As we've said over the years, stock buybacks are nothing more than a tax dodge, magically turning cash flows that would otherwise be taxed at ordinary income rates as dividends into higher stock prices due to monotonic and incessant buying pressure from corporations, which cap gains are taxed at much-lower capital gains rates.
The buybacks have an added bonus, at least from management's perspective, of dramatically increasing the value of shares based compensation by using corporate assets—the cash flows that otherwise would be distributed as dividends— to boost a company's stock price, as opposed to the whims of an actual market.
The flaw has two parts, 1) The November 17, 1982 SEC ruling on Rule 10b-18 which opened the floodgates of kleptocratic value extraction of American businesses by giving corporations a safe harbor against charges of stock manipulation when buying their own shares and 2) The smart kids, members of Phi Scamma Jamma, are still pitching a differential between tax on earned income and tax on capital gains even though the efficacy of capital gains tax breaks in performing their original purposes, investment and job creation, has been declining since the 1970's and is now just an excuse for a loophole. See "TAXES, CAPITAL AND JOBS" for an exceptionally lucid discussion, again, if interested.
The new law, and the Administration's proposed increase, are a fig leaf slapped over the naughty bits, designed to give the appearance of doing something while having no discernible real-world effect on behavior.
From MarketWatch, February 7:
The tax applies only to net buybacks, which are much smaller than gross repurchases
The Biden administration’s new stock buyback tax will have little impact on the overall stock market. It might even actually help it. I’m referring to the new 1% excise tax on share repurchases that went into effect on Jan. 1.
This tax has set off alarm bells in some corners of Wall Street, on the theory that buybacks were one of the biggest props supporting the past decade’s bull market — and anything weakening that prop could lead to much lower prices.
Even more alarms went off after President Joe Biden telegraphed his intent to quadruple federal taxes on buybacks, to 4%. [State of the Union speech]
While this proposal is considered dead on arrival on Capitol Hill, the focus on possibly increasing this tax from 1% reduces the likelihood that it will be eliminated anytime soon.
Tax applies to net repurchases
Yet stock-market bulls shouldn’t worry. One reason is that the new excise tax — whether 1% or 4% — is applied to net buybacks — repurchases in excess of how many shares the corporation may have issued.
As has been widely reported for years, the shares that many companies are buying back often are barely enough to compensate for the new shares they issue as part of their compensation of company executives. As a result, net repurchases — on which the new tax will be levied — are an order of magnitude smaller than gross repurchases....
....MUCH MORE
William Lazonick, Professor Emeritus of Economics at UMass has done some very interesting work on the interplay of resource mis-allocation (those cash flows) with declining innovation and financialization/value extraction versus value creation in tech industries. His book, "Sustainable Prosperity in the New Economy? Business Organization and High-Tech Employment in the United States", although going on fifteen years old is still pertinent. Here's an example.
In June 2021 we linked to a New York Times article in "How the World Ran Out of Everything" which, among much else had these three little throwaway lines:
....Still, the shortages raise questions about whether some companies have been too aggressive in harvesting savings by slashing inventory, leaving them unprepared for whatever trouble inevitably emerges.
“It’s the investments that they don’t make,” said William Lazonick, an economist at the University of Massachusetts.
Intel, the American chip-maker, has outlined plans to spend $20 billion to erect new plants in Arizona. But that is less than the $26 billion that Intel spent on share buybacks in 2018 and 2019 — money the company could have used to expand capacity, Mr. Lazonick said.....
Twenty months later we read at Barron's:
Intel’s Quarter Was Brutal. There’s Still No Bottom In Sight.
“The magnitude of the deterioration is stunning," one Wall Street analyst wrote on Friday. There's no easy fix in store for the chip maker.
- "Managing Decline: The Economy of Value Extraction"
- "With CHIPS Act, US Risks Building a White Elephant" (incentives matter)
- "Vampires at the Gate? (Finance and Slow Growth)"
- "Share Buybacks and the Contradictions of 'Shareholder Capitalism'”
- Taibbi: "The S.E.C. Rule That Destroyed The Universe"
- Harvard Business Review Announces "The Best Management Article Of 2014"
