Forty years of buyback growth

Stock buybacks — the practice of a company using its cash to repurchase its own shares — were essentially prohibited under SEC rules from the 1930s until 1982. The repurchases that did occur were treated as potential market manipulation and were heavily scrutinized.

In 1982, the SEC adopted Rule 10b-18, providing a safe harbor for buybacks that met specific volume, timing, and pricing constraints. The rule was framed as administrative tidying. Its effect was to legalize at scale a practice that had previously been suspect.

Forty years later, buybacks are the largest single use of S&P 500 cash flow. They have exceeded business investment in many recent years. They have exceeded dividends consistently. In some industries, they have exceeded R&D, capital expenditure, and net debt repayment combined.

What buybacks actually do

A buyback reduces the number of shares outstanding. The same earnings, divided across fewer shares, produces higher earnings per share. Higher EPS, in turn, mechanically lifts the share price (assuming the price-to-earnings ratio holds). Executive compensation tied to share price or EPS therefore rises with the buyback, often substantially.

The economic literature on buybacks is divided in detail but converges on a few points:

• Buybacks are largely a substitute for dividends, with a tax preference. Both return cash to shareholders. Dividends are taxed when paid; buybacks are taxed only when the recipient sells the share, often at lower long-term capital gains rates. The shift from dividends toward buybacks since the 1980s tracks the tax-preference closely.
• Buybacks correlate with executive pay timing. Studies have repeatedly shown that buyback volume spikes in periods immediately preceding executive equity vesting events.
• Buybacks do not, in themselves, signal underinvestment. A company with no profitable internal investment opportunities returning cash to shareholders is not, in principle, doing something wrong. The case against buybacks has to be more specific than that.

The case against buybacks (specifically)

The substantive critiques are narrower:

1. Buybacks during layoffs or wage suppression. When a company is laying off workers, freezing wages, or asking for public bailouts while simultaneously running buyback programs, the political case for restrictions is straightforward. The 2020 pandemic made this vivid: airlines and hotels that had spent their post-2017 tax-cut windfalls on buybacks then sought federal aid when revenue collapsed.
2. Buybacks that leverage the balance sheet. Some buybacks are funded by issuing debt — exchanging a buffer against future shocks for an immediate share-price boost. This is the most defensible target of regulation.
3. Buybacks in heavily regulated or subsidized industries. Pharmaceuticals (where R&D costs are partly underwritten by federal funding), defense contractors (where most revenue is federal), and large banks (which depend on FDIC insurance and Fed liquidity) are sectors where the case for restricting buybacks is sharpest.

The buyback excise tax

The 2022 Inflation Reduction Act introduced a 1% excise tax on net stock buybacks by publicly traded US corporations. The mechanism is straightforward: the tax applies to the dollar value of buybacks, net of new share issuances, above a small threshold.

The 1% rate was modest by design. At that level, the tax raises meaningful revenue (~$70-80 billion over a decade in JCT estimates) but does not materially shift corporate behavior. Most analysts estimate the 1% rate roughly offsets the tax preference for buybacks over dividends — it does not penalize buybacks; it just removes the small tax advantage.

The proposals on the table to expand it are substantive:

• Raise the rate to 4%. The Biden FY24 budget proposed this. At 4%, the tax meaningfully changes the cost-benefit calculation of buybacks vs. dividends or reinvestment.
• Apply higher rates during layoffs. Several proposals would impose elevated rates on buybacks conducted within 12 months of major workforce reductions.
• Restrict buybacks in regulated industries. Restoring some version of the pre-1982 rules for specific sectors — notably banks, defense, and pharmaceuticals.
• Restore SEC scrutiny. Tightening Rule 10b-18 to flag buybacks that occur near insider trading windows or that materially shift firm leverage.

What the empirical case can and can’t establish

The buyback debate often overreaches. Buybacks in themselves are not the cause of US wage stagnation, declining business dynamism, or weak public investment. The cause of those things is the combined effect of decades of tax-code, antitrust, labor-law, and corporate-governance choices.

What buybacks are is a marker. A firm that returns the bulk of its cash flow to shareholders rather than reinvesting it is signaling that it has no profitable internal investment opportunities — which is sometimes correct, but is also a sign of a firm or an economy that has stopped innovating. A national economy in which buybacks consistently exceed business investment is signaling the same thing at scale.

What to watch

• Effective tax-rate disclosures from the largest issuers. When a company’s effective tax rate falls during a buyback-heavy year, that is the kind of pattern the CAMT was designed to catch.
• SEC rulemaking on buyback disclosure. The 2023 disclosure rule requires more granular reporting; some of it is being challenged in court.
• Sector-specific proposals. Pharmaceutical-industry buyback proposals tend to advance further than general-purpose proposals because of the public-funding angle.
• Banking sector. Bank capital rules and buyback authorizations are reviewed annually; restrictions during stress can be implemented administratively.

Bottom line

Stock buybacks are not the central pathology of US corporate capitalism. They are a symptom — and a useful one, because they are visible, measurable, and tractable to regulation. The 1% excise tax is a beginning. Expansions of it are among the most concrete, achievable corporate-tax reforms on the current agenda.