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Record stock buybacks—driven in part by the corporate tax changes in the Tax Cuts and Jobs Act (TCJA)—have sparked a media and political furor. Unfortunately, they’ve also created a great deal of confusion. To help elevate the debate, here are three things you should know.

1. Repatriated overseas profits are the main way TCJA is boosting buybacks

By slashing corporate taxes, TCJA will boost after-tax profits and cash flow. Companies will use some of that cash to buy back shares. But that is not the main way TCJA is fueling today’s record buybacks.

The big reason is the “liberation” of around $3 trillion in overseas profits. Our old system taxed the earnings of foreign affiliates only when the domestic parent company made use of them. To avoid that tax, many companies left those earnings in their affiliates. They could reinvest them in their foreign operations or hold them in U.S. financial institutions and securities, but they couldn’t use them for dividends to parent company shareholders or stock buybacks.

By imposing a one-time tax on those accumulated profits, the TCJA freed companies to use the money wherever they wanted, including in the United States. And multinational firms are leaping at the chance. Cisco, for example, says they are repatriating $67 billion and buying back more than $25 billion in stock.

Cisco’s response reflects a broader trend. Repatriated profits will account for two-thirds of this year’s increase in stock buybacks, according to JP Morgan. Stronger earnings, due to both improved before-tax profits and lower taxes, make up only one-third.

2. Buybacks do not mechanically increase stock prices

Buybacks can help shareholders. But it’s not as simple as much commentary suggests.

The common story is that buybacks boost stock prices by reducing the number of shares outstanding. That sounds like basic economics: Reduce supply, increase price. But buybacks have a second effect that pushes the other way.

When companies pay out cash, their value falls. This effect is easy to see when companies pay dividends. On the morning after a dividend, a company’s stock price usually drops. One day the stock price reflects the company’ s operating value plus the cash it will use for the dividend. The next day it’s just the operating value.

That also happens when a company buys back stock. It spends its cash, so the value of each share declines. But this decline isn’t conspicuous. It doesn’t happen on an announced day (as with a dividend payment), and it happens at the same time the supply effect is pushing the other way. So commentators tend to overlook the stock price hit from cash going out the door.

How do the two effects net out? It depends. For starters, suppose we live in a frictionless (and mythical) world. There are no taxes, everybody is well informed, executives are perfect agents of shareholders, and it’s costless to raise new capital. In that world, the two effects exactly offset. The decline in the stock price from paying out cash matches the increase in the stock price from having fewer shares outstanding. And the stock price does not change.

In this world, a dollar on the company’s balance sheet has the same value for investors—one dollar—as a dollar on the investors’ own balance sheets. Stock buybacks simply move some dollars from the company to its investors. But they don’t create or destroy any value.

Of course, the real world isn’t frictionless. Taxes matter, as do imperfect information, misaligned incentives, and the cost of raising capital. The question is how do they matter. Is a dollar on a company’s balance sheet worth more than an investor’s dollar? Less? The same?

It depends. Suppose a company has many promising investment opportunities. If raising capital is expensive, a dollar inside the company may be worth more than a dollar outside. Investors value the ability to pursue good opportunities without the burden of raising new capital. In this case, a (misguided) stock buyback would drive the value of the stock down, not up.

Another company might have few promising investment opportunities. Shareholders might worry executives will squander extra cash, perhaps through empire building, executive perks, or just taking their eye off the ball. Investors might therefore treat a dollar of cash inside this company as worth less than a dollar, perhaps 90 cents or even as little as 40 cents. In these cases, stock buybacks would drive the value of the stock up.

On average, stock buybacks are more common in the second scenario than the first. So buybacks do tend to lift stock prices. Not because of the mechanical link between supply and price, but because shareholders value a dollar on their own balance sheets more than a dollar inside the companies buying back stock.

3. Today’s buyback furor reflects a much larger debate about shareholder capitalism.

Concern about buybacks didn’t start with the TCJA. Some commentators have long worried that shareholders can be shortsighted. They may focus too much on next quarter and too little on next decade. If so (there is much debate), shareholders may undervalue cash inside companies. Buybacks may thus be too large, hurting shareholders themselves and the broader economy.

