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Buybacks Aren’t Inherently Evil, But…

5 | By Shah Gilani

Last week, senators Chuck Schumer (D. NY) and Bernie Sanders of (D. VT) co-authored an opinion piece in the New York Times titled, “Limit Corporate Buybacks” with the subtitle “Corporate self-indulgence has become an enormous problem for workers and for the long-term strength of the economy.”

They’re right that buybacks should be limited, but wrong about their impact on workers and the economy.

So, today I’ll tell you what the senators got right, what they got wrong, and how buybacks should be treated.

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I’ll make this quick, because I want to get into why Chuck Schumer and Bernie Sanders are both right and wrong about buybacks, but this is extremely important:

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How’s THAT Dutiful?

Let’s get into it.

In the opinion piece, the senators said, “From the mid-20th century until the 1970s, American corporations shared a belief that they had a duty not only to their shareholders but to their workers, their communities, and the country.”

The senators go back to the mid-20th century to make their case, that through the 1970s corporations were dutiful to shareholders, workers, and the economy.

That’s untrue.

Corporations have been fighting workers for more than a century. From the 1830s and 1840s textile workers strikes to the 1870s to 1970s railroad workers, steelworkers, farm workers, newspaper workers, autoworkers, aviation workers, hospital workers, and truckers strikes have marred the relationship between corporations and workers.

How’s that dutiful?

Corporations have hardly ever felt a duty to workers, other than to keep them working to continue to produce the goods and services management is trying to sell.

Bestowing the kinds of benefits the senators demand corporations lavish on their workers, their communities, and the economy is not a primary corporate goal of for-profit companies.

Their primary duty is to their shareholders. And like it or not, their business is making money for their owners, their shareholders. That’s what they’re structured to do.

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The senators said, “Over the past several decades, corporate boardrooms have become obsessed with maximizing only shareholder earnings to the detriment of workers and the long-term strength of their companies, helping to create the worst level of income inequality in decades.”

Plenty of corporations certainly aided and abetted their earnings potential by supporting trade deals, like NAFTA, that “offshored” American jobs to where labor markets and worker protections were cheaper and friendlier, to countries like Mexico and China.

Our legislators voted for those trade deals.

Congress is to blame for aiding and abetting corporations offshoring jobs, for killing manufacturing in the U.S., for eviscerating the middle class by selling their job prospects, their futures, for campaign donations.

It’s easy to blame greedy corporations, the same way it’s easy to blame Warren Buffet for paying less than $2 million in tax last year when he’s worth more than $80 billion.

But what they do is legal. The laws in America are designed by corporations who want to make more money and by people of means who don’t want to pay a lot of tax.

You can’t blame them for using the law to their favor.

The senators say, “One way in which this pervasive corporate ethos manifests itself is the explosion of stock buybacks.”

I agree, but again, buybacks are legal. Companies are simply using what’s available to them to enhance shareholder returns and management compensation. That’s an indisputable fact.

What’s not actually factual is the senators saying, “So focused on shareholder value, companies, rather than investing in ways to make their businesses more resilient or their workers more productive, have been dedicating ever larger shares of their profits to dividends and corporate share repurchases.”

Most companies, not all for sure, engage in share buyback programs with excess profits or with excess cash flow – after reinvesting in plant and equipment and after paying dividends with capital they don’t have another immediate or even near-term need for.

Companies that can’t afford buyback programs and borrow to buy their shares back on the open market are a real problem.

In a way, they’re a good problem for some traders and investors. That’s because traders like me research those companies and bet against them, knowing they’re leveraging themselves up and risking not only future profitability of the company, but also the company itself. Right now, there are a lot of companies that are about to take huge hits if interest rates rise more, if the economy slows down, especially if it enters a recession, and if their stock prices fall, which many of them are already seeing.

But that’s the free market.

This is How to Reduce Inequality

Companies are free to fail, just as they’re free to use buybacks to enrich management if it’s legal.

A pair of senators, moreover Congress as a democratic institution, dictating by fiat what corporations should do with the money they earmark for buybacks and dividend payments is a socialist manifestation of the progressive liberal ethos and has no place in our economy.

What makes sense is changing tax rules to benefit workers, the economy, and shareholders.

The easiest way to do that would be to change the way retained earnings, cash, or borrowed money is taxed based on what a corporation is using it for.

Since the senators are so worried about workers and have done nothing in their combined almost 60 years in government to protect workers’ pensions or retirement accounts or aided their ability to accumulate wealth through stock ownership and receipt of dividends, that’s where they should start.

