Biden’s Buyback Derangement Syndrome
President Joe Biden plans to call for quadrupling of the one percent surcharge on stock buybacks during his State of the Union address on Tuesday night.
The proposal is likely dead on arrival because Republicans, who control the House of Representatives, are unlikely to support it. Yet it is worth considering the buyback tax in order to highlight the terrible, ignorant, and just plain weird ideas that are behind it.
The Biden administration’s misleadingly named Inflation Reduction Act included a one percent stock buyback tax that went into effect at the start of this year. Even when it was in the process of being enacted, most analysts agreed that it would not do much to reduce plans by corporations to repurchase their shares because the one percent rate was too low to make much of a difference. Critics of the plan said the one percent was a kind of Trojan Horse tax: once it made it inside the gates of the tax code, Democrats would eventually and inevitably seek to hike it in search of more revenue. Eventually and inevitably turned out to be just a month after the one percent tax became effective.
State of the Union Sneak Peak
Why are Democrats — and sometimes Republicans — trying to tamp down on stock buybacks? The Biden White House on Monday released a preview of tonight’s State of the Union speech that included a rambling and confused explanation:
President Biden signed into law a surcharge on corporate stock buyback [sic], which reduces the differential tax treatment between buybacks and dividends and encourages business to invest in growth and productivity as opposed to paying out corporate executives or funneling preferred profits to foreign shareholders.
There are lots of half-formed arguments in that statement; so, let’s take them one at a time starting with the notion that companies are somehow neglecting to invest in growth and productivity because they are spending their money on buybacks. This is a strange argument because it implies that investors are wrong about their own interests, that they are rewarding companies for buying back shares when the money could be more profitably used to “invest in growth and productivity.”
Basic finance suggests this is not true. Stock prices reflect expectations of future earnings discounted for risk and time. A company that buys back stock at the expense of future earnings is likely to see its stock price decline. Executives who oversee capital plans that push down share prices are likely to become ex-executives in short order, which is why they do not usually do this. When companies buy back stock, it is usually because management believes the stock is undervalued or that they have already fully invested profits in things like R&D and have concluded that the best thing to do is return capital to shareholders.
Fact Check: Do Buybacks Reduce Investment?
It also is not true that companies that buy back their shares are not investing in growth and productivity. Apple is a huge repurchaser of its shares, and it is also a huge investor in research and development. Last year, Apple spent $27.7 billion on R&D, an almost 20 percent increase from the prior year. It also bought nearly $90 billion of its own shares. Does anyone seriously think that Apple miscalculated and is under-investing in its business? Probably not. Instead, Apple is spending a tremendous amount on growth, but it earns so much money that it still has excess cash left over.
A 2017 study by Silvina Rubio of Spain’s University Carlos III de Madrid looked at the effect of buybacks by companies whose shares have recently fallen, where management is likely motivated to buy back shares in an effort to stabilize their price. She discovered that these companies raised investment in their businesses in the first and second years following an announced repurchase. Capital expenditures at the stablizing-buybackers were twice that of non-buybackers. Spending on R&D was 27 percent higher. This makes sense because the executives and boards approving buyback plans believe in the future earnings potential of their companies — so they invest and repurchase shares.
The idea that buybacks prevent investment in growth and productivity is backward. Businesses tend to raise capital when they want to invest — going to venture capitalists or public markets — and to return capital when they do not have further profitable investment opportunities. Importantly, that returned capital does not vanish. The investor proceeds are received by the shareholders, who can and typically do invest the proceeds elsewhere. Even if the investors simply spend the money on consumer goods and services, this transfers the profits to other businesses that may have better uses for them.
By the way, the foregone investment objection to returning capital to shareholders would apply just as much to dividends as to buybacks. Yet the Biden administration’s statement implies that buybacks are somehow worse in this respect than dividends. This makes no sense whatsoever.
The Taxman Cometh
There is one perspective in which dividends are preferable to buybacks, and that is the perspective of the tax collector. Dividends are taxed as income to shareholders, but shares sold in a buyback might incur a capital gains tax, which is often lower than the income tax rate. So, buybacks arguably cost the U.S. government revenue, which is likely one reason a big spender like President Biden would like to crack down on them.
However, the revenue loss may not be anywhere near as high as it seems. Many households own stock through pensions and tax-shielded retirement accounts, so they are not paying dividend taxes anyway. For many others, dividends and capital gains are taxed at the same rate anyway. What’s more, many companies may simply choose to hoard cash—perhaps hoping for tax relief in the future—than pay it out in a way that inflicts a large tax bill on some shareholders. Forcing companies to switch to dividends from buybacks may simply not produce the gains the government beancounters expect.
Stranger Things: Biden Wants Fossil Fuel Companies to Have More Money
Which brings us to the weirdest aspect of the American left’s war against buybacks: effectively it is a call for corporate management to retain more control of how their profits are invested. Instead of capital getting distributed out to investors, it would be concentrated in corporate treasuries. The decisions about how that capital would be invested would be made by executives instead of investors. Does Biden really think the world is a worse place because investors are deciding how to allocate the windfall profits from last year’s transitory energy boom rather than the folks who run oil and gas companies?
Actually — and bizarrely — the answer is yes. “Last year, oil and gas companies made record profits and invested very little in domestic production and to keep gas prices down—instead they bought their own stock, giving all that profit to their CEOs and shareholders,” the White House said in its preview last night.
There are many reasons why investors want domestic oil and gas producers to return capital. First, in the recent past, oil profits were spent extravagantly on expansion and produced enormous losses. Second, the left’s war on fossil fuels leaves investors worried about the long-term viability of the business. Third, enthusiasm for ESG investing and climate change fears have made further investment in fossil fuels unfashionable and fraught from a public relations standpoint. Many investors would prefer to sell their shares back to the company and invest in green energy.
Biden apparently thinks this is a bad thing—at least when he is seeking to impose a tax on buybacks.
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