President Trump Should Rethink Stock Buybacks: They're Good for the Economy
President Trump has sharply criticized major corporations for using the proceeds of the 2018 tax cut for stock buybacks. He said that corporations were supposed to use this extra cash flow to increase investments, thereby expanding the economy.
Trump misses here. Stock buybacks are good for the economy.
Figure that corporations have been buying back shares for years. In fact, from 2007 to 2017, before the tax cut, S&P 500 companies purchased $4 trillion of outstanding shares. They also paid shareholders more than $3 trillion in dividends.
Many very well respected economists like Nobel Prize winner Paul Krugman point out that because of stock buybacks, the tax cut did not lead to an investment boom. He said, “looks like the tax cut is a nothing burger.”
It is true that total business investment did not substantially increase in 2018 or 2019, but it wasn’t because of stock buybacks. It was mostly due to uncertainty, both on the domestic side and in foreign trade.
In 2018, lowering the corporate tax rate from an average of 35% to a flat 21% certinaly did increase corporate cash flow. Trump hoped corporations would use those funds to increase business investment, which expands the economy. At the same time, the U.S. found itself in the middle of trade disputes with Mexico, Canada, South Korea, Japan, India and China. Largely due to the uncertainty there, businesses were reluctant to invest.
Furthermore, businesses at times lack profitable investment opportunities such that they pass extra cash onto their owners, the shareholders. The owners often feel they have better and more profitable investment opportunities outside of said corporation, at which point they welcome dividend payments. With stock buybacks, the nice thing about them is that investors have a choice. They can either sell their shares back to the corporation, thus potentially incurring a tax liability, or they can hold onto their shares.
The net result of the stock buybacks is that the shareholders that sold the stock now have capital to invest in growing and more profitable ventures that need capital to expand. Since this new capital flows to companies most in need, it is an overall positive for the economy, not a negative.
Lastly, let's not forget that the purpose of the 2018 tax cut, which reduced tax rates for most Americans and most corporations, was to free up more capital. Stock buybacks do just that, thus setting the stage for more growth.
President Trump misses the obvious good of stock buybacks in that he ignores how they speed up the process whereby capital reaches its most optimal use. Such is the genius of stock buybacks.
Let the market decide where that capital is best directed. Stock buybacks are simply part of the process.