Others object to shareholder capitalism more fundamentally. Comparing the value of dollars inside and outside a company presumes those dollars belong to shareholders. Our system largely works that way today. But what if workers and other stakeholders also have a claim? If so (again there is much debate), buybacks may allow shareholders to capture all the value from what should be shared resources. This concern animates Senator Cory Booker’s recent proposal to limit stock buybacks.

Evaluating these concerns is a job for another day. For now, remember that the stock buyback debate boils down to three basic questions. When do investors think money inside a company is less valuable than outside? How well do investors make that judgment? Should investors be the only ones with a claim on a company’s money? Debate over those questions will continue long after today’s focus on the TCJA.

This post originally appeared on TaxVox, the blog of the Tax Policy Center.

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For your weekend listening pleasure (?): I visit the ReConsider podcast to chat money, inflation, fiat currencies, gold, Bitcoin, & Uncle Sam’s balance sheet. Starts at 4:59.

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The tax treatment of employee stock and options raises a classic Goldilocks problem. We want to tax this compensation neither too much or too little. In a recent policy brief, I consider three questions about how to strike that balance.

Do companies get excessive tax deductions for employee stock and options?

This concern rocketed to prominence in 2012 when Facebook went public. Its employees earned billions from their stock options and restricted stock units. The company, in turn, got billions in tax deductions, reducing its income taxes for years.

Those deductions outraged some observers who asked how Facebook could get billions in tax write-offs when its financial statements showed much lower compensation costs. Lawmakers on both sides of the aisle denounced the “stock option loophole” and proposed limiting these deductions.

While there are good reasons for Congress to worry about companies gaming the tax code, this is not one. The tax deductions that companies receive for employee stock and options are, with few exceptions, just like those for cash wages, salaries, and bonuses.

Here is an example: Suppose Esther has 1,000 options from her employer, Acme, Inc. Each allows her to buy a share of Acme stock for $10. If Esther exercises her options when Acme stock is worth $15, she pays $10,000 for stock worth $15,000 and thus has a $5,000 gain. Esther pays ordinary income taxes on the $5,000 while Acme deducts $5,000 as compensation. And both Esther and Acme pay payroll taxes on the $5,000.

Esther’s stock options are taxed just as if she received a $5,000 cash bonus. The deduction for Acme, just like the deduction for Facebook, is an integral part of our income tax system. Employees pay income taxes on their compensation, and businesses get a corresponding deduction. Lawmakers should maintain the parallel treatment of cash and equity compensation in any tax reform.

Does taxing options at exercise pose a special challenge for employees of private companies?

Employees owe income and payroll taxes when they exercise most options. That’s not a problem for employees who have easy access to the cash they need to pay their tax bill. But it can be a problem for employees who find themselves option rich and cash poor.  Employees of publicly traded companies can always cover their tax bill by selling stock. But employees of private companies often can’t. This problem is rare, but has reportedly become more common as successful start-ups stay private longer.

A bipartisan group of lawmakers has proposed to solve the problem with the Empowering Employees through Stock Ownership Act. The bill allows employees of privately-held firms to defer their taxes from exercising options for up to seven years or until their stock becomes liquid, whichever comes first.

Deferral of tax payments would help solve the liquidity problem. But it also would give equity compensation a notable advantage over cash compensation. Deferral of tax payments would be valuable for all employees, not only those with limited liquidity. Even taxpayers who have available cash would welcome the chance to defer their taxes for several years. Charging interest on the amount of deferred taxes would be one way to maintain some balance between cash and equity compensation.  (In essence, this approach would treat the deferral of tax payments as a loan from the IRS.)

Does the AMT pose a special burden for employees who receive incentive stock options?

