The Coronavirus Stimulus Bill is stalled in Congress because the Republicans have included a provision for a open-ended bailout of large distressed corporations and the Democrats oppose this .
Phil Mattingly summarized the main sticking Monday in a CNN article.
“The proposal includes roughly $500 billion in funds for loans and loan guarantees to be doled out to distressed companies, states and localities. What it doesn’t include, however, are strict guidelines as to which companies would be eligible, guarantees that any company that taps the funding pool maintains its current workforce and the ability for the treasury secretary to waive, at his discretion, any restrictions on stock buybacks for recipients. It also doesn’t require any reporting of which companies took loans until six months after the fact. (The italics are mine.)
The lack of oversight and significant discretion given to the part of the treasury secretary infuriated Democrats and perhaps just as importantly, their outside allies, and played a major role in unifying the caucus against the proposal on Sunday.”
To understand the Democrats’ position, we need to reexamine Donald Trump’s Tax Cuts and Jobs Act. The new tax law created two significant changes that are relevant to the current issue.
First, as outlined succinctly by Kyle Pomerleau in an article written for the Tax Foundation;
“The Tax Cuts and Jobs Act (TCJA) reduced the U.S. federal corporate income tax rate from 35 percent to 21 percent. However, corporations operating in the United States face another layer of corporate income tax levied by states. As such, the statutory corporate income tax rate in the United States, including an average of state corporate income taxes, is 25.7 percent. This rate puts the United States in line with the average among Organization for Economic Co-operation and Development (OECD) member nations.”
Second, as Janet Berry-Johnson points out in an article for Bench on bonus depreciation tax write-offs;
“Thanks to the Tax Cuts and Jobs Act of 2017 (TCJA), a business can now write off up to 100% of the cost of eligible property purchased after September 27, 2017 and before January 1, 2023, up from 50% under the prior law.
Qualified business property includes:
- Property that has a useful life of 20 years or less. This includes vehicles, equipment, furniture and fixtures, and machinery. It doesn’t include land or buildings.
- Qualified improvement property. This includes improvements made to the interior of “nonresidential real property” (also known as a commercial building), as long as the improvement is made after the building is open for business.
- Computer software.
- Some listed property. Listed property includes property that tends to be used for both business and personal use, such as vehicles and cameras. To qualify for bonus depreciation, the asset has to be used for business at least 50% of the time.”
For a good example of how these tax benefits work, consider an airline that buys an airplane for many millions of dollars. Instead to writing off the costs over the plane’s useful life (generally 20 years), the entire cost can be treated as a deduction in calculating income in the year of acquisition. Then, if the airline still has a taxable income, the federal tax rate is 14% less than it was before the TCJA. (For accounting purposes, the plane appears on the balance sheet as an asset.)
The intent of Trump’s program was to goose the economy by increasing the ability of corporations (especially large ones) to earn profits. The idea was to benefit executives and shareholders while (hopefully) having some of the largess filter down to employees.
What resulted however, over the next three years, was an unprecedented increase in “corporate share buybacks”.
There is an excellent summary of the purpose of stock buybacks on Investopedia. Below is a summary of the relevant points;
“There are several ways in which a company can return wealth to its shareholders. Although stock price appreciation and dividends are the two most common ways, there are other ways for companies to share their wealth with investors. … one of those overlooked methods: share buybacks or repurchases.
- A stock buyback occurs when a company buys back its shares from the marketplace.
- The effect of a buyback is to reduce the number of outstanding shares on the market, which increases the ownership stake of the stakeholders.
- A company might buy back shares because it believes the market has discounted its shares too steeply, to invest in itself, or to improve its financial ratios.
Why do companies buy back shares? A firm’s management is likely to say that a buyback is the best use of capital at that particular time. After all, the goal of a firm’s management is to maximize return for shareholders, and a buyback typically increases shareholder value. The prototypical line in a buyback press release is “we don’t see any better investment than in ourselves.”
