Sabtu, 03 Maret 2018

The Buyback Fallacy

Many commenters on the tax bill repeat the worry that companies will just use tax savings to pay dividends or buy back shares rather than make new investments.

Savannah Guthrie, interviewing Paul Ryan on the Today Show, thought she had a real gotcha with
"What they [CEOS] are planning to do is stock buybacks, to line the pockets of shareholders."
(She then moved on to a question most guaranteed to produce retweets of partisan admirers, and least likely to produce an interesting answer,
"I'll ask you plainly, are you living in a fantasy world?"
NBC then wonders that it is charged with partisan bias.)

Peggy Noonan, in an otherwise thoughtful column, echoed the same worry:
"Big corporations can take the gift of the tax cut ... and do superficial, pleasing public relations sort of things, while really focusing on buying back stock and upping shareholder profits."
(Just how taking less of your money is a "gift" is a question for another day.)

So, having established that this is a bipartisan worry, let's put the fallacy to bed. It is the fallacy of composition, that actions of one company mirror actions of the economy as a whole. It is the fallacy of "paper investments" vs. "real investments." That distinction can apply to a company, but not to the whole economy.

What corporate cash is not. 
No, companies do not sit on vast swimming pools of gold coins, like Scrooge McDuck. One company's "cash" is a short term loan to another company, which the latter uses it to make real investments. Every asset (paper) is also a liability, backed by an investment. The charge fails to track the money.  One of the few things economists know how to do is always to ask, "OK, and then what do they do with the money?" Money is a veil, and real decisions are (to first order) independent of financial decisions. (I use italics to suggest some ways to remember these basic economic ideas.)

Suppose company 1 gets a tax cut, doesn't really know what to do with the money -- on top of all the extra cash the company may already have -- as it doesn't have very good investment projects. It  sends the money to shareholders. Well, what do shareholders do with it? (Hint: track the money.) They most likely roll the money in to other investments. They find company 2 that does need the money for investment, and send it to that company. In the end, they only consume it if nobody has any good investment ideas.

If company 1 doesn't have any good investment ideas, even after the tax cut, and company 2 does have some good investment ideas, made better after the tax cut, the economy needs to get money from company 1 to company 2. Company 1 could buy company 2; company 1 could invest in company 2 by buying its stock or buying its debt (all that "cash" you hear about); company 1 could return money to shareholders, and the shareholders could invest in company 2. They're all the same, to economics. Of all the ways to do this, actually, the last might well be the most efficient. Shareholders might have better ideas about good investments than managers of a company that doesn't have any good investment ideas.

The larger economic point: In the end, investment in the whole economy has nothing to do with the financial decisions of individual companies. Investment will increase if the marginal, after-tax, return to investment increases. Lowering the corporate tax rate operates on that marginal incentive to new investments. It does not operate by "giving companies cash" which they may use, individually, to buy new forklifts, or to send to investors. Thinking about the cash, and not the marginal incentive, is a central mistake. (It's a mistake endemic to Keynesian economics, but the case here is supply-side, incentive oriented.)

The point is the same as one I made in an earlier post, not to expect "repatriation" of corporate profits to make much difference to investment. Apple Ireland could already put money in a bank that lends to a US bank that lends to Apple US, if that money's best use was in the US. The marginal profitability of investment is all that matters.

Now, let me also quickly grant that there are second-order effects and frictions. Perhaps due to "agency costs," internally generated cash is a cheaper source of investment funds than cash obtained by issuing stock or borrowing. In that case, financing decisions do matter. Tracking down this sort of thing is what makes economics fun. But good economic analysis always starts with the relevant budget constraint or neutrality theorem, and then adds the frictions. Neither Ms. Guthrie nor Ms. Noonan had such a second order financing friction in mind.

Do not take this post as criticism of either author. They just happened to repeat the charge, which is floating around as part of the larger talking-point battle surrounding the tax cuts. Ms. Guthrie is an anchor trying to lob nasty questions, and Speaker Ryan could have answered this way. He chose a better answer in fact, recognizing that like "fantasy world" it was not a serious question. Ms. Noonan is a political commentator, and this minor fallacy does not detract from her interesting, larger, political point: Forget that returning cash to investors who quietly put it in better companies is economically efficient. If large companies are seen to just hand out presents to investors rather than to invest the funds internally, the political optics of the tax cut will be bad for its defenders. Sometimes paying attention to fallacies can be good P. R. It is, however, the job of economists as public intellectuals (subject of an upcoming post) to patiently point out this sort of thing, so maybe someday voters will not confuse P. R. stunts with progress.