The Power of Profits

Larry Kudlow
|
Posted: Dec 27, 2003 12:00 AM

Corporate profits are the mother's milk of business. Rising profits lead to business expansion, and falling profits lead to business recession. And right now profits are flowing in, yet another affirmation that the Bush boom is for real and that new jobs are on the way.

The final report for third-quarter gross domestic product reveals that profits have increased a huge $101 billion, gaining 25 percent over the past year. This is just about in line with the broad advance of the stock market. More, over $1.1 trillion in new earnings has increased the profit share of GDP to 10.1 percent, way up from the cyclical low of 7.1 percent in the third quarter of 2001. This is an impressive move.

Behind the profits recovery are two key factors: cost cutting and productivity. Both reflect a more efficient business sector -- especially the productivity miracle, which has reduced unit labor costs (the largest expense for businesses) well below final product prices.

Business revenues are also beginning to pick up, meaning that next year, steady revenue growth coupled with improved profit margins will drive profits up by another 20 percent.

The Bush tax cuts are also playing a critical role in this profit recovery by significantly reducing after-tax capital costs to business. Besides giving investor returns a much-needed after-tax boost, lower tax rates on dividends and capital gains have reduced the cost-of-capital "breakeven hurdle rate" for business investment. And lower business-investment costs are being passed on in the form of reduced production costs. That's one reason why the production of business equipment and software increased 17.6 percent at an annual rate in this year's third quarter and 8 percent in the second quarter, after a lengthy decline for corporate investment.

And here's another big plus for the profits recovery: Bush's 50 percent expensing bonus for the tax write-off of new equipment purchases is playing a major role in shaving the cost of corporate capital.

The importance of accumulating corporate profits is always underestimated. Yet when corporate profits increase, sizable job expansion follows, as firms have plenty of spare cash to replace, modernize and update all of their production facilities. This, of course, includes the tech software and hardware equipment to support new demands from wireless, cable, Internet telephony and consumer electronics. Profit-funded job creation will also occur among commodity producers, energy firms, industrial smokestacks and financial businesses.

Liberal politicians love jobs, but they don't seem to favor the profits that finance jobs. It doesn't take long to think of politicians who rail against excessively profitable companies, yet it is these very same firms that create jobs with their profits.

During the 2000 election, Al Gore continuously attacked drug companies, insurance companies, oil companies and others for "excess profits." Taking a cue from Gore populism, Howard Dean not only wants to break up big media companies, he never has a good word for business.

To Dean, the corrupt Enron symbolizes business. And as the election cycle heats up, it often seems like he's running against Halliburton, rather than for the great American business sector. Yet Halliburton is a good and clean company. Its biggest problem is frivolous asbestos lawsuits, a tort attack that nearly bankrupted the company and would have destroyed tens of thousands of jobs. Ever hear Howard Dean call for limited lawsuit tort reform? Don't hold your breath.

Corporate profits are a vital form of capital, and capital is the key ingredient in capitalism. If the latter is to work and expand prosperity, then the former must be saved. In fact, corporate profits shouldn't be taxed at all.

It would be much better to abolish the corporate tax code, along with all of its special-preference complexities that reward political lobbying rather than work effort or entrepreneurial investment. The taxation of corporate capital gains and paid dividends should similarly be abolished. Company investments should be cash-expensed immediately in the first year.

In place of today's cumbersome corporate tax code, why not institute a simple flat tax on corporate sales revenues? Taxing business consumption is a much better idea than taxing business saving and investment. And a business-revenue tax would be much less volatile for government budget purposes.

Profits are the seed corn of economic growth. Eliminating the tax burden on profits will reap a record harvest of jobs and prosperity.