Corporate America is flush with cash and is buying back a near-record amount of stock this year. President Biden wants to increase the taxes on those buybacks. Biden is said to propose in his State of the Union speech tonight to raise the tax companies pay when they buy back their own shares, to 4% from 1%. The theory is that requiring additional taxes on buybacks will encourage companies to invest in hiring more people or making capital expenditures (more plants, buildings, or technology) rather than buying back their own stock. While the validity of that theory is debatable, there is no doubt that companies seem to be starting buybacks. Many observers predict that 2024 could be a near-record year for buybacks. Why buybacks are on the rise After a record 2022, when $950 billion in shares were bought back, 2023 was a disappointing year, largely due to a lack of earnings growth. But 2024 and 2025 look like near records. Buybacks: growing? (implemented repurchases) 2024 (est.) $925 b. 2023 $815 b. 2022 $950 b. 2021 $919 b. 2020 $538 b. 2019 $749 b. Source: Goldman Sachs Jeffrey Yale Rubin at Birinyi Associates estimates that companies there announced $187 billion in buybacks in February alone, second only to the record $225 billion announced in February 2022. “Solid earnings growth will be the main tailwind to buybacks at high valuations. and political uncertainty will be adverse,” Goldman Sachs said in a recent report. Goldman recently raised its 2024 buyback forecast to $925 billion (up 13% year over year) and $1.075 billion in 2025 (up 16% year over year). Goldman noted that a good portion of the buybacks are being driven by record profits in big tech: “We expect buyback growth in 2024 to be driven largely by the mega-cap tech stocks,” the bank said. Indeed, Goldman noted that the Magnificent 7 by itself accounted for 26% of the repurchases of the S & P 500 in 2023. Corporations prefer stock repurchases. Corporate America has wide latitude in what it does with the cash flow it generates. Excess cash will typically fall into three buckets: buybacks, dividends, and capital expenditures. While the percentage that goes to each bucket ebbs and flows, companies have recently shown a greater penchant for buybacks. 2023: What corporate America did with its cash flow Purchases $765 b. Capital expenditures $597 b. Dividends $588 b. Source: S & P Global The reason: buybacks can boost stock prices because they reduce shares outstanding and, in theory, improve earnings per share. Of course, dividends are an alternative source of returning shareholder money. And big tech companies may be moving in that direction. At the same time it announced a recent buyback, Instagram parent Meta Platforms also declared its first dividend. Three of the Magnificent 7 (Alphabet, Amazon and Tesla) do not pay any dividend. Goldman found that large companies with stable earnings, high profit margins and cheap valuations are the most likely to initiate dividends. Using this framework, they noted that Alphabet and Amazon respectively rank as the 1st and 8th most likely stocks in the Russell 3000 Index to start paying a dividend. Diverting cash to capital and employment an open question It is possible that companies will divert spare cash to increased capital spending and enhanced employment if repurchase taxes are increased but, at least for large-cap technology stocks, the decision is more likely to be driven by the state of technological growth, not tax avoidance. The Big 7 spent $407 billion on capital expenditures and research and development in 2023, representing 23% of their annual revenue and 27% of all S&P 500 capex and R&D spending. “If management teams see attractive investment opportunities beyond this increase in spending, they may limit growth in buyback programs to finance investment,” Goldman said. Elsewhere, much of the decision to invest in one bucket or another boils down to economic growth: higher growth means companies will be more willing to invest in hiring more people and making capital expenditures. Goldman noted that its economic teams expect economic growth to slow in the second half of 2024, suggesting that investors will continue to favor companies that return cash to shareholders. “However, if the momentum of economic growth instead continues to build, investors may begin to increasingly reward companies that invest for growth,” Goldman said. Would higher taxes discourage companies from doing buybacks? In early February, Meta authorized an expanded $50 billion share buyback program, equivalent at the time to about 5% of outstanding shares. Under the current tax, the company would pay $500 million, according to Biden’s proposed tax, it will rise to $2 billion. That’s a significant amount of money, but it’s not clear whether it would cause Meta to divert money from buybacks to capital investment. “I haven’t seen anything that would demonstrate that tax buybacks would cause corporations to divert money to capital spending,” Howard Silverblatt, senior index analyst at S&P Global, told me. Silverblatt echoed Goldman’s analysis, noting that corporations would rationally decide to put more money into employment and capital spending if the economy continues to grow: “That’s what they should do, going where the growth is,” he told me.