and other incentives should discourage consumption for the benefit of greater rates of savings which ultimately find their way into our financial markets and reinforce our capital base. Instead the government’s policies are designed to encourage consumption spending, thus reducing the level of savings. If the government’s policy had been the reverse of what it is, we would recover more slowly from the recession but both short term and long term inflationary pressures would be lessened, interest rates would decline, and a base would be laid for a more stable, long term recovery wherein people could make their business and personal financial ‘plans with a greater degree of security and predictability. The added funds that went into additional capital would create the long term, productive jobs that would truly reduce unemployment and inflation. The long term answer to inflation is adequate capacity to meet realistic needs ‘and the ,……..11411111iliglitrallgraftartiliklia06.0″, 041e… .. ,ovomsc.lown.
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