Stock Buybacks Could Be Deterred by Biden Tax

Supporters of the Biden buyback tax say it will be good for the economy. Skeptics say it will hurt investment.

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Corporate America has been feeding a stock buyback boom for decades, with companies spending trillions of dollars to repurchase their shares without paying any taxes on those transactions.

That could soon change.

In President Biden’s roughly $2 trillion Build Back Better Act, which narrowly passed the House on Friday but faces a tough fight in the Senate, Democrats have proposed a 1 percent tax on stock buybacks. Although it may not seem like much, the tax is a way to raise as much as $124 billion over 10 years, according to government estimates, and could help pay for the social spending and climate package.

Both supporters and critics of the proposed surcharge say it could alter the behavior of companies, but in ways that would have very different consequences for the economy.

To carry out a buyback, a company typically uses its excess cash — or even borrows — to repurchase shares from investors. The goal is to lift the price of a stock by reducing the number of shares outstanding, which rewards existing shareholders.

Supporters hope the tax will make buybacks less attractive and instead nudge companies toward investing their excess cash in their business and their work force. That, in turn, could provide a boost to the wider economy.

“There is good evidence that stock buybacks have been used in ways that are contrary to the health of firms and the health of the economy and workers,” said David Kamin, a deputy director of the National Economic Council in the White House.

Many top Democrats, including Senator Sherrod Brown, Democrat of Ohio, and academics also see buybacks as a form of harmful corporate behavior that they hope a tax would thwart. They contend that chief executives favor big buyback programs in large part because the programs help bolster their compensation, which comes mainly in the form of company stock. This, they say, helps create a corporate culture in which top executive pay keeps growing, widening the gap between the C-suite and rank-and-file employees.

Critics of the proposed tax view it very differently. Buybacks, they say, route money — via investors — from mature companies that don’t need as much cash to younger firms that are hungry for capital. A tax on buybacks could distort that flow of money by forcing companies to rethink their policies, said Alex Edmans, a professor of finance at London Business School.

“Like any tax, even if it’s pretty small, it will just weigh on companies’ decisions,” Mr. Edmans said.

Since buybacks are so entrenched on Wall Street, it may take more than a 1 percent tax to reduce them by much. But one thing is clear: A lot of money is at stake.

In the past decade, companies in the S&P 500 stock index have repurchased over $5 trillion of their own shares, according to a New York Times analysis of data from S&P Capital IQ. Apple alone spent $423 billion on buybacks in the last decade, the largest total for an S&P 500 company, according to a Times analysis of the company’s financial statements. That sum dwarfs the $233 billion that Apple, which rakes in enormous amounts of cash from the sales of iPhones and other products, spent on capital expenditures and research and development over the same period. The company declined to comment.

So far this year, companies have announced — although not completed — more than $1 trillion in share buybacks, according to a recent research note from Goldman Sachs. The investment bank said the impact of a 1 percent tax on buybacks would be “marginal.”

Most companies seek to reward their shareholders in two ways: through share buybacks and dividends. The buyback tax, if approved, is expected to push companies to pay more out in dividends. But Mr. Edmans said that could limit a company’s flexibility. If a company primarily uses buybacks to pay shareholders back, it can control the timing — hoarding capital when the business outlook is uncertain or grim and repurchasing shares when profits are rolling in. But since dividend payments for each quarter are set in advance, any sudden change could make shareholders nervous, Mr. Edmans said.

“Once a company has a certain level of dividend, it’s really hard to cut the dividend subsequently without the stock price tanking,” he said.

From the government’s perspective, though, the move to dividends might not be such a bad thing. In calculating the estimated $124 billion in revenue from the 1 percent tax, the Joint Committee on Taxation assumed that companies would shift some of their shareholder distributions to dividends — allowing the Treasury to collect more from that source, according to a congressional staff member familiar with the committee’s calculations.

Dividends are typically subject to a 23.8 percent tax, but it’s the recipient of the dividend, and not the company, who pays it. So to some, a buyback tax would be a way to make things consistent.

“Buybacks aren’t evil; they’re just undertaxed relative to dividends,” said Daniel Hemel, a professor at the University of Chicago Law School.

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Apple’s headquarters in Cupertino, Calif. The company has spent $423 billion on buybacks in the last decade.Credit…Jim Wilson/The New York Times

And a switch by companies to dividends might lead to something that some Democrats have long yearned for: a way to get billionaires to pay more tax. Since the ultrawealthy rarely sell their stock, they don’t pay large sums in capital gains taxes, and fund their lifestyles by instead borrowing against the immense stakes they hold in their firms. But if companies shift to paying more out in dividends, the billionaires will face taxes on the dividends from the shares they hold.

“If corporations respond to the excise tax by paying dividends rather than doing buybacks, their billionaire founders and major shareholders will start paying taxes on those dividends,” Mr. Hemel said.

The debate over buybacks flared in 2017 when President Donald J. Trump’s tax cuts became law, giving many companies a financial windfall. This was an opportunity to see whether companies would favor the quick and simple option of giving the money to shareholders over figuring out new investment projects to spend on. It turned out that companies went on a buyback splurge in 2018 that was far larger than the amount by which they increased spending on research and development and new plants and equipment.

Even so, some experts say there is little evidence that buybacks crimp investment. Charles C.Y. Wang, an associate professor at Harvard Business School, has done research showing that corporate investment has remained roughly constant as a percentage of companies’ sales in recent years.

“That companies are not making more investments is not an issue about their capacity to do so, and more likely about whether attractive investment opportunities exist,” Mr. Wang said. “After all, in 2019, public firms held about $5.2 trillion in cash.”

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