Employees who get a special type of stock option—known as incentive stock options—face a different tax structure. ISO gains are taxed at capital gains tax rates, not ordinary income rates. And taxes aren’t due until the employee sells their stock, which could be long after they first exercise their options. That’s a big advantage for employees. But businesses don’t get a tax deduction for the compensation. Since the loss to firms is usually larger than the gain to employees, ISOs are rare. (This could change if Congress cuts the corporate rate much more than individual rates in a coming tax bill.)

But there’s a catch. Under the Alternative Minimum Tax, ISO gains are taxed when exercised. This creates an unwelcome surprise for employees who are unaware of the AMT and its accelerated tax on ISOs. Indeed, it can create financial hardship when stock prices fall, leaving taxpayers with a big tax bill on gains that have since evaporated.

This problem was especially severe during the financial crisis. Congress responded by temporarily exempting ISO gains from the AMT. That exemption has long since lapsed. Congress could permanently fix the problem by repealing the AMT, as the GOP framework and many other plans propose.

Stock options create some unusual challenges for tax writers, and they’ll have to be careful to be sure they are treated fairly relative to other forms of compensation to avoid creating incentives for tax-motivated compensation schemes.

On Tuesday, I had the chance to testify before the Senate Finance Committee on business tax reform. Here are my opening remarks. They are a bit on the glum side, emphasizing challenges and constraints lawmakers face.  Moving from optimistic rhetoric about tax reform to legislative reality is hard. You can find my full testimony here.

America’s business tax system is needlessly complex and economically harmful. Thoughtful reform can make our tax code simpler. It can boost American competitiveness. It can create better jobs. And it can promote shared prosperity.

But tax reform is hard. Meaningful reforms create winners and losers. And you likely hear more complaints from the latter than praise from the former. I feel your pain. At the risk of adding to it, my testimony makes eight points about business tax reform.

  1. Thoughtful reform can promote economic growth, but we should be realistic about how much.

More and better investment boosts economic activity over time. The largest effects will occur beyond the 10-year budget window. If reform is revenue neutral, revenue raisers may temper future growth. If reform turns into tax cuts, deficits may crowd out private investment. Either way, the boost to near-term growth may be modest. Dynamic scoring will thus play only a small role in paying for tax reform.

  1. The corporate income tax makes our tax system more progressive.

The corporate income tax falls on shareholders, investors more generally, and workers. Economists debate how much each group bears. Workers are the most economically diverse. But they include highly paid executives, professionals, and managers as well as rank-and-file employees. The bulk of the corporate tax burden thus falls on people with high incomes even if workers bear a substantial portion.

  1. Workers would benefit from reforms that encourage more and better investment in the United States.

In the long run, wages, salaries, and benefits depend on worker productivity. Reforms that encourage investment and boost productivity would thus do more to help workers than those that merely increase shareholder profits.

  1. Taxing pass-through business income at preferential rates would inspire new tax avoidance.

When taxpayers can switch from a high tax rate to a lower one, they often do. Kansans did so when their state stopped taxing pass-through income. Professionals use S corporations to avoid payroll taxes. Investment managers convert labor income into long-term capital gains. Congress and the IRS can try to limit tax avoidance. But the cost will be new complexities, arbitrary distinctions, and new administrative burdens.

  1. Capping the top rate on pass-through business income would benefit only high-income people.

To benefit, taxpayers must have qualifying business income and be in a high tax bracket. Creating a complete schedule of pass-through rates could reduce this inequity. But it would expand the pool of taxpayers tempted by tax avoidance.

  1. Taxing pass-through business income at the corporate rate would not create a level playing field.

Pass-through income faces one layer of tax. But corporate income faces two, at the company and again at taxable shareholders. Taxing pass-throughs and corporations at the same rate would favor pass-throughs over corporations. To get true tax parity, you could apply a higher tax rate on pass-through business income. You could levy a new tax on pass-through distributions. Or you could get rid of shareholder taxes.

