The DealBook newsletter delves into a single topic or theme every weekend, providing reporting and analysis that offer a better understanding of an important issue in the news. This week, the financial journalist Roger Lowenstein weighs in on a plan by Senate Democrats to tax stock buybacks. If you don’t already receive the daily newsletter, sign up here.
Corporate share buybacks have been a boogeyman on the left ever since Senator Bernie Sanders attacked them during his presidential run in 2016.
Now the cause has been taken up by Senate Democrats, who want to tax corporations on their stock repurchases. The stated reason is that companies should use their cash to increase wages rather than goose their stock prices and reward their chief executives.
But the truth is that taxing or restricting share buybacks won’t end corporate greed, or excessive compensation.
Despite the pronouncements by business leaders about their efforts to help society, most of the social good that they do arises incidentally, as a result of their success. Private businesses may be fundamental to the American experiment, but most do not set out to improve overall living standards or, specifically, to create jobs.
Take Bill Gates. When he started Microsoft with Paul Allen in 1975, he had no notion of turning it into one of the country’s largest employers. He was a bright, ambitious kid who liked computers. Today, the company has nearly 200,000 people on its payroll. Incidentally, Microsoft just announced a $60 billion stock repurchase program.
Mr. Gates and Microsoft exemplify the paradox famously conceptualized by Adam Smith: Every individual “neither intends to promote the public interest, nor knows how much he is promoting it.” Instead, “he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.”
Modern corporate decisions, including those determining capital levels, are similarly made for selfish, or self-interested, reasons. Subject to well-enforced laws and vigorous regulation, more success typically results in more jobs and investment. Conversely, during the financial crisis, when corporations were flailing, Main Street was hurting even worse.
The system of public capital depends on corporations’ selling stock, but we do not require that companies sell stock. There is no public duty (except in regulated industries such as banking) to maintain any specific level of capital.
Here’s one way to think about it: If it is not wrong for a corporation to sell $3 billion in stock, is it wrong for it to sell $4 billion and later buy back $1 billion? In the end, it is the same thing.
Buybacks are simply a means, via the intermediary of investors, of reallocating capital from companies with a surplus to companies with a capital need. And too much capital can be just as harmful as too little, leading to a misallocation and a waste of social resources.
“The best use of cash, if there is not another good use for it in business, if the stock is underpriced is a repurchase,” Warren Buffett said in 2004.
Business & Economy
Even so, businesses frequently make capital allocation mistakes. Determining the right level of capital depends on forecasting future returns, a highly imperfect science.
It is also true that buybacks are often made from a misbegotten obsession with short-term stock prices. But it would be hard to legislate a distinction between “bad” buybacks and “good” ones.
Proponents of taxing share buybacks say the 2017 corporate tax cut touched off a wave of stock repurchases. They argue that chief executives used the cash for selfish reasons rather than invest in workers.
But the supposed link between buybacks and inequality is unproven. (In some periods, the correlation actually runs the other way.) Share buybacks from S&P 500 companies hit a record $806 billion in 2018. They have fallen since but remain at historically high levels. Meanwhile, in a roughly coincident period, 2016 to 2019, inequality as measured by both income and wealth was modestly falling — reversing the trend of sharply rising inequality since the financial collapse, according to the Federal Reserve’s triennial Survey of Consumer Finances.
Inequality, of course, remains high (and was given a further push by the pandemic). Its causes are complex. But in general, companies do not raise salaries because they have excess capital; they raise wages to attract more and more talented workers. If there is a link between buybacks and wages it is pretty obscure; what we know for certain is that before the pandemic, when executives were busily repurchasing shares, relative wages for those at the bottom were finally starting to recapture lost ground.
The worst aspect of penalizing share repurchases to restrain executive pay is that it is a painfully indirect approach. The argument that buybacks sometimes have the effect of enhancing executive compensation is true of anything that enhances share prices. That can include investing in a new product, leveraging the balance sheet by borrowing (which has the same effect as retiring equity), cutting expenses or doing anything else that shareholders decide to reward.
Those against the corporate tax cut could better accomplish their aims by reversing it than by taxing the buybacks that were a supposed and relatively minor outcome of the reduced tax rates.
For those who think that executives unreasonably and often obscenely game their control of corporate assets, it would be more effective to attack the problem head-on. Raise the marginal income tax on ultrahigh earners.
More directly, the Securities and Exchange Commission could require that executive pay plans above a minimum threshold be subject to a binding vote by shareholders, who are footing the bill.
Finally, there is an argument that options granted to insiders create an untenable conflict of interest and an abuse of fiduciary responsibility. Perhaps they should be banned or the profits on options should be taxed at punitively high rates.
But does the buyback deserve to be a whipping child for real or imagined corporate ills? Common sense suggests it is 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 stock buybacks? Are there better ways of keeping executive pay in check? Let us know: [email protected].