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17 USC 102

How The GOP Tax Cuts may have doomed the economy

August 7, 2018

 

Two words: stock buybacks.

 

In May, JPMorgan projected that in 2018, S&P 500 companies would invest about $1 trillion (with a "t") stock buybacks due to “savings on tax, strong earnings and the repatriation of cash,” according to MarketWatch’s Ciara Linnane. Companies that have committed to buybacks include Alphabet (Google’s parent company), PepsiCo, Wells Fargo, and Cisco. Just today, Goldman Sachs released a report that this year’s buyback total may reach $1 trillion. Last week, Warren Buffet, previously a critic of buybacks, has hinted that Berkshire Hathaway may follow the same path. E tu, Warren?

 

One of the companies that made headlines around the time the tax bill did was Apple, which was then in the spotlight for holding cash offshore, in Ireland specifically, to dodge American tax law. CEO Tim Cook cleared up the ensuing controversy during a Congressional hearing, but not before Apple’s case became a convenient strip mine for Republicans who needed to sell their corporate tax cuts. As the company’s money came back from the land of Guinness and the tax plan had been signed into law, Apple announced $100 billion in buybacks.

 

Companies buy back their own stock for several reasons, but the biggest one is to inflate their own stock value by decreasing the number of shares in the market. This usually happens when earnings are high and shareholders are expecting a paycheck. In theory, stock buybacks are healthy for a company with excess cash to utilize earnings to promote growth in R&D and to provide returns to investors when business is going well. However, in practice, the fiduciary success of buybacks when it comes to a company’s own returns is muddy and even their conception is an eyebrow-raiser at their best and a prelude to recession at their worst.

 

I think Gregory Milano, CEO of Fortuna Advisors, has a helpful system of studying how market currents, bull markets in particular, interact with induced stock value inflation. Fortuna, calculates a "buyback ROI" (return on investment) wherein a ratio between two percentages—buyback as a percentage of market capitalization and that company’s return on investment post-buyback—is used to measure the success, or lack thereof, of stock buybacks.

 

Capital repatriation was used to justify the tax bill in December 2017—the idea was peddled by both Congressional Republicans and the White House that tax cuts for U.S. businesses would encourage corporations to bring their money back home, ideally to be either used for wage increases and/or other capital expenditures like R&D. Instead, companies have a new surplus of cash that they don’t know what to do with, and have begun buying back their own shares. Money that was advertised to aid consumers and workers started flowing to corporate executives and shareholders.

 

Again, widespread buybacks across the market are, in theory, a sign of growth. But in practice, they frequently have a nasty side effect: income inequality. A record low of 54 percent of the country owns any stocks at all, so most of the returns flow instead to the top ten percent of investors who own 84 percent of all stocks. Furthermore, every dollar that’s used to buy back stock in anticipation of a return is one less dollar that goes into innovation or worker wages. “The nation now spends on the order of twice as much on stock buybacks as it does on all R&D,” entrepreneur Nick Hanauer said in an interview with Arne Alsin of Forbes. “You cannot build the kind of high-growth economy that we deserve, if you're … basically burning 4 percent of GDP on stock buybacks, in this giant shell game—this sort of financial merry-go-round benefiting a few owners, a few corporate executives, and Wall Street. It's among the most corrosive and corrupt practices in an already pretty corrosive and corrupt economy.”

Money that was advertised to aid consumers and workers started flowing to corporate executives and shareholders.

We get a number of inconsistencies when we actually put the pre-conceived consequences of stock buybacks to the test using the Fortuna “buyback ROI” as well as observational company shortcomings like wage stagflation and underfunded R&D. The result is sobering—buybacks widen the gap between the rich and the poor. They don’t noticeably drive innovation and growth and in this particular instance, driven by the Republican tax cuts, don’t increase stock value. All they represent is a loaded dividend to the major, large-stake investors.

 

Even for new investors, Fortune magazine recommends not to heed the short-term hype. The largest takeaway from all this is that companies, especially bigger companies whose stock evaluation have little “room to run,” as Ryan Derousseau calls it, don’t always get the greatest financial results, most certainly not when the country’s economy is in the ninth year of a bull market. In other words, this sudden trigger of buybacks may signal an incoming recession if profits aren’t turned.

 

It seems we’re headed in that exact direction. “U.S. companies are buying back record amounts of stock this year, but their shares aren’t getting the boost they bargained for,” reads the lede of a Wall Street Journal article by Michael Wursthorn. This could be light of other factors that are keeping stock prices down, like a looming trade war. Jeff Cox of CNBC supposes that political currents may be the biggest threat to the market and that buybacks are the only thing keeping the stock market afloat. But even if that is true—which I highly doubt because of a noticeable rise in corporate earnings over the last couple years—it doesn’t excuse the insidious, classist nature of stock buybacks (some have called for the SEC to place regulations on stock buybacks. Others have called for buybacks to be voted on by shareholders during annual proxy meetings).

 

With all this being said, the Republican tax plan either delayed the next recession or brought us significantly closer to it. At the end of the day, however, it doesn’t really matter, because the outcome will be the same—business executives win and wage-earning Americans lose.

 

Photo credit John Ramspott, Creative Commons

 

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