Against Taxing Corporate Stock Buybacks.

• Author: West, Richard R.
• Position: BRIEFLY NOTED

Among the potpourri of tax increases in President Biden's 2024 budget is a proposal to raise the nondeductible excise tax on corporate stock buybacks from 1 to 4 percent. Many proponents, including Sens. Charles Schumer (D-NY) and Bernie Sanders (I-VT), claim their primary objective is not to raise revenue but to encourage companies to invest more in plant, equipment, and research and development. Their basic premise--that the alternative to buying back stock is to reinvest the funds in company operations--and other criticisms of buybacks reflect misunderstanding of the role played by share repurchases in corporate activities. Once that role is properly understood, the case for taxing buybacks vanishes.

Corporate investment unaffected / Firms exist to determine what businesses to be in, how much to invest in them, and how to finance their activities. Having made these decisions, they then consider whether, how, and when to distribute cash to their shareholders, either by paying dividends or buying back stock. Corporate investment decisions therefore affect distributions to shareholders, including buybacks--not the other way around. Tamping down buybacks, by taxes or other means, does not magically create profitable investment opportunities. Misunderstanding this is why some buyback critics mistakenly claim that buybacks starve firms of investment capital.

While those who mistakenly argue that stock repurchases starve companies of investment capital have played the leading role in the campaign to regulate them, they are hardly alone in their opposition. In addition, critics assert that buybacks are bad because they are used to manipulate earnings, inflate executive compensation, and provide a basis for a form of insider trading. On examination, however, none of those claims are any more persuasive than the notion that buybacks take away funds from productive corporate investment activities.

Earnings per share concerns / There are other criticisms of buybacks. One is that buybacks improperly manipulate earnings. Repurchasing stock increases all per-share metrics, notably earnings per share (EPS). But an important 2016 study by McKinsey & Co. concluded that "the mechanical effect (of share repurchases) on EPS is totally irrelevant." To quote the study, "While improving a company's EPS can improve the return to shareholders, the contribution of share repurchases is virtually nil." Other studies reached the same conclusion: there is no empirical evidence of a positive correlation between stock buyback activities and total returns to shareholders. As the McKinsey study succinctly concludes: "It's the generation of cash flow that creates value, regardless of how that cash is distributed...