The tax on share buybacks, a misguided way to encourage investment

Share buybacks have gained a bad reputation in recent years as policymakers have blamed them for a range of economic ills, ranging from encouraging focus on short-term profits to cutting back on investment. Now Senators Ron Wyden (D-OR) and Sherrod Brown (D-OH) have targeted buybacks for a 2% excise tax in the reconciliation file. But research shows that the shared view of share buybacks is wrong and that taxing them would not be the right policy solution to encourage long-term investment or raise wages.

Share buybacks are a way for companies to restore value to shareholders; they occur when companies buy back outstanding shares of their own stock from existing shareholders. Under current law, a shareholder who resells their shares is taxed on any resulting capital gain, and to the extent that repurchases increase the share price over time, the remaining shareholders would have to pay tax on the shares. capital gains on any increase in value on the sale of their shares. Wyden-Brown’s proposal would be in addition to these current legal taxes.

Wyden and Brown echo two common arguments against buyouts: 1) that they reduce reinvestment in companies and employees, and 2) that they create distortions, such as short-term sugar highs that push up share prices to enrich existing shareholders to the detriment of long-term value. Economist Alex Edams reviews both claims and prove that they are not true:

What about the long-term effects of redemptions? A seminal article found that companies that buy back shares subsequently outperform their peers by 12.1% over the next four years. This result is surprisingly robust – when it applied to American companies in the 1980s, a study published this year [2019] surveyed 31 other countries and found that the results were valid in most of them, including the UK. This evidence contradicts “high sugar” concerns, but is conveniently ignored in claims that buyouts destroy long-term value …

Other studies show that buyouts occur when growth opportunities are low and when companies have excess capital. So companies first make investment decisions and buy back stocks with the excess cash, rather than buying back stocks first and investing only with the leftovers.

In 2019, with PwC, Edams conducted a study to examine how UK companies used share buybacks over a 10-year period:

Perhaps the most striking result is that in the 10 years studied, no company in the FTSE 350 has successfully used share buybacks to achieve EPS. [earnings per share] target. Specifically, no company has exceeded its EPS target, which would have been lower if it had not repurchased shares. Additionally, companies that fell above their EPS target repurchased fewer shares than those that fell below, which is inconsistent with fears of meeting the target through buybacks. .

The authors found no relationship between share buybacks and investment, inconsistent with concerns that executives would abandon investment projects to fund buybacks. Instead, it seems companies make investment decisions first and only make buybacks if they have cash left.

Wyden and Brown’s proposal would apply a 2% excise tax on the amount companies spend on share buybacks. An excise tax is an inappropriate policy because share buybacks do not create a negative externality that requires an excise tax to be internalized, nor is there an argument for a charge to be incurred. use apply to share repurchases.

When companies have more cash than they can use for their current investment opportunities, they can either keep this excess liquidity or return it to shareholders. A large body of evidence supports the idea that companies generally only consider share buybacks when they have exhausted their investment opportunities and fulfilled their other obligations, that is, it is the residual cash flows that are used for redemptions. In fact, share buybacks can complement capital investments, as they can help reallocate capital from old and established businesses to new and innovative ones.

If lawmakers are really concerned about cases of corporate short-termism, research indicates they should look at root causes, such as executive compensation structure or quarterly earnings reports, not stock buybacks in general. Buyouts do not replace productive investments and do not come at the expense of workers – so they should not be targeted by a tax increase based on these misperceptions.

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