Since President Donald Trump took office in January 2017, things haven't always gone according to plan (see healthcare reform). In fact, as a result of Trump's lack of political or military experience, things have, at times, been quite unorthodox. But one thing that did go as planned was Trump's campaign promise to deliver individual and corporate tax cuts.
After months of debate, the Tax Cuts and Jobs Act became law in December. For working Americans, it offered a number of ways to put more money in their pockets. Specifically, the standardized deduction was nearly doubled and the income ranges associated with particular income tax rates were widened (with some of the corresponding tax rates lowered a bit). And for parents, the Child Tax Credit was doubled to $2,000 and the amount of the credit that's refundable increased to $1,400. If you want a more thorough explanation of everything the Tax Cuts and Jobs Act does and doesn't do for taxpayers, check out my colleague Matthew Frankel's detailed explanation of the law.
While the Tax Cuts and Jobs Act attempts to do a lot for individual taxpayers, it's the expectations for the corporate side of the aisle that's more important to Trump's long-term goals of growing the U.S. economy. The relatively new tax law reduces the peak corporate income tax rate from 35%, as it had been for years, to 21%.
The thinking here was that companies would take this extra capital and put it toward job creation, higher wages, research and development, and other aspects that would lead to long-lasting economic growth. However, initial indications suggest that this critical assumption has failed miserably to take shape.
This Trump tax plan assumption has (thus far) been completely wrong
According to CNN, publicly traded companies took their windfalls from extra profits as a result of paying lower corporate tax rates and put them to work by... purchasing a record amount of their own common stock -- an all-time record $436.6 billion worth of common stock during the second quarter, to be exact. This obliterated the previous all-time record of $242.1 billion in stock buybacks that was set... wait for it... during the preceding first quarter. That means we've witnessed back-to-back quarters of record share buybacks since the Tax Cuts and Jobs Act became law.
In terms of quantifying these buybacks, an analysis of the Russell 1000 companies from Just Capital on corporate tax reforms recently found that a significant amount of capital was being diverted to pleasing shareholders. Of the 137 Russell 1000 companies that have announced their intentions with this extra capital following tax reform, 57% of that capital was being used for share repurchases or dividend increases compared to just 19% for job creation and 7% for wage increases and/or one-time bonuses.
Which companies were the biggest culprits of these buybacks? Primarily, it was Apple (NASDAQ:AAPL) and a number of large financial institutions that were given the OK by the Federal Reserve to return a boatload of capital to shareholders via share buybacks and/or dividend increases.
Tech kingpin Apple announced a whopping $100 billion share-repurchase plan during the second quarter. Since announcing the initiation of a dividend and share-repurchase program in March 2012, Apple has increased its aggregate returns to $400 billion with this latest repurchase agreement. Apple also bought a heathy $22.8 billion worth of its stock during the second quarter of 2018.
Meanwhile, big banks like Wells Fargo (NYSE:WFC), JPMorgan Chase (NYSE:JPM), Bank of America (NYSE:BAC), and Citigroup (NYSE:C) combined for more than $83 billion in buybacks after they passed the Fed's stress test with flying colors. Wells Fargo topped the list, with $24.5 billion in announced buybacks followed by JPMorgan Chase's $20.7 billion, Bank of America's $20.6 billion, and Citigroup's $17.6 billion in repurchases not far behind.
Here's why this is both a blessing and a curse
To be perfectly fair, it often takes a good 18 to 24 months before enough data has been culled on the economy, corporations, employment, and wages to make a concrete determination on whether or not a new tax plan is having its desired effects. Essentially, it means that these initial indications could be a bit premature. But what can be said, assuming this data proves consistent over the next year and beyond, is that these stock buybacks represent both a blessing and a curse for Trump's tax plan.
On one hand, two consecutive quarters of record stock buybacks could help buoy or increase the value of the major U.S. stock indexes. The purpose of a stock buyback is to reduce the number of shares outstanding in a company, making each remaining share scarcer. More important, it means that net income is divided into a smaller number of outstanding shares, which can increase earnings per share and make a company appear more attractive from a fundamental perspective. An ongoing bull-market run in stocks has the potential to inspire confidence in the U.S. economy, which, in turn, could coerce steady expansion and hiring by businesses.
On the other hand, corporations putting a majority of their extra cash to work by purchasing their own stocks are doing nothing more than increasing income inequality in America. A working paper released last year by New York University economist Edward N. Wolff found that 10% of the wealthiest American households owned 84% of the total value of all stocks, as of 2016. Comparatively, that's up significantly from 2001, when the top 10% of American households owned 77% of the total value of all stocks.
Additionally, Wolff finds that nearly all of the very rich (94%) had significant stock holdings, which were defined at $10,000 or more in shares of public companies. By comparison, only 27% of the middle class, which consisted of the 60% of Americans not included in the poorest 20% and richest 20% of Americans, had significant stock holdings.
Though it's just a single study, it suggests that Trump's tax plan is disproportionately favoring the rich, which could worsen income inequality. And as a reminder, growing income inequality has made life tougher for low- and middle-income Americans by reducing post-secondary education opportunities and making access to medical care challenging.
Though Trump's tax plan still has time to prove these early indications wrong, it certainly appears to have gotten off on the wrong foot.