Banning Stock Buybacks Won’t Do Much for Wages
(Bloomberg Opinion) -- As part of the quest to raise wages, some politicians are suggesting a new approach -- a ban on stock buybacks. Senators Chuck Schumer and Bernie Sanders have argued that share repurchases prevent businesses from investing, thus hurting workers in order to enrich wealthy shareholders.
Many have noted that the most immediate effect of President Donald Trump’s tax cuts was to make companies buy back shares at a tremendous rate, while the rise in business investment has been rather anemic:
This is part of a long-standing pattern -- in the past few decades, corporations have tended to use the stock market to return money to shareholders rather than to raise cash, using debt instead of equity to finance expansion plans (possibly because of the tax advantages involved). In the meantime, as the graph above shows, businesses have been investing less.
Banning buybacks might help reverse the trend. Without the ability to repurchase their shares, companies might instead return money to shareholders via dividends, or hold it in cash. But they might also use the money to invest in their own businesses, especially if taxes on dividend income were raised. It’s hard not to notice that the decline in business investment as a share of the economy began in the middle of the 1980s -- just a couple of years after buybacks were legalized in 1982. That might be a coincidence, but reversing the legal change at least has a shot of reversing the investment trend.
And standard economic theory says that higher business investment should result in higher wages. When businesses expand their capital stock -- buildings, vehicles, machines and software, as well as brands and other intangible assets -- it should also increase the productivity of workers, who will then command greater pay.
But what if standard economic theory is wrong? It wouldn’t be the first time. It’s possible that rather than investing in tools to make workers more productive, businesses would invest in ways to replace them.
That might sound like a rise-of-the-robots scenario, but it’s actually a lot more pedestrian. In addition to replacing manufacturing workers with machine tools, companies can simply restructure, finding ways to use more capital and less labor. Or they can invest in businesses that tend to generate monopoly rents through network effects, intellectual property or other means.
The degree to which companies can dispense with human workers is called capital-labor substitutability. Most economists tend to find that this substitutability is low, suggesting that capital and labor tend to be complements -- if you buy more equipment or expand into new businesses, you need to hire more employees. But those estimates tend to rely on theoretical assumptions that might be mistaken.
Economists Daniel Garrett, Eric Ohrn and Juan Carlos Suarez Serrato take a simpler approach. They look at a policy that has modestly succeeded in boosting business investment -- bonus depreciation. This policy increased the percentage of new investments (in buildings, equipment, software and so on) that businesses can write off from their taxes. Businesses that got a bigger write-off ended up investing more. This allowed economists to observe that bonus depreciation really does raise investment.
But it might not help workers much. Looking at specific geographic areas, Garrett et al. found that bonus depreciation had no effect on average earnings. It did increase local employment, but not by an impressive amount -- only one new job for every $53,000 of tax credit. This led the authors to conclude that in recent years, businesses have been able to substitute capital for labor fairly easily.
If this result holds true -- and as usual, more research is needed -- it means that even if banning buybacks and taxing dividends pushed businesses to invest, workers might not end up seeing much of the benefit. And if the link between investment and wages has been severed, it means that politicians looking to give wages a boost should look to more direct measures -- payroll tax cuts, minimum wage hikes or even wage subsidies. Banning buybacks, or other policies to force businesses to invest, might end up simply being a distraction.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Noah Smith is a Bloomberg Opinion columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.
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