Tax Cuts For Dividends/Buybacks — What’s the Deal?

Now that the U.S. tax cuts have been approved, one of the main critic from the left has been that the tax cuts for corporations are likely to be “wasted” on dividend and buybacks to shareholders. This argument has its flaws as noted here: Basically the idea is that this isn’t going to be a waste but rather it will allow reallocation of resources so that investors could use the added funds they would receive from corporations — that don’t use the tax cuts to invest and rather distribute their excess cash to their shareholders via dividends and buybacks — to invest in companies that do require funds to expand their business or even use it for consumption, which, in turn may also boost demand and perhaps, down the line, create opportunities for more companies to invest. I think this argument has its merits and also keeps us open to think how policy could affect a complex economy and appreciate it.

At the same time we also  should NOT hastily discard the idea that this kind of redistribution has its limitations and isn’t expect to yield a big return on this policy. Especially when you consider the following:

  • The tax bill was estimated to cost roughly $1 trillion over the next decade (with only a return of $0.5 trillion for a $1.5 trillion static cost). So by the end of the day even with dynamic scoring, the economy might be better off — at least for the deficit hawks — without this tax bill;
  • Follow the money 1: Let’s not forget that a big chunk of investors (I think around 30%) are outside of the U.S. and could use the funds to consume in their respective country, which might not help the U.S. economy’s demand side. Also, most U.S. investors are at the top 10% (I think well over 50%); and since they don’t tend to expand their consumption if they get more funds, it means yet again little impact on the demand side.
  • Follow the money 2: Investors and corporations could also opt out to use their windfall cash to invest abroad, which again doesn’t bode well for capital formation in the U.S. (although it may reduce the deficit in the CA — so silver lining?!)
  • This only address supply side and doesn’t — at least not directly — impact the demand for investment; the reallocation could boost the aggregate after tax rate of return but until the demand picks up it will be hard to see companies expand their capex let alone hire more people.

 

The bottom line is that investors may be able to reallocate their resources, which could lead to more investments but given the state of the U.S. economy, low interest rates and all the other issues I have listed above, I suspect this redistribution could wind up having way more limited impact on the capital formation of the U.S. in the coming years.