Eighty-three years ago, President Franklin D. Roosevelt had a new plan for tackling income inequality.
FDR argued companies were intensifying the gap between rich and poor not by showering investors with too much wealth—but rather by paying them too little.
“The evil has been a growing one,” FDR said in a speech on March 3, 1936. “It has now reached disturbing proportions from the standpoint of the inequality it represents and on its serious effect on the federal revenue.”
Companies, then generally taxed at a maximum 13.75%, were squirreling away their earnings rather than distributing them to investors, who were taxed at up to 75%.
That created a “serious two-fold inequality,” said FDR: Capital piled up, idle and undertaxed, inside corporations. Meanwhile, “stockholders who need the disbursement of dividends” weren’t getting the income they were entitled to.
It was almost the polar opposite of today. This past week, Senators Chuck Schumer of New York and Bernie Sanders of Vermont decried what they called “the explosion of stock buybacks.”
Their issue: Companies are sending back too much, not too little, money to shareholders.
Companies that repurchase their shares have created “an enormous problem” of “income and wealth inequality,” the senators wrote in an editorial in The New York Times, enriching “shareholders and executives, not workers.” By transferring assets to investors through buybacks and dividends, corporate managers “restrain their capacity to reinvest profits more meaningfully in the company.”
The senators plan to sponsor legislation prohibiting companies from buying back stock unless they pay all employees at least $15 an hour and beef up retirement, health-care and other benefits. The senators also warned that they would “seriously consider” similar limits on dividends, too.
In a buyback, a company uses its cash (or borrows money) to repurchase stock from investors, typically increasing the stock price. During the third quarter of 2018, S&P 500 companies spent $203.8 billion buying back shares, a record for any calendar quarter, according to S&P Dow Jones Indices. Over the 12 months ending Sept. 30, S&P 500 companies spent a record $720.4 billion on repurchases, up 39% over the same period one year earlier.
If companies cut back on buybacks, Sen. Schumer said on the Senate floor on Feb. 4, they would free up cash for training workers, offering better benefits and investing in new equipment. Those, he said, are “the kinds of things we always thought American corporations would do and now they do scantily when compared to how much they do in terms of buybacks.”
At the heart of the recent criticism is the belief that companies can best sustain innovation and reduce inequality by retaining most of their capital rather than paying it out to investors.
To be sure, as I’ve often pointed out, such payouts can be problematic. Companies tend to buy their shares back most eagerly at the worst possible times. Also, by counteracting the dilution from new shares issued to managers exercising stock options, buybacks can placate investors who might otherwise toss out overpaid and underperforming bosses.
Overall, however, buybacks (and dividends) return excess capital to investors who are free to spend or reinvest it wherever it is most needed.
By requiring companies to hang onto their capital instead of paying it out, Congress might—perhaps—encourage them to invest more in workers and communities.
But the law most likely to govern here is the Law of Unintended Consequences.
The history of investment by corporate managers with oodles of cash on their hands isn’t encouraging. Hugh Liedtke, the late chief executive of Pennzoil, reportedly liked to quip that he believed in “the bladder theory”: Companies should pay out as much cash as possible, so managers couldn’t piss all the money away.
In the 1970s and early 1980s, giant oil companies, flush with dollars after the boom in oil prices, binged on buying department stores and developing electric typewriters. (Montgomery Ward stores and Qyx typewriters didn’t turn out to be gushers.)
In the late 1990s, most technology startups refused to pay dividends, instead plowing all their cash back into the business. Employees got free massages, dentists on call, mobile gyms, stock options and other great benefits—until many of the companies went bust, leaving workers and investors alike in the lurch.
Today, some of the companies that have bought back the greatest proportion of their shares—
, for example—also score highest on rankings of how they treat employees.
Complex problems seldom have simple solutions, as even FDR discovered.
After the stock-market crash, dividends had fallen 55% between 1929 and 1933. The investment analyst Benjamin Graham estimated that in 1934 fewer than one-third of New York Stock Exchange companies had repurchased shares.
“The grotesque result,” Graham wrote, was that “the typical stockholder is weighed down by financial problems while the corporation wallows in cash.”
That, and FDR’s calls to free up corporate cash, prompted Congress to enact an undistributed profits tax, penalizing companies for not maximizing their payouts to shareholders.
The undistributed profits tax did prod companies into raising dividends by approximately 25%, but it also led to so much corporate tax avoidance that Congress unwound it in 1938.