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Why not make any corporate retained earnings not taxable if it’s applied towards a company’s pension obligations? That would help workers.

Why not make dividends not taxable to non-manager workers who own company shares?

Why not make share contributions as bonus compensation to workers making less than six times minimum wage 100% tax deductible to the corporation and the recipient?

Why not make the tax on capital spent on buybacks something like 50%, while the tax on retained earnings to pay dividends zero?

Shareholders, and hopefully more workers becoming shareholders, benefit by dividend payments, which often make their way into the economy. That is, if they aren’t reinvested towards buying more shares.

Buybacks aren’t inherently evil, but they are problematic. They serve too few Americans.

The way to fix the problems with buybacks isn’t by dictating corporate policy as if we’re a socialist command economy.

By applying smart, widely beneficial, expansive, not confiscatory and punishing tax policies, America can redirect the buyback mania and greatly reduce inequality.

Sincerely,

Shah

5 Responses to Buybacks Aren’t Inherently Evil, But…

  1. Anthony Powers says:

    Re share distribution to employees: In 1934/36 American Airlines paid the mechanics in shares because cash was not available. The mechanics in Newark were not happy they “had to pay a pilot to go to NYC to convert the shares into money”. Quote from my father. Times have changed, but people I’ve met in hard labor jobs – oil field, farming, mining, steel mill etc dont have much use for shares of stock. They want more cash NOW, not a maybe sometime in who knows when future. Other than that, your idea is good.

  2. reuben abraham says:

    sorry, i support socialism up to a point because greedy employers will buy a bigger mansion and a bigger yacht before they’ll offer any pension or higher salaries to their workers. they can’t control their greed so i expect the government to do it for them. lack of control is the cause to this enormous gap between ceo’s incomes and their workers.

  3. Rita Grolitzer says:

    Very original and praiseworthy suggestions to mitigate the growing economic inequality in the U.S. over the last 20(?) years, Now, how can we the people/investors help get your suggestions implemented?

  4. Michael Gaudet says:

    Excellent idea and thought piece. With your contacts why not talk with Larry Kudlow, then meet with the POTUS. Then he and Larry and his team can build some support with Companies and a few on the Hill, and then pitch it to the American public. I suspect he could call Buffet in and few others to meet with Larry and he and his team, and position it as great for the workers.

    Thanks.

    MikeyG

  5. James Welge says:

    While I agree with the basic premise that Shah has, namely that corporate policies regarding dividends and buybacks should not be driven by draconian command economy like limitations, I disagree with the mechanics of how these things are accomplished.

    1. I agree that there is merit in allowing corporations to reduce taxable income if they use the reduction to reduce a companies Pension obligations. This makes sense. It would have to be strongly enforced, with strong IRS oversight, problematic given the IRS’s current underfunding.

    2. Making dividends paid to non-managment workers who own company stock non-taxable makes sense, and aligns the interest of nonmanagement employees with the goals of the company they work for.

    3. Making share contributions to workers making less than 6 times minimum wage 100% tax decuctible to the corporation may make sense as an incentive to employees by corporation.

    4. A 50% tax on capital spent to fund stock buybacks seems extremely punitive. This could be a very complicated tax, and to me would have to be computed as a seperate tax from a Corporate Income Tax. The mechanics are complicated.

    I would prefer, rather, that the interest on money borrowed to finance stock buybacks be made non-tax deductible in computing the Corporate Income Tax!!!!! This would reduce the incentive for corporations to engage in the irrresponsible behavior of funding buybacks with borrowed money and thus leveraging the company to finance the buyback.

    In my own view stock buybacks are in general a gimic which reduces a companies outstanding shares, raises earnings per share, and resultantly stock prices, and provides a deduction to the corporation for the difference between the exercise price of the stock and the increased market price. It is obviously an incentive to managements, but in most instances the corporate managers immediately sell the stock. The buybacks do nothing to raise revenue, or encourage rationalization of expenses or capital investments which make operations more efficient.

    It makes sense to disallow the deductability of interest incurred to borrow money to finance stock buybacks for Corporate Tax purposes. This disincentivizes some, but not all stock buybacks.

    It remains for investors to be educated not to buy the stocks of companies that engage in stock buybacks that make no sense, and to buy dividend paying stocks.

    Possibly Tax policy needs to be revisited to make dividends more favorably treated by taxpayers whose incomes (salary and compensation) fall below certain thresholds. This would encourage middle income taxpayers who are prudent to invest in dividend paying stocks, rather than those which do stock buybacks.

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