Another reason a company might pursue a buyback is solely to improve its financial ratios—the metrics used by investors to analyze a company’s value. This motivation is questionable. If reducing the number of shares is a strategy to make the financial ratios look better and not to create more value for shareholders, there could be a problem with management. However, if a company’s motive for initiating a buyback is sound, better financial ratios as a result could simply be a byproduct of a good corporate decision. Let’s look at how this happens.
First, share buybacks reduce the number of shares outstanding. Once a company purchases its shares, it often cancels them or keeps them as treasury shares and reduces the number of shares outstanding in the process.
Moreover, buybacks reduce the assets on the balance sheet, in this case, cash. As a result, return on assets (ROA) increases because assets are reduced; return on equity (ROE) increases because there is less outstanding equity.3 In general, the market views higher ROA and ROE as positives.
Suppose a company repurchases one million shares at $15 per share for a total cash outlay of $15 million. Below are the components of the ROA and earnings per share (EPS) calculations and how they change as a result of the buyback.
|Before Buyback||After Buyback|
|Earnings Per Share||$0.20||$0.22|
As you can see, the company’s cash hoard has been reduced from $20 million to $5 million. Because cash is an asset, this will lower the total assets of the company from $50 million to $35 million. This increases ROA, even though earnings have not changed. Prior to the buyback, the company’s ROA was 4% ($2 million/$50 million). After the repurchase, ROA increases to 5.71% ($2 million/$35 million). A similar effect can be seen for EPS, which increases from 20 cents ($2 million/10 million shares) to 22 cents ($2 million/9 million shares).
The buyback also improves the company’s price-earnings ratio (P/E). The P/E ratio is one of the most well-known and often-used measures of value. At the risk of oversimplification, the market often thinks a lower P/E ratio is better. Therefore, if we assume that the shares remain at $15, the P/E ratio before the buyback is 75 ($15/20 cents). After the buyback, the P/E decreases to 68 ($15/22 cents) due to the reduction in outstanding shares. In other words, fewer shares + same earnings = higher EPS, which leads to a better P/E.
Based on the P/E ratio as a measure of value, the company is now less expensive per dollar of earnings than it was prior to the repurchase despite the fact there was no change in earnings.”
According to CNBC, stock buybacks were 1.1 Trillion dollars in 2018 and Goldman Sachs estimated that 2019 buybacks were 710 Billion dollars.
Almost 2 Trillion dollars in buybacks went a long way towards making large company stocks more and more attractive to investors but did very little, if anything, for rank-and-file employees.
Below is a MarketBeat list of a few of the larger stock buy backs from some of the most recognizable companies just in the last 6 months of 2018.
Boeing 20 Billion
Pfizer 10 Billion
Mastercard 6.5 Billion
Northrop Grumman 3 Billion
Intel 15 Billion
3M 10 Billion
Merck 10 Billion
Charles Schwab 1 Billion
E*Trade 1 Billion
Texas Instruments 12 Billion
Oracle 12 Billion
Nordstrom 1.5 Billion
Conoco Phillips 9 Billion
Morgan Stanley 4.7 Billion
Bank of America 20.6 Billion
In 2019, Wells Fargo’s Board authorized 23.1 Billion dollars in buybacks and Bank of America 30.9 Billion dollars. Go to Marketbeat if you want all the details.
As I am typing this, my iPad informed me that the 2 Trillion-dollar coronavirus rescue bill has been blocked by the Democrats for the second day in a row. While the Republicans are levying charges of obstructionism, the Democrats are demanding more for healthcare workers and the untold numbers of people who have, and will, lose their jobs.
So, ask yourself would you support a bill that lacks strict guidelines as to which companies would be eligible, does not guarantee that any company that taps the funding pool will maintain its current workforce and the permits the Treasury Secretary to waive, at his discretion, any restrictions on stock buybacks for recipients ? Would you sanction the passing into law provisions that don’t require any reporting of which companies took loans until six months after the fact?
I would not.