  1. It is difficult to pay for large cuts in business tax rates by limiting business tax breaks and deductions.

Eliminating all corporate tax expenditures except for deferral, for example, could get the corporate rate down to 26 percent. You could try to go lower by cutting other business deductions, such as interest payments. But deductions lose their value as tax rates fall. To pay for large rate reductions, you will need to raise other taxes or introduce new ones. Options include raising taxes on shareholders, a value-added tax or close variant like the destination-based cash flow tax, or a carbon tax.

  1. Finally, making business tax cuts retroactive to January 1, 2017 would not promote growth.

Retroactive tax cuts would give a windfall to profitable businesses. That does little or nothing to encourage productive investment. Indeed, it could weaken growth by leaving less budget room for more pro-growth reforms. Another downside is that all the benefits would go to shareholders, not workers.

How fast will the US economy grow? When mainstream forecasters consult their crystal balls, they typically see real economic growth around 2 percent annually over the next decade. The Congressional Budget Office (CBO) and midpoint estimates of Federal Reserve officials and private forecasters cluster in that neighborhood.

When President Trump looks in his glowing orb, he sees a happier answer: 3 percent.

That percentage point difference is a big deal. Office of Management and Budget director Mick Mulvaney recently estimated the extra growth could add $16 trillion in economic activity over the next decade and almost $3 trillion in federal revenues.

But could our economy really grow that fast? Maybe, but we’d need to be both lucky and good. We’ve grown that fast before. But it’s harder now because of slower population growth and an aging workforce. And there are signs that productivity growth has slowed in recent years.

To illustrate the challenge, I’ve divvied up past and projected economic growth (measured as the annual growth rate in real gross domestic product) into three components: the growth rates of population, average working hours, and productivity.

d_marron_20170807

The link between population and growth is simple: more people means more workers generating output and more consumers buying it. Increased working hours have a similar effect: more hours mean more output and larger incomes. Hours go up when more people enter the labor force, when more workers find jobs, and when folks with jobs work more.

Productivity measures how much a worker produces in an hour. Productivity depends on worker skills, the amount and quality of capital they use, managerial and organizational capability, technology, regulatory policy, and other factors.

As the first column illustrates, the US economy averaged 3 percent annual growth over more than six decades. Healthy growth in population and productivity offset a slight decline in average hours. Of course, that six-decade average includes many ups and downs. The Great Recession and its aftermath dragged growth down to only 1.4 percent over the past decade. In the half century before, the United States grew faster than 3 percent.

Mainstream forecasters like the CBO and the Federal Reserve expect slower future growth along all three dimensions. People are having fewer children, and more adults are moving beyond their child-rearing years, so population growth has slowed. Our workforce is aging. Baby boomers are cutting back hours and retiring, and younger workers aren’t fully replacing them, so average working hours will decline. Productivity growth has slowed sharply in recent years, for reasons that are not completely clear. Productivity is notoriously difficult to forecast, but recent weakness has inspired many forecasters to expect only moderate growth in the years to come.

Proponents of President Trump’s economic agenda offer a rosier view. Four prominent Republican economic advisers—John F. Cogan, Glenn Hubbard, John B. Taylor, and Kevin Warsh—recently argued that policy, not just demographic forces, has brought down recent growth. They claim supply-side policy reforms—cutting tax rates, trimming regulation, and reducing unproductive spending—can bring it back up. They argue that encouraging investment, reinvigorating productivity growth, and drawing enough people into the labor force to offset the demographic drag would generate persistent 3 percent growth.

Many analysts doubt such supply-side efforts can get us to 3 percent growth (e.g., here, here, here, and here). Encouraging investment and bringing more people into the labor force could certainly help, but finding a full percentage point of extra growth from supply-side reforms seems like a stretch. Especially if you plan to do it without boosting population growth.

The most direct supply-side policy would be expanding immigration, especially among working-age adults (reducing our exceptional rates of incarceration could also boost the noninstitutional population). But the Trump administration’s antipathy to immigration, and that of some Republicans in Congress, pushes the other way. Cutting legal immigration in half over the next decade could easily take 0.2 percentage points off future growth (see this nifty interactive tool from ProPublica and Moody’s Analytics). Three percent growth would then be even more of a stretch.

