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Shareholders sole winners of U.S. tax plan
Saturday, December 16, 2017
ROME -- Donald Trump is promising a "big, beautiful Christmas present" for Americans in the form of the deepest tax cuts in three decades. The U.S.
President seems likely to keep his promise. The Republicans are anxious to ram through the bill before Democrat Doug Jones, the surprise victor in this week's Alabama Senate race, arrives in Washington. Once he lands, the Republicans' already slim Senate majority would fall to 51 of 100 seats.
The tax bill would cut the corporate tax rate from 35 per cent to 21 per cent, making it one of the lowest in the Western world. The personal rate for top earners would fall from 39.6 per cent to 37 per cent. Mr. Trump has said the tax overhaul would supercharge economic growth, stimulate investment, create jobs and repatriate manufacturing - the classic "trickle down" economic theory championed in the 1980s by Ronald Reagan.
Never mind that "trickle down" has been widely disparaged - the International Monetary Fund said the best way to boost growth is to cut taxes for the poor, not the rich - or that the Trump plan would send the budget deficit soaring. It also shows unwarranted faith on Mr. Trump's part in corporations to behave well.
Behaving well would see corporations spending all that freed-up cash on innovation, higher wages for employees, productivity gains, efficient new factories or energy conservation. Instead, any savings from low tax rates are almost certain to be funnelled into share buybacks.
How do we know? Because share buybacks have turned into market-eating monsters since the Reagan era, all in the name of maximizing shareholder value. There is also a historical precedent to bolster the argument the Trump tax plan will be little more than a giveaway to shareholders, most of whom are already rich. In the United States, 20 per cent of the population owns 80 per cent of the shares.
In 2004, the U.S. Congress passed the Homeland Investment Act (HIA), which was part of the American Jobs Creation Act. It called for a one-time tax holiday on earnings parked overseas, where they had escaped the high U.S. corporate tax rate. The overseas cash hoard had been, and still is, rising every year. At last count, it was estimated at $2.5-trillion (U.S.). That's about 14 per cent of American GDP.
Members of Congress argued the tax holiday would create 500,000 jobs over two years and companies suggested they would put the money to good use by paying down debt, financing capital expenditures and R&D and making acquisitions. The HIA worked brilliantly in the sense that repatriations under the temporary tax holiday surged from an average of $62-billion a year to $300-billion in 2005.
In every other respect, it was an utter failure. Few jobs were created and the repatriated cash was not put into R&D and the like. Instead, it was plowed into share buybacks.
A 2011 study about the "unintended consequences" of the act, by the American Finance Association, found that for every $1 increase in repatriations, payouts to shareholders (largely buybacks, but some dividend increases) rose by 60 cents to 92 cents. The report concluded that "the HIA does not appear to have spurred domestic investment and employment in firms that used the tax holiday."
But shareholders were certainly happy to get wealthier on the taxpayer-financed repatriations, as were executives, who typically get most of their compensation from stock schemes, such as rewards and options.
There is no reason to believe Mr. Trump's corporate tax giveaway will produce a different result. Assuming the tax plan passes - there is still some chance a couple of rogue Republicans could sink the whole show - you can bet the pace of share buybacks will surge. Remember, every dollar spent on buybacks is one fewer dollar available for corporate and employee development.
There was a time when buybacks were illegal because they were deemed to be a form of stock-market manipulation. That changed in 1982, after which there were virtually no regulatory restrictions on the use of buybacks.
Since then, executives have used them with alacrity to boost earnings per share (since the earnings are spread over fewer shares), the share price and, of course, their stock-based compensation plans. In the 10-year period through 2015, the S&P 500 companies spent $3.9-trillion on buybacks, equivalent to almost 54 per cent of net income.
It can come as no surprise that some of the companies that hosed out fortunes on buybacks instead of using the loot to make themselves more competitive got into trouble. BlackBerry, when it was called Research In Motion, was one of them. Once-mighty General Electric is a current example of the dangers of lavish buybacks.
Research done by William Lazonick, professor of economics at University of Massachusetts Lowell, notes that GE was spending $5.4-billion a year on average on buybacks in the decade through 2015. In 2016, the company, under pressure from hedge funds, quadrupled the buybacks to $22-billion. This year, drained of financial resources, GE cut its dividend and the shares collapsed.
Mr. Trump's trickle-down tax plan will not only make the rich richer, it could hurt the long-term health of Corporate America. Believing the plan will boost growth and competitiveness as buybacks accelerate is nothing but a fantasy.
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