Most people are often unwilling to call Warren Buffett out for being wrong. After all, the founder and chairman of Berkshire Hathaway (NYSE:BRK-A, NYSE:BRK-B) has done more to redefine the investing world than almost anyone else. But one leading economist recently called out the Oracle of Omaha for his statements on stock buybacks. As Robert Reich sees it, Buffett’s recent comments in his letter to shareholders contained an incorrect assessment of the impact of buybacks on the economy as a whole. This comes at a time when President Joe Biden has proposed increasing the tax imposed on stock buybacks by the Inflation Reduction Act (IRA) from 1% to 4%.
Stock buybacks surged to record highs during the first quarter of 2021. As InvestorPlace‘s Louis Navellier reported, the tech companies had the most, followed by the financial and healthcare sectors. Two years later, that trend doesn’t seem to be slowing down. And while Buffett has preached that they are not harmful to the economy, Reich has made it clear that he sees it differently.
Who is Right About Stock Buybacks?
Reich has worked as the Secretary of Labor for multiple presidential administrations. And while in the position, he’s been a staunch advocate for creating a fairer and more just economy. This mission recently led him to address what he sees as a fundamental flaw in Buffett’s logic on stock buybacks in his digital newsletter. Specifically, he cited the following passage from Buffett’s recent letter:
“When you are told that all repurchases are harmful to shareholders or to the country, or particularly beneficial to CEOs, you are listening to either an economic illiterate or a silver-tongued demagogue (characters that are not mutually exclusive).”
Most people likely wouldn’t apply either of those terms to Reich, who is considered a leading voice among economic thinkers. While he acknowledges that Buffett is correct that buybacks benefit shareholders as they lend corporate power to every share, he doesn’t see them as helping the economy as a whole. Quite the opposite, in fact. He notes that 10% of the United States owns more than 90% of the stock market, specifically the wealthiest 10%. This leaves less than 10% of the country who benefit at all from stock buybacks.
As Reich highlights, it is a popular misconception that if an economic measure is good for shareholders, it must be good for the entire economy. This has been discussed by experts such as Andrew Ross Sorkin of the New York Times‘ Dealbook, who Reich believes cannot draw the proper distinction between the two. He cites Norfolk Southern (NYSE:NSC) as a recent example of a company that reported record revenue and operating income last year to the tune of $3.2 billion in 2022 Q4. He also notes that the company invested a “record $4.7 billion in buybacks and dividends last year,” chiefly by implementing layoffs and taking safety risks. In just the past month, the company has had two major train derailments.
The Bottom Line
This should remind investors why it is dangerous to assume that buybacks improve a company instantly. In some cases, the opposite can be true. As Reich states:
“Companies don’t get better because of buybacks. Shareholders only get richer. While railroads spent more on stock buybacks than rail safety, Warren Buffett’s wealth increased by $42 billion.”
If companies do improve following stock buybacks, it is likely in spite of them, not because. That is an important distinction to make as the buyback trend increases. As Reich argues, this should strengthen the case for why the Stock Buyback Accountability Act of 2023, the legislation aimed at increasing the tax on buybacks to 4%, could benefit the economy as a whole. For this reason, he sees President Biden as being correct about taxing buybacks and Buffett’s pro-company argument as flawed.
On the date of publication, Samuel O’Brient did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.