Another group of economists believes that demand-side policies—higher spending and supportive monetary policy—could lift growth above mainstream forecasts.

One trio of economists took a critical look at past efforts to forecast potential GDP growth, a key driver of long-run growth forecasts. They conclude that forecasters, including those at the Federal Reserve and the CBO, have overreacted to temporary economic shocks, overstating potential growth when times are good and understating it when times are bad. We’ve recently had bad times, so forecasters might be underestimating potential GDP almost 10 percent. If so, policies that boost demand could push up growth substantially in coming years. (For a related argument, see here.)

So where does that leave us?

Well, every crystal ball (and glowing orb) is cloudy. We should all be humble about our ability to forecast the economy over the next decade. Scarred by the Great Recession and its aftermath, forecasters may be inadvertently lowballing potential growth. Good luck and good supply- and demand-side policies might deliver more robust growth than they anticipate. But those scars remind us we can’t always count on good policy, and luck sometimes runs bad.

We can hope that luck and good policy lift growth to 3 percent. But it’s prudent to plan for 2 percent, and pray we don’t fall to 1 percent.

The House Freedom Caucus wants to eliminate the Budget Analysis Division at the Congressional Budget Office and rely on outside research organizations, including the Urban Institute, instead. As a former acting director of CBO and an Institute fellow at Urban, I think this is a terrible idea. It would harm fiscal policymaking and weaken the Congress.

Here’s the proposal offered by Representatives Scott Perry (R-PA), Jim Jordan (R-OH), and Mark Meadows (R-NC):

The Budget Analysis Division of the Congressional Budget Office, comprising 89 employees with annual salaries aggregating $15,000,000, is hereby abolished. The duties imposed by law and regulation upon the employees of that Division are hereby transferred to the Office of the Director of the Congressional Budget Office, who shall carry out such duties solely by facilitating and assimilating scoring data compiled by the Heritage Foundation, the American Enterprise Institute, the Brookings Institution, and the Urban Institute.

We certainly appreciate the shout out. Here at Urban, we have amazing researchers who model policies involving health insurance, Social Security, taxes, food stamps, housing, and many other programs. We are proud of our work and try to be as helpful as possible to lawmakers across the political spectrum.

But neither we nor other private organizations can replace CBO’s budget group. Our skills overlap, but we fill different niches in the policy ecosystem.

Consider the sheer scope of CBO’s responsibilities. As Director Keith Hall noted in recent testimony, the agency expects to publish official scores of more than 600 pieces of legislation in the next year. The scores will estimate the spending and, usually with input from the Joint Committee on Taxation, the revenue implications of every provision in those bills. They will also assess whether the bills impose substantial mandates on the private sector or state, local, and tribal governments.

To do this, CBO has staffers familiar with every nook and cranny of the government, from agriculture to veterans. In just the past week, CBO has published more than two dozen cost estimates covering everything from flood insurance to child care to maritime administration to sanctions on Russia, Iran, and North Korea. Not to mention scoring Senate proposals to repeal and possibly replace the Affordable Care Act. Only CBO and its White House equivalent, the Office of Management and Budget, have the capacity to model every facet of federal spending.

Outside groups could certainly expand their capacities. And Congress could expand the list of anointed organizations. But the bottom line is that we would need substantial new resources, both funding and people. Replacing the capacities of CBO’s budget division is not something research organizations can or should do for free.

But resources aren’t the core issue. In addition to its published cost estimates, CBO provides thousands of confidential cost estimates to members of Congress and their staffs as they craft potential legislation. This service is vital to thoughtful legislating. Confidential feedback helps members test new ideas, consider alternatives, and refine proposals until they are ready to go public.

Outside organizations can, and indeed already do, provide similar modeling help to members. At Urban, we frequently get requests from Representatives and Senators of both parties. But working through iterations of potential legislation works best when lawmakers and their staffs work directly with the analysts who will give them official scores. Working with CBO’s budget team is a much more effective process than trying to coordinate different scores, based on different models and assumptions, from multiple outside organizations.

