Free-Market Fundamentalism Defines Conservative Movement

IRVING KRISTOL, Two Cheers for Capitalism (1978)

The modern conservative movement traces its origins to the free-market ideology that developed in opposition to Franklin Roosevelt’s New Deal, which critics sometimes decried as evidence of creeping socialism. These critics worried that excessive government interference with the economy would strangle free enterprise and lead inevitably to constraints on individual liberty, and this ideology captured the Republican Party, informing Reagan-era “supply-side economics.” Here, the intellectual hero of neoconservatism, Irving Kristol, discusses the effect of government regulation on the national economy.

In all of the recent discussion of our economic condition, there has been controversy over whether tax cuts are really necessary and, if so, what kind would be most beneficial. To the best of my knowledge, no one — not even John Kenneth Galbraith1 — has dreamed of proposing a tax increase. Yet that is what we keep on getting — specifically an increased tax on corporate income — only no one seems to notice.

It is not really as surprising as one might think that our economists, our accountants, even our business executives should be oblivious to the steady increase in corporate taxation that has been taking place. Habitual modes of perception and conventional modes of reckoning are likely to impose themselves on a changing reality rather than go through a painful process of adaptation. And the learned economist or alert executive can fail to observe an important feature of a situation because he wasn’t looking for it.

Here is an example of what I mean. Corporation X, in order to meet water pollution standards set by the Environmental Protection Agency, has to install new filtering equipment that costs $2 million. How is this expenditure to be accounted for? Well, at present, it is counted as a “capital investment” and is carried on the books as an “asset” of the corporation. But does that make any sense?

After all, a “capital investment” is supposed to promise an increase in production or productivity, or both. An “asset,” similarly, is supposed to represent earning power, actual or potential. But that new filtering equipment may do none of these things. Indeed, it may actually decrease productive capacity and productivity. In short, the $2 million ought properly to be counted as a government-imposed cost — in effect a surtax or effluent tax — and the company’s stated after-tax income should be reduced accordingly.

Instead of imposing an actual tax and using the proceeds to purchase and install the equipment, the government mandates that the firm do so. The end result, however, is the same.

I am not saying that the new filtering equipment is just money down the drain. It does buy cleaner water, after all. But that cleaner water is a free “social good” and a “social asset” to the population in the neighborhood (and for the fish, too); it represents no economic gain to the corporation, which has only economic assets and knows nothing of “social assets.” It also buys governmental “good will,” but so do bribes to foreign officials, and I am not aware that anyone has yet thought to capitalize them. On the other hand, the new equipment is unquestionably an economic cost to the corporation and, of course, to the economy as a whole.

As things now stand, we render those economic costs invisible. That is both silly and undesirable. Silly, because they are real costs. Undesirable, because we shall never persuade the American people to take the problem of regulation seriously until they appreciate, in the clearest possible way, what it is costing them as stockholders, consumers, and employees.

The costs we are talking about are by no means small, and their impact by no means marginal. In fact, they are far, far larger and more serious than most people realize. Unfortunately, there are no comprehensive, precise estimates available. But one can get a sense of the magnitude of such costs from the following bits and pieces of information.

None of the above figures is particularly reliable, and they may not even be entirely consistent with one another. But they do suffice to give a pretty fair indication of what is going on. Even so, important costs are omitted — those, for example, which involved product redesign or the design of the work place. Thus, the increased cost of housing over these past years results, to a significant degree, from various environmental regulations. And Ewan Clague, former U.S. Commissioner of Labor Statistics, points out that productivity in bituminous mining has decreased 30 percent since 1970, largely as a result of the passage in that year of the Coal Mine Health and Safety Act. These indirect costs are not capitalized, of course, and technically are not “hidden.” On the other hand, who would claim that the public appreciates their dimensions?

As one contemplates those numbers, various inferences suggest themselves. One is that a clear distinction ought to be made between “capital spending” and “capital investment.” We were told, for instance, that capital investment in 1976 amounted to $121 billion, and economists were somewhat disappointed that this represented only a 7.5 percent increase over 1975. But if, as seems likely, as much as 10 percent of that figure should not have been counted as “capital investment” at all — since it consisted of economically unproductive expenditures — where does that leave us? It leaves us, I would suggest, with a net reduction in true capital investment in 1976, the economic effects of which will be with us for years ahead. One such probable effect, a decline in the rate of growth of the American worker’s productivity, has already been noticed, though never accounted for.

It may be argued that these economically unproductive expenditures do, after all, create jobs (temporarily) and do contribute to the Gross National Product. But so would the corporate construction of beautiful pyramids, at government behest. That would create jobs (temporarily), inflate the GNP, and provide us with a “social good” (a great spectacle). But it would be a cost to the economy, and if our conventional statistics are incapable of showing it as such, then those statistics need revision.

It is also true that, in many cases, corporations are able to maintain their profit margins by passing on their increased costs directly to the consumer and indirectly to their stockholders (by holding down dividends) or to their employees (by granting lower wages than they otherwise might). But that is what usually happens to corporate taxes; they get passed on to someone since the corporation itself is only an economic mechanism, not an economic person (except, fictitiously, in law). In the world market of today, however, not all corporations can pass on those costs. In those instances, we get declining businesses, declining industries, and a sagging economy. In any case, those costs — passed on or not — should be visible, instead of hidden as they now are. The Federal Reserve’s index of plant capacity, for example, apparently makes no effort to distinguish between capital expenditures and capital investments, and to that degree is misleading.

It is true, too, that firms can depreciate their uneconomic, mandated capital expenditures. But that equipment will have to be replaced as it depreciates with age; we are not talking about a one-time expense.

The situation we have gotten ourselves into would be ridiculous if it were not so serious. We have been much exercised — and quite rightly — by the fact that the OPEC monopoly has cost this country well over $30 billion in increased oil prices since 1972. But in that time we have inflicted upon ourselves much larger economic costs through environmental and other regulations and will continue to do so, perhaps at an increasing rate.

Yes, these economic costs do buy real “social goods.” But may the prices not be too high? Is the resulting inflation of prices, constriction of productive capacity, and increase in unemployment worth it? Would it not be appropriate for us to ask ourselves this question openly, instead of going along with the environmentalists’ pretense — so pleasing to our politicians — that our “social goods” cost us nothing at all? Isn’t it time that business stopped bleating in a general way about those costs and showed us what they really mean, all the way down to the bottom line?

Irving Kristol, Two Cheers for Capitalism (New York: Basic Books, 1978), 50–53, 54.

READING AND DISCUSSION QUESTIONS