Cochrane Fails to Make His Case for the Trump Tax Cut Again

John Cochrane recently noted:

Stock Buybacks Are Proof of Tax Reform’s Success… A short oped for the Wall Street Journal here on stock buybacks. As usual, they ask me not to post the whole thing for 30 days though you can find it ungated if you search.

I did search and found this. Does the Wall Street Journal get the fact that rebutting weak arguments against a policy are not exactly making an affirmative case for the policy? Permit me to note two places where Cochrane and I agree:

echoing illogical claims is not a contribution to that debate. Granted, Republicans invited the attack by trumpeting worker bonuses. But a bad argument for the cut does not redeem a worse counterargument.

Well thanks for that and now an argument from the left that is also weak:

To cast corporate tax cuts as a “scam” and redistribution to the wealthy, opponents have shifted their focus to the evils of stock buybacks and dividends…Share buybacks and dividends are great. They get cash out of companies that don’t have worthwhile ideas and into companies that do. An increase in buybacks is a sign the tax law and the economy are working. Buybacks do not automatically make shareholders wealthier. Suppose Company A has $100 cash and a factory worth $100. It has issued two shares, each worth $100. The company’s shareholders have $200 in wealth. Imagine the company uses its $100 in cash to buy back one share. Now its shareholders have one share worth $100, and $100 in cash. Their wealth remains the same.

When I read this argument over at Cochrane’s blog, I decided to provide this link:

Merton H. Miller liked to tell a joke about Yogi Berra, the famous baseball catcher. Berra once told his trainer that he was particularly hungry, and he instructed him to cut his pizza into 12 pieces instead of six. The quip illustrated vividly the celebrated theorem about capital structure that Miller devised with MIT’s Franco Modigliani and published in 1958. As every finance student is taught, the Modigliani-Miller theorem states that a firm’s value is independent of how it is financed, much like the size of a pizza is independent of how you slice it. The two researchers published another landmark paper three years later, the same year in which Miller—who would go on to win the 1990 Nobel Memorial Prize in Economic Sciences—moved to the University of Chicago Graduate School of Business (now Chicago Booth). “Dividend Policy, Growth, and the Valuation of Shares,” which appeared in the Journal of Business, told essentially the same story as its predecessor paper but using a different mechanism.

Cochrane rebuttal of the buybacks argument is simply the other Miller and Modigliani proposition. I sometimes wonder why a professor of finance does not simply say so. But my main complaint with his Wall Street Journal oped is how he made – actually did not make – the case for the reduction in the corporate tax rate:

Wouldn’t it be better if the company invested the extra cash? Wasn’t that the point of the tax cut? Perhaps. But maybe this company doesn’t have any ideas worth investing in. Not every company needs to expand at any given moment. Now suppose Company B has an idea for a profitable new venture that will cost $100 to get going. The most natural move for investors is to invest their $100 in Company B by buying its stock or bonds. With the infusion of cash, Company B can now fund its venture. The frequent rise in stock price when companies announce buybacks proves the point. In my example, Company A’s share price stays fixed at $100 when it buys back a share. But suppose before the buyback investors were nervous the company would waste $40 of the $100 cash. Imagine an overpriced merger or excessive executive bonuses. Not every investment is wise!

Hold on a second. Company A does not invest more on its business regardless of what the corporate tax rate is whereas Company B wanted to invest more in its business even before the reduction in the corporate tax rate. OK! But in a Miller-Modigliani world, company B would have all sorts of means for financing the new investment even without Company A’s assistance. So where in this oped has Cochrane make his alleged case that the new tax law will increase investment demand? Is this it?

The economic logic of the tax cut is to create good incentives for profit-maximizing management teams—not to “trickle down” cash to workers from philanthropic management.

What exactly is this logic again? Yes company B will get to keep more of its cash flows with a lower tax rate but then it also bears more of the systematic risk. Furthermore, the general thrust of Trump’s fiscal policy is to reduce national savings even as it allegedly may shift the investment demand schedule outwards. Brad DeLong casts this argument in terms of the standard Solow growth model:

One thing we in the academy can do is to explicitly make bulls— deduction an explicit student learning goal. For example: We ask students to do practice problems using the Solow growth model on paper, and then to reproduce the analysis and draw the graphs on the exam. But the problem is that after the final exam students are very unlikely to ever be asked to do anything similar again. If Intermediate Macroeconomics is to be useful—if its learning goals are to be worth anything—it is because it will put in the back of your brain stuff so that when they in the future read things like

He was referencing:

the Nine Unprofessional Republican Economists who placed their letter in the Wall Street Journal

And it seems that this same Wall Street Journal published the latest non-case from John Cochrane.