The most important difference between research organizations and Congress is also the most obvious. CBO works for Congress and only for Congress. CBO works closely with the budget committees and House and Senate leadership to juggle priorities, set deadlines, and provide the analyses Congress needs and wants. CBO obeys congressional budget rules, even when it disagrees with them. CBO has the backing of Congress when it gathers data and information from agencies.

CBO thus has an edge in providing the analyses Congress needs, when it needs them. Research organizations can and do provide timely analysis as well, but there are limits. We have other projects and demands on our time.

Moreover, we outside researchers rely heavily on the work that CBO’s budget analysis division currently does. CBO’s annual baselines, for example, often provide the starting point for our analyses. And CBO scores provide many of the numbers we use to model alternative policies. Eliminating CBO’s budget team would undermine our ability to deliver the type of analyses that Congress wants.

Eliminating CBO’s budget team would also weaken Congress. Congress created CBO in the early 1970s as part of a larger battle with President Nixon about power over the purse. Congress created CBO to ensure its own source of credible budget information. Defunding CBO’s budget team would weaken Congress at a moment when objective budget information and a balance between Congress and the President are as important as ever.

My colleagues and I would welcome opportunities to provide more help to Congress as members grapple with policy challenges, develop options, and try to understand the range of potential outcomes. But asking us to replace CBO’s budget team would undermine thoughtful policy making and weaken the Congress.

Mexico won’t willingly write the check for Donald Trump’s wall. So the president is hunting for a way to make Mexico pay.

That search isn’t going well.

Last week, press secretary Sean Spicer floated one idea: the destination-based cash flow tax. The DBCFT taxes imports and exempts exports. We import about $50 billion more from Mexico each year than we export. So the DBCFT could raise substantial revenue from trade with Mexico. Maybe Trump could earmark that money to pay for the wall?

Such earmarking sounds superficially plausible. But it has fundamental budget and logic flaws.

The budget problem is that Congress has other plans for that money. The DBCFT is the centerpiece of the House proposal for tax reform. House leaders insist reform will be revenue neutral. Any new money from the DBCFT will offset money lost from cutting business taxes. That leaves nothing for Trump’s wall.

Broader point: You can’t pay for anything with revenue-neutral tax reform (or, for that matter, with revenue-losing “tax relief”).

Trump may be more concerned with messaging than with these budget niceties. So he could still try to rhetorically link the DBCFT to paying for the wall.

But that leads to the logic problem. We run trade deficits with many countries. If the DBCFT makes Mexico pay for the wall, what does it make China pay for? Germany? Japan? Vietnam? And what about countries like Hong Kong, where America has a trade surplus? Are we paying them for something? And what happens when the wall has been paid for? Does Mexico become exempt from the DBCFT? Or does it start paying for something else?

These questions have no sensible answers. The DBCFT treats Mexico like every other nation, so it can’t make Mexico pay for the wall.

Some observers initially thought Spicer was suggesting a new tariff on Mexican imports. Most economists rightly hate that idea and fear it could spark retaliation against American products. And it seems clear that Spicer really meant the DBCFT. But let’s give that interpretation some credit. A tariff, unlike the DBCFT, could raise new revenue specifically from trade with Mexico.

But a tariff still faces a fundamental economics problem. A tariff doesn’t work like Las Vegas. Just because it targets Mexican products doesn’t mean the tax stays there. Instead, businesses will raise prices, passing some tax on to American customers. Consumers would pay more for cars, TVs, and avocados. Businesses would pay more for auto parts, trucks, and telecommunications equipment. Some burdens would decline over time as businesses shift to suppliers outside Mexico. But some shift of the burden to Americans is inevitable. A tariff would thus make American consumers and businesses, not just Mexicans, pay for Trump’s wall. And that’s without any retaliation.

If President Trump wants to target Mexico alone, he needs another strategy. Neither the DBCFT nor a tariff can make Mexico pay for the wall.