Tax Policy – Sanders and Schumer’s Misguided Stock Buybacks Proposal

On Sunday, Senators Bernie Sanders (I-VT) and Chuck Schumer (D-NY) announced plans for legislation which would limit corporations from engaging in stock repurchases unless they meet several requirements. This proposed legislation is flawed and represents a misunderstanding of stock buybacks.

The proposal would prevent corporations from engaging in stock buybacks, and perhaps dividend issuances, without addressing concerns of employees: first, paying wages of at least $15 an hour; next, providing seven days of paid sick leave; and then offering other benefits. The senators believe this will help address income inequality, but there are at least four problems with the analysis and proposal.

    1. It’s important to understand why stock buybacks occur and the economic role they play. The new tax law lowered the corporate income tax rate, which incentivizes new investment moving forward. A lower rate also means that corporations will receive larger profits than anticipated on investments they made in the past—it should be expected that companies would share at least some of this unexpected increase in cash with their shareholders.

 

    1. Does this mean companies aren’t investing? No. Analysis of stock buybacks must go further than just their issuance. It’s the final use of the cash that matters, not the initial use. Stock buybacks are complements to investment, not substitutes for it.

Research

    shows that stock buybacks do not deprive firms of capital that they would otherwise invest, and further, that stock buybacks can facilitate long-term investment by redirecting funds from lower growth firms to higher growth firms.

  1. The senators compare the level of stock buybacks with the level of firm profits. This is a misleading comparison. Profit is a measure of cash left over after investments, research and development (R&D), wages, and other expenditures have been made. Alarm over stock buybacks and profits misconstrues that buybacks occur from residual cashflow after a company has exhausted its investment opportunities.
  2. Stock buybacks shouldn’t be blamed for other trends. As the recent Harvard Business Review article explains:

    Employees of S&P 500 firms are unlikely to be systematically hurt by either dividends or buybacks….When an S&P 500 firm sheds employees, it’s doubtful the downsizing is driven by lack of cash. A more likely culprit is changing business conditions. In our dynamic market economy, firms frequently expand and contract, with employees and assets moving from shrinking enterprises to growing ones. Indeed, if a firm is seen distributing cash to shareholders and laying off workers, the most plausible explanation is that it cannot efficiently utilize either all its cash or all its employees, not that the payout itself is causing the layoff.

  3. Shareholders are more than just the wealthy. In 2015, the total value of outstanding U.S. corporate stock was nearly $23 trillion, and retirement accounts held the largest share of that stock at 37 percent, or about $8.4 trillion. Pension and retirement accounts are another avenue used by the middle class to invest in the stock market.

This proposal stems from a fundamental misunderstanding of why stock buybacks are occurring, and the long-term benefits they can generate. Viewing stock buybacks in the proper context shows why they do not harm workers, retirees, or others in the economy. Limiting the ability of a corporation to return value to shareholders—value which was created by productive investments made in the past—will not improve economic conditions.


Source: Tax Policy – Sanders and Schumer’s Misguided Stock Buybacks Proposal