The DealBook Newsletter dives into a single topic or theme each weekend, providing reporting and analysis that provides a better understanding of a key topic in the news. This week, the financial journalist Roger Lowenstein weighs in on a Senate Democrat plan to tax share buybacks. If you do not yet receive the daily newsletter, Register here.
Company stock buybacks have been a bogeyman on the left ever since Senator Bernie Sanders attacked them during his presidential run in 2016.
Now the case has been taken up by Senate Democrats, who want to tax companies on their share buybacks. The reason mentioned is that companies should use their money to raise wages rather than raise their stock prices and reward their CEOs.
But the truth is that taxing or restricting share buybacks will not end corporate greed or excessive fees.
Despite the statements made by business leaders about their efforts to help society, most of the social good they do arises incidentally, as result of their success. Private companies may be fundamental to the American experiment, but most are not intended to improve general living standards or, specifically, to create jobs.
Take Bill Gates. When he started Microsoft with Paul Allen in 1975, he had no idea how to make it one of the largest employers in the country. He was a smart, ambitious boy who loved computers. Today, the company has nearly 200,000 people on its payroll. Incidentally, Microsoft just announced a $60 billion share repurchase program.
mr. Gates and Microsoft are a famous example of the paradox conceptualized by Adam Smith: Each individual “does not intend to advance the common good, nor does he know to what extent he promotes it.” Instead, “he has only his own gain, and in this, as in many other cases, he is guided by an unseen hand to further an end which was not part of his intent.”
Modern business decisions, including those that determine capital levels, are similarly made for selfish or self-serving reasons. Depending on properly enforced laws and strict regulations, greater success typically results in more jobs and investment. Conversely, during the financial crisis, when businesses struggled, Main Street was in even more pain.
The system of public capital depends on the selling shares of companies, but we do not require that companies sell shares. There is no public duty (except in regulated industries such as banking) to maintain a certain level of capital.
Here’s one way to think about it: If it’s not wrong for a company to sell $3 billion worth of stock, is it wrong to sell $4 billion and then buy back $1 billion later? In the end it’s the same.
Buybacks are simply a means of reallocating capital from companies in surplus to companies with capital needs through investor intervention. And too much capital can be just as damaging as too little, leading to misallocation and a waste of social resources.
“The best use of cash, if there’s no other good use for it in business, if the stock is underpriced, is a buyback,” Warren Buffett said in 2004.
Business and Economy
Yet companies often make mistakes when allocating capital. Determining the right level of capital depends on predicting future returns, a very imperfect science.
It’s also true that buybacks are often made out of a misguided obsession with short-term stock prices. But it would be difficult to differentiate between “bad” repurchases and “good” repurchases.
Proponents of taxing share buybacks say the corporate tax cut in 2017 sparked a wave of share buybacks. They argue that top executives used the money for selfish reasons rather than investing in workers.
But the supposed link between buybacks and inequality has not been proven. (In some periods, the correlation actually goes the other way.) Share repurchases of S&P 500 companies hit a record $806 billion in 2018. They’ve fallen since then, but remain at an all-time high. Meanwhile, in a roughly coinciding period, 2016 to 2019, inequality measured by both income and wealth modestly declined — reversing the trend of soaring inequality since the financial collapse, according to the triennial Survey of Consumer Finances. of the Federal Reserve.
Inequality remains high, of course (and was boosted by the pandemic). The causes are complex. But in general, companies don’t raise salaries because they have excess capital; they raise wages to attract more and more talented workers. If there is a connection between repurchases and wages, it is rather obscure; what we know for sure is that before the pandemic, when executives were busy buying back shares, relative wages for those at the bottom had finally begun to regain lost ground.
The worst thing about penalizing share buybacks to limit executive pay is that it’s a painfully indirect approach. The argument that buybacks sometimes increase executive pay applies to anything that raises stock prices. This could include investing in a new product, leveraging the balance sheet by borrowing (which has the same effect as withdrawing equity), cutting costs, or doing anything else that shareholders decide to reward.
Those who opposed the corporate tax cut were more likely to achieve their goals by reversing it than by taxing the buybacks that were an assumed and relatively small consequence of the reduced tax rates.
For those who believe that executives are unreasonably and often obscenely playing their control over company assets, it would be more effective to tackle the problem head-on. Increase marginal income tax for ultra-high earners.
More directly, the Securities and Exchange Commission could require that executive compensation plans above a minimum threshold be subject to a binding vote by shareholders, who foot the bill.
Finally, there is an argument that options granted to insiders create an untenable conflict of interest and abuse of fiduciary responsibility. Perhaps they should be banned or the profits on options taxed at high rates.
But does the buyback deserve to be a whip child for real or imagined business problems? The evidence suggests it’s better to leave it alone.
Roger Lowenstein is the author of six books, most recently “America’s Bank: The Epic Struggle to Create the Federal Reserve.” He is also a director of the Sequoia Fund. He writes regularly here.
What do you think? Should the government tax share buybacks? Are there better ways to control executive pay? Let us know: firstname.lastname@example.org.