Buybacks Aren't the Problem!

The environment on Capitol Hill has made populism a bipartisan affair, with Republican Senator Marco Rubio now joining the fray with a call to tax corporate stock buybacks.

His argument? Corporations are buying back stock instead of making productive investments. He's not alone in arguing that weak investment is the reason the economy isn't growing faster. Meanwhile others argue the corporate tax cut of 2017 fell flat as tax savings went towards a surge in buybacks, not investment.

Rubio also bemoans that stock buybacks face a lower tax rate than dividends. But qualified dividends (which are the vast majority of dividends paid by public companies) are taxed at the same rate as capital gains, so we're not quite sure how he comes to this conclusion.

Let's break down the issues with his argument. To start, companies have been investing. Think about it. If companies were under-investing, there would be shortages, and that is simply not the case.

Another reason his argument fails scrutiny – and probably the most common misperception when it comes to corporate investments – is that people mistake nominal investment for real investment.

The price of technology has fallen dramatically while its capabilities have surged. You can buy a smartphone or tablet today for hundreds of dollars, while just a decade ago those embedded technologies would have cost millions of dollars (and required a suitcase to lug around). Airlines can now book passengers using an App instead of a ticket office. Brick and mortar stores are being replaced by logistics software and delivery vehicles. A decade ago it took more than two months to frack a well, now it takes two weeks.

In other words, the price of production is falling while profit margins have improved. The declining costs for improved performance make it appear that companies aren't investing, when in reality they are. In fact, productivity at the corporate level is booming, and that's exactly why corporations can return so much capital to shareholders. On a nominal basis, business investment was 13.7% of GDP in the last quarter of 2018, exactly where it was in 2001 and 2008. But on a real basis (where inflation – or in the case of technology, deflation -is accounted for), business investment was 14.7% of GDP, the highest on record.