The Trump administration enacted a $1.5 trillion tax cut at the end of 2017 on the premise that it would have such a stunning and long-term impact on economic growth, it would pay for itself. Fast forward 18 months, and while growth indeed hit an impressive 4.2% annualised rate in Q2 2018 it has since been steadily dropping, with Q2 growth this year hitting 2.1%, dragged down by the worst business investment in over three years. The thing is, many prominent economists have been screaming into the void that this was entirely predictable. Tax cuts never pay for themselves. They blow up the deficit time and time again.
This fallacy somehow refuses to die, no matter how much empirical evidence piles up against it. This latest endeavour in delusional thinking will send the US deficit beyond $1 trillion dollars this year after being reigned in year-by-year during the Obama administration from post-global financial crisis (GFC) highs to just over $400 billion. During times of economic recovery, intelligent fiscal policy dictates the national debt should be paid down, so that there is sufficient weaponry left in the armoury when shit hits the proverbial fan. Instead, the US national debt is set to surpass $22 trillion this year, and fiscal policy will be unprecedentedly hamstrung in any potential future economic downturn.
The argument that tax cuts pay for themselves is, however, not the only delusion used to justify the anti-tax agenda. The notion that corporate tax cuts in particular are used by corporations primarily to invest in new projects and capital, with profound flow-on effects for job creation is largely misguided. While some of this newfound profit of course gets invested, with real impacts for the economy, what is often neglected is the extent to which companies take this money and simply buy huge quantities of their own stock, artificially inflating demand for it and therefore sending the stock price soaring.
This practice, known as a stock buyback, is popular with CEOs for two main reasons. Firstly, it’s easy. Imagine you’re a CEO of a large corporation and you’ve just been given a billion dollars. Now you could direct your upper management to derive new and potentially risky projects that may also be costly to execute that, if successful, will lead the stock price of your company higher and make your shareholders happy (let’s not forget that CEOs are ultimately beholden to their shareholders). Alternatively, you could just spend the bulk of that money buying existing stock to achieve the same end with zero risk. Sound fishy? Well that’s because it is.
There used to be a rule that was implemented after the giant stock market crash of 1929 and the Great Depression that followed it that prevented companies from doing anything to manipulate their stock price. Seems like a reasonable measure after such a catastrophic episode wherein companies were excessively overvalued right? That rule stood until Ronald Reagan, the darling of free market fetishists, decided in 1982 that it was no longer needed. What followed was trillions of dollars of stock buybacks, with an estimated 94% of corporate profits in the US over the last 15 years spent on buybacks and dividends.
The second reason CEOs love stock buybacks is that stocks of the company they are overseeing are often part of a CEO’s compensation package. Not only are they lining the pockets of their shareholder base by driving up the stock price, they are enriching themselves in the process. This also creates a perverse incentive for short-term gain over the long-term health of the company. Average US CEO tenure has been shortening in recent years, with the median length of CEO tenure at S&P 500 companies dropping by a year to 5.0 years between 2013 and 2017 — years of relative economic prosperity. Basically, CEOs are increasingly boosting the share price of their company and cashing out. This is unsurprising considering the structural incentive towards short-termism currently in place, but at a macro-level, a short-term rationale like this also provides profound long-term risks to the health of the economy.
In other words, the money these CEOs are splurging on stock buybacks for their own and their shareholders’ enrichment could be spent in other ways that would be more beneficial to society at large. The Roosevelt Institute released a report last year that estimated the $20 billion that Walmart was using for stock buybacks in light of the Trump tax cut could boost wages to more than $15 an hour — in line with the minimum wage level currently sought after by Bernie Sanders and others. This would not only vastly improve living standards for hundreds of thousands of its workers, but would create additional expenditure in the real economy, driving GDP growth higher. It’s uncontroversial that rich people don’t spend higher investment income on consumption to the same degree that those at the bottom do when given a pay rise, so if economic growth and job creation is the goal,¹ raising wages is vastly more effective than boosting the value of rich people’s share portfolio.
The concept of trickle-down economics — so pervasive in this current era of neoliberal hegemony — begs to differ; arguing that giving rich people and corporations more money is the most effective way to pull living standards up for those at the bottom. The argument goes that rich people and CEOs of corporations are best positioned to direct this additional money to “productive” ends, generating employment and economic growth. This simply does not hold up under closer inspection, and stock buybacks are a clear demonstration of this fact.
If you give somebody living paycheck to paycheck more money, they will spend that money on things they’ve been wanting to buy but couldn’t previously afford. If you inflate the value of a wealthy person’s stock portfolio, there’s just as good a chance that that money will continue to sit in their stock portfolio as there is of them taking it out and reinvesting or spending it in the real economy.
It’s worth a reminder at this point that there’s been very little correlation between the fortunes of the stock market and real wages for a long time, with real wages in the US actually falling during the 80's while the stock market soared, and only moderate increases during Trump’s presidency despite a massive rise in the stock market to all-time highs.
These stock market gains are primarily realised by a strikingly small proportion of society, with the richest 10% of households in the US controlling 84% of stocks. When corporate taxes are cut, there is of course some payoff in the real economy, but it is little more than a sugar hit; the real legacy is amplified wealth and income inequality. And when the deficit inevitably explodes, conservative politicians will eagerly proclaim that “costly social programs” are to blame, which must be cut in order to restore the government’s balance sheet. This would, of course, hit the poorest in society and further exacerbate inequality.
US companies spent an all-time record $806 billion on stock buybacks in 2018, up 55% from 2017, the year preceding Trump’s giant corporate giveaway, and 36% higher than the previous high watermark in 2007, the year that preceded the GFC. This has punched a massive hole in the US deficit, and taxpayers will at some point in the future be asked to foot the bill. This amounts to an exercise in large-scale corporate welfare, funded by an intergenerational tax grab. So, the next time you hear someone whinging about higher taxes and wealth distribution, remember the figure $806 billion: more than the value of Facebook or of Google’s parent company Alphabet, more than the GDP of Switzerland, and more than an entire year’s budget for the US military. But tell us again how we can’t afford food stamps for the poor or a quality education for our kids. Give me a break.
¹ Economic growth actually shouldn’t be the primary goal, but that’s a topic to be covered in a future post