Stock buybacks, good or bad?

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I take a very simple view of stock buybacks:

  1. People give a company money to do stuff.
  2. The company does stuff with the money.
  3. The stuff that the company does makes money.
  4. The company gives the money it makes in step 3 back to the people who gave it money in step 1.

People like to overcomplicate this. “Companies should not give money back to shareholders,” they say; “they should invest it in new factories and growth and innovation.” Yes fine often that is true, agreed. But at some level it cannot be perpetually ruled out that the people who give companies money to do things can never get their money back. Why would you invest money in a company if it could never give you any money back?

This is oversimplified, of course, and you could have quibbles. “The company can pay you a dividend, but it cannot ever buy back stock” seems to be a view that some people have. I find it a little baffling but, fine, whatever, that’s a way for the company to pay people for providing capital; it can work. One practical reason that you might have this view, in the US in 2022, is that stock buybacks are much more tax-efficient than dividends. When a company pays a dividend, all its shareholders pay tax on the entire amount of the dividend. When a company spends the same amount of money buying back stock, most shareholders don’t pay taxes (because they don’t sell any stock), and the ones who do only pay taxes on their gain (the difference between what they paid for the stock and the buyback price). When investment bankers pitching share-repurchase strategies, this was a good argument for doing a stock buyback instead of a dividend. But if you are suspicious of stock buybacks, this is a bad thing: This is just “stock buybacks let companies pay money to shareholders without making them pay tax.” You might want them to pay tax!

And so the Inflation Reduction Act of 2022 imposes a 1% excise tax on stock buybacks by public companies. The people who demanded that tax probably dislike stock buybacks a lot more than I do, so in some theoretical sense I feel like I should disapprove of this tax. But on the other hand the excise tax just makes stock buybacks slightly less tax efficient, putting them on closer to a level playing field with dividends, and I guess that’s fine. I can’t get too worked up about it.

That said there are some oddities. At Axios, Dan Primack reports that the 1% tax “could be applied to SPAC redemptions.” The way a special purpose acquisition company works is:

  1. A sponsor raises money by selling stock to the public at $10 per share.
  2. She puts the money in a pot and looks for an acquisition target.
  3. If she finds one, the SPAC merges with the target. The target gets the money in the pot and becomes a public company; the shareholders of the SPAC get shares of the target.
  4. If she does not find a target (or the shareholders don’t approve the one she finds), which seems increasingly likely for a lot of SPACs these days, then the SPAC liquidates and returns the money in the pot (plus a bit of interest) to shareholders.

Is that a “stock buyback”? Well, sure, I guess. People put money into the company, time passed, and the company gave them the money back. The company tried to do something with the money, but it failed, so it just returned it. And there’s a 1% tax on the way out.