As the federal government continues to grapple with its budget deficit, lawmakers are proposing a new tax on stock buybacks that could help close the gap. President Biden and Senate Democrats have proposed a new tax on such purchases, aimed at reducing corporate spending on share repurchases and incentivizing investment in employee wages and benefits, as well as research and development.
The proposed tax would levy a 4% charge on all stock buybacks (sometimes referred to as repurchases) made by companies and would apply to both publicly traded and privately held firms. According to a statement released by the Senate Finance Committee, the tax is intended to “encourage companies to invest in their workers and in long-term growth, rather than simply prioritizing short-term gains for shareholders.”
The proposal has sparked fierce debate among investors and analysts, with some arguing that it could help to reduce income inequality and encourage long-term investment, while others fear it could stifle growth and be a burden on businesses.
Stock buybacks, also known as share repurchases, are when a company buys back its own shares of stock from the market. This can be done for a number of reasons, including to return value to shareholders, to boost earnings per share, or to signal to the market that the company believes its stock is undervalued. In recent years, stock buybacks have become increasingly popular among corporations, with many using them as a way to return value to shareholders rather than investing in long-term growth.
Supporters of the proposed tax argue that stock buybacks primarily benefit wealthy shareholders and corporate executives, and that the tax would help to redistribute wealth and reduce income inequality. They also argue that stock buybacks can be a sign of short-term thinking and can deprive companies of the capital they need for long-term investment. According to a report from the Institute for Policy Studies, between 2010 and 2019, the 500 largest US companies spent $5.3 trillion on stock buybacks, more than the $4.3 trillion they spent on capital expenditures.
They’re a big problem and growing. In 2022, corporations announced plans to buy back $1.2 trillion worth of their stock—a one-year record. That trend accelerated further in January 2023, when firms unveiled plans for $132 billion in repurchases—a record for the first month of a year. In early 2023, Chevron announced a $75 billion share repurchase program, one of the biggest in history, after record profits of $35.5 billion in 2022. This acceleration took place even though the Inflation Reduction Act’s 1% stock buyback excise tax had just taken effect.
Opponents of the proposal, on the other hand, argue that it would be a burden on businesses and could discourage investment and growth. They also argue that stock buybacks can be an effective way for companies to return value to shareholders and that the tax could hurt the retirement savings of millions of Americans who invest in the stock market.
The proposed tax has gained support from several prominent Democrats in Congress, including Massachusetts Senator Elizabeth Warren who that said the issue of stock buybacks has been accelerating in recent years.
“Corporate executives have been using stock buybacks to enrich themselves and their wealthy shareholders at the expense of workers and long-term investment,” Warren said. “We need to put an end to this practice and ensure that companies are investing in their workers, their communities, and their futures.”
However, the proposal has also faced opposition from some Republicans and business groups. The US Chamber of Commerce, for example, issued a statement condemning the proposal as “a job-killing tax on businesses that would hurt the economy and harm workers.”
“Stock buybacks play an important role in the functioning of healthy and efficient capital markets,” said U.S. Chamber Executive Vice President and Chief Policy Officer Neil Bradley.
Despite the excise tax taking effect on January 1, it does not appear that buybacks are slowing, in fact, the early evidence looks like 2023 could be another marquee year for buybacks, according to the Institute on Taxation and Economic Policy (ITEP). In addition to the Chevron announcement, Meta (the parent company of Facebook) announced a new $40 billion buyback plan. In total, $132 billion in new buyback plans were announced in January 2023. If this trend holds throughout the year, a 1% excise tax is not likely high enough to significantly impact the tax disparity between dividends and buybacks.
An ITEP report raises the question: how high would the buyback excise tax need to rise to be at parity with taxes on dividends? There is no single answer, according to the Washington based think tank, because different investors are subject to different dividend tax rates, and the excise tax lowers potential future earnings per share whereas taxes on dividends do not.
The proposed tax also faces challenges in terms of implementation, as it would require companies to track the price of their stock over a period of years and to calculate the tax owed on each buyback. This could be a burdensome process for many companies, particularly smaller ones that may not have the resources to comply with the new regulations.
Despite these challenges, proponents of the proposal remain optimistic that it could gain traction in Congress. They point to the growing public concern about income inequality and the increasing scrutiny of corporate behavior as evidence that the time may be right for such a tax.
“At a time when the wealthiest Americans are paying historically low tax rates, it’s time for corporations to start paying their fair share,” said Senator Elizabeth Warren, Democrat of Massachusetts, in a recent interview. “The proposed tax on stock buybacks is a step in the right direction.”
Critics of the proposed tax, however, argue that it could have unintended consequences. For example, some companies may choose to issue dividends instead of engaging in stock buybacks to avoid the tax, which could have negative consequences for shareholders who rely on those dividends for income. Others argue that the tax could discourage investment and growth by making it more expensive for companies to return value to shareholders.
Another concern is that the proposed tax may not accomplish its intended goal of reducing income inequality. While stock buybacks may benefit wealthy shareholders, they also have the potential to boost the value of retirement savings accounts, such as 401(k)s and IRAs, which are held by millions of Americans. By discouraging stock buybacks, the proposed tax could hurt the retirement savings of these individuals.
Despite these concerns, supporters of the proposed tax argue that it is necessary to address the growing problem of income inequality in the United States. They point to the fact that the wealthiest 1% of Americans now own more wealth than the bottom 90% combined and argue that the tax system needs to be restructured to address this imbalance.
In a statement, Warren said that the tax “will help ensure that companies are investing in their workers and in their long-term future, rather than just enriching their executives and shareholders.”
Senators Sherrod Brown, Democrat of Ohio and Ron Wyden, Democrat of Oregon, recently introduced the Stock Buyback Accountability Act of 2023, which would increase taxes a publicly-traded company spends on buying back its own stock from one percent to four percent.
This legislation includes an improvement to rules for when a company buys back stock but then issues new stock, and it can generally reduce the amount of its buyback tax—this is referred to as the “netting rule.” One significant source of new stock issuance is stock compensation for employees, and this netting rule creates a small incentive to share stock with the employees of a company. But Wyden warned that some companies may abuse the netting rule by increasing stock-based compensation packages to their wealthy executives, rather than sharing stock with their workers. To minimize this impact, this provision would exclude the stock compensation to the top executives and highest paid employees from the netting rule. A similar rule in the tax code already makes a portion of this compensation non-deductible.
The debate over the proposed tax on stock buybacks is likely to continue in the coming months, as lawmakers and industry experts weigh the potential benefits and drawbacks of the measure. However, the issue of income inequality and economic opportunity will remain at the forefront of the national conversation.
While the proposal faces challenges in terms of implementation, it remains to be seen whether it will gain enough support to become law.
For more information about the current 1% stock buyback excise tax, see Checkpoint’s Federal Tax Coordinator ¶F-11920.
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