Missing Some Context on Stock Buybacks

May 8, 2018

Since the enactment of the Tax Cuts and Jobs Act (TCJA), armchair economists across the spectrum have looked through the data and anecdotes to identify whether the anticipated economic gains are coming to fruition and how the benefits could flow through to workers and shareholders.

Some have assumed that news of stock buybacks proves that the corporate tax cuts will primarily benefit wealthy shareholders. But that isn’t quite the case. In fact, it’s consistent with the idea that corporate cuts can help wages and productivity. Many economists believe that the corporate tax rate reductions will boost worker pay in the long run, but stock buybacks could increase in the short term following a corporate rate cut.

My colleagues Kyle Pomerleau and Scott Greenberg described the process.

If companies are receiving higher profits from investments they made in the past, it is not surprising that they would distribute these profits to shareholders in the form of buybacks. But this does not preclude the possibility that companies will also increase their investment spending—which would help workers in the long run.

Another relevant nuance about the recent buyback announcements is that buyback levels were unusually low in 2017, perhaps because companies were waiting to see how a federal tax reform package would shake out. As a result, the elevated buyback amounts in 2018 may partially reflect a timing shift, rather than a longer-lasting level change.

They continued:

Ultimately, the effect of buybacks will also depend on what shareholders do with the money they receive. For instance, shareholders might just reinvest the money they receive from some companies’ buybacks into other stocks. In this case, the buybacks could actually have a positive economic effect, transferring capital from less productive businesses into more productive ones. Or, perhaps, the buybacks would lead some shareholders to increase their personal consumption, which would not have a positive economic effect in the long run. Either way, looking at the total amount of buybacks doesn’t tell us which story is playing out.

It’s also quite possible that shareholders use a combination of those two approaches. Shareholders decide to invest part of their newfound capital and consume part as well.

Regardless of how shareholders decide to spend their buybacks, it will take years to fully assess the economic impact of the TCJA.

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