During last night’s State of the Union, President Joe Biden announced a quadrupling of the corporate buyback tax, which was introduced in the 2022 Inflation Reduction Act. The tax will be applied to stock purchases made by domestic public companies.
For reasons that are clear, the political left has long looked askance at stock buybacks. It has much to do with the transactions involving colossal amounts of money undertaken by massive business enterprises. The former is undoubtedly tempting as a target for official pilfering, whereas the latter are reliably despised by policymakers. It’s surprising, really, that a measure to chasten the latter by seizing a portion of the former, especially when spun as some form of “justice” or restitution, has taken so long.
The tales are familiar. Corporate stock buybacks are driven by “greed,” of course, and allegedly fuel “wealth inequality.” Instead of repurchasing shares in the market, say activists and politicians (virtually none of whom have ever owned a business, let alone managed a massive one), employees should be given pay increases. Or new innovation should be explored.
Congresspeople and regulators are the last people who should be telling entrepreneurs and corporate executives that they should be on the lookout for new innovation. That’s already in their DNA as creators, and it bears mentioning that, at times, there are no applicable innovations in or coming to the market. As for awarding pay raises, why would any firm paying what the market will bear – even more importantly, what their business segment and the unique labor market in their locality bears – increase compensation across the board?
So yes, a new tax is born. This one will do what all taxes do, to some extent or another: curtail the newly targeted activity while creating an incentive to explore imaginative workarounds.
But on the other hand, the billions or tens of billions of dollars raised will go to a fund that directly addresses the numerous groups severely injured by stock buybacks. Teachers, firefighters, union workers, and other groups — hard working Americans, all — will receive US government checks cut from the buyback tax fund to remedy the gross inequalities rooted in the heinous act of firms buying their own stock in the market.
No, of course they won’t. All funds raised by taxing buybacks, which have purportedly served as an economic war machine in the service of plutocrats, will go directly into the US government’s coffers — some of which will go toward providing actual war machines for Ukraine. The rest will be used for purposes ranging from wrestling with the mounting debt service on over $31 trillion of government debt to creating woke indoctrination programs for the US armed forces and other federal agencies.
When corporate executives decide to direct funds into share repurchases, they are conceding that there are no clearly profitable projects, worthwhile product lines, or synergistic acquisitions worth spending on at the moment. Older, larger firms — sometimes called “cash cows” — frequently find themselves in this position. They may choose between doing nothing with their unused cash (which is a disservice to shareholders and employees), paying a dividend (which rewards certain shareholders but also brings inflexibility and tax consequences), or they may buy their own stock in the market. (Unlike the world inhabited by the vampires of the Beltway, in the productive world commercial opportunities come and go unpredictably. And there are consequences for engaging in unprofitable ventures in the real world, unlike in DC.)
There is a view that stock buybacks are a tacitly manipulative exercise, undertaken simply out of “greed” to raise stock prices. It simply isn’t the case. While with each buyback a (somewhat) smaller number of remaining shareholders will share in the benefits of a larger share of future earnings, the company’s value is decreased by the total shares purchased. Below is a chart of the five year return on the S&P 500 index as compared to four indices and financial products that track the performance of stocks undertaking large buybacks. All underperformed the S&P 500, clearly demonstrating that large scale corporate share repurchases do not drive up stock prices.
S&P 500 Index returns vs. S&P 500 Buyback index, Solactive US Buyback Index, Invesco Buyback Achievers ETF, and NASDAQ Buyback AchvTR (2018 – present)
Buybacks aren’t undertaken with the sort of sloppy momentum buying seen in meme stock trading campaigns. Most are undertaken as block purchases from asset managers. In the event buybacks were to drive stock values into egregiously overvalued territory, two things would occur: first, short sellers would sniff out the excess profit opportunities in no time at all. And second, the firm purchasing its own stock would have accumulated a position in overvalued stock.
Indeed, buybacks often increase when the broad stock market is down. In March 2020, the US stock markets crashed for the first time in 33 years, and over the next two quarters, stock buybacks surged. But it bears mentioning that corporate decision makers are fully cognizant of the effect that expansionary monetary policy has on financial assets, so it’s hardly surprising that they would continue buying throughout 2021. It would be a disservice to shareholders, approaching depraved fiduciary indifference, to know of the likely economic effects of central banks flooding the world with money but not act upon it.
Questions remain: how are the stock purchases associated with the issuance of convertible bonds to be treated? What of share repurchases undertaken as part of anti-dilutive measures to balance shares associated with 401Ks or Employee Stock Options Plans (ESOPs)? Will Special Purpose Acquisition Companies (SPACs) or corporate actions like mergers and acquisitions trigger the tax? The answers to these questions will potentially impact hundreds of millions of investors to the tune of tens or hundreds of billions of dollars. And they will all need to be answered.
Given the current political makeup of Congress, this particular increase in the corporate repurchase excise tax seems unlikely to pass, but some form of it probably will in the future. When it does, another market function will have fallen prey to the unslakable thirst of the insatiable American state.