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Stock Buybacks are Good, Not Bad

Buybacks Set Pace for Record.” This is the headline at the top of the front page of the February 28 print edition of the Wall Street Journal. While the Journal reporter, Hannah Miao, does an admirable job of simply reporting the facts, other commentators, especially Democratic members of Congress, have been much more critical of stock buybacks. In a February 2019 op/ed in the New York Times, for example, Senators Chuck Schumer and Bernie Sanders wrote: 

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. When a company purchases its own stock back, it reduces the number of publicly traded shares, boosting the value of the stock to the benefit of shareholders and corporate leadership. 

Of course, with fewer stocks, the value per share is higher. But if stock buybacks are a good move from the viewpoint of shareholders, they increase the overall value of the firm. Imagine that a firm has three options: (1) stock buybacks, (2) making their companies more resilient, and (3) making their workers more productive. If either the second or third option is better for the firm than the first option, and if investors understand that, then stock buybacks would reduce the value of the firm. The reason: The money spent on the buybacks would not be going to its highest-valued use. But if stock buybacks increase the value of the firm, then Schumer’s and Sanders’s preferred uses are inferior. 

Under the misnamed Inflation Reduction Act, which should have been called the Drug Reduction Act, the federal government imposes a tax of 1 percent on stock buybacks. The tax became effective on January 1. Yet President Biden used his State of the Union speech to advocate quadrupling that tax to 4 percent. Could the record pace of stock buybacks be due in part to the fear that the tax might increase? 

Fortunately, Erica York, a senior economist at the Tax Foundation, nicely shows why stock buybacks often make sense. They tend to happen when a firm doesn’t have better investment options. Stock sellers can then use the funds to invest in firms that do have better investment options. Oh, and by the way, who owns a large percent of corporate America? Pension funds. Many workers rely on these funds for their retirement. Those tears that Schumer and Biden are shedding for workers are crocodile tears.