Buyback tax proposal could blunt a major driver of stock market returns, experts warn
Democrats in Congress are racing to find ways to raise money to pay for an ambitious agenda of social spending on programs ranging from a monthly child tax credit to two free years of community college for all Americans, and one proposal that has gotten attention in recent days is a new 2% excise tax on corporate stock buybacks.
Democratic Sens. Sherrod Brown of Ohio and Ron Wyden of Oregon unveiled the proposal on Friday, estimating that the new levy would raise $100 million over 10 years, but rumors that Washington would target the cash-distribution strategy had been circulating in the weeks before, and investors have been listening.
“Stocks with the largest buybacks have lagged peers in recent weeks, potentially reflecting concern about the recent proposals to impose an excise tax on share repurchases,” wrote Goldman Sachs analysts led by David Kostin in a weekend note to clients. Kostin argued that a 2% tax would not likely have a major impact on earnings-per-share for the S&P 500 SPX,
It was once rare that public companies in the U.S. would repurchase shares of their own stock for fear of shareholder lawsuits, but a 1982 rule adopted by the Securities and Exchange Commission created a safe harbor that paved the way for a surge in the practice, which enables companies to manage their earnings-per-share metric and return cash to shareholders in a way that doesn’t trigger a tax liability, as dividends do.
Following the passage of President Donald Trump’s 2017 corporate tax cut, share buybacks became national news as the nation’s largest companies used their tax savings to buy back shares to the point that corporations became the largest source of demand for U.S. equities, when compared with foreign investors, households, mutual funds and pension funds, according to Goldman.
“Rather than investing in their workers, megacorporations used the windfall from Republicans’ 2017 tax cuts to juice their stock prices and reward their wealthiest investors and their executives through massive stock buybacks,” Wyden said in a press release. “Stock buybacks are currently heavily favored by the tax code, despite their skewed benefits for the very top and potential for insider game-playing. Our bill simply ends this preferential treatment and encourages megacorporations to invest in their workers.”
Critics of stock buybacks, however, say the proposal doesn’t go far enough. “I don’t think companies should be allowed to do buybacks at all,” said William Lazonick, a University of Massachusetts economist.
Lazonick’s pioneered research into the impact of stock buybacks on the U.S. economy, arguing that they drain corporate coffers and divert investment away from new technologies and employees toward already wealthy management and shareholders. Then Vice President Joe Biden cited his work in a 2016 op-ed in which he argued for reforming regulations that promote share repurchases.
“Since the Biden administration came to power, I’ve been disappointed that Democrats haven’t talked a lot about buybacks,” he said. “The main focus of Democrats after the 2017 tax cuts was that companies were just going to use the tax cuts to do more buybacks, and that’s what happened.”
Lazonick argued that a better policy would be to ban stock buybacks altogether, as Democratic Sen. Tammy Baldwin of Wisconsin proposed in 2019.
Stock market investors who worry that a new excise tax could slow share repurchases that have helped drive recent gains may take solace in the fact that the proposed tax is just 2% and appears designed to raise revenue rather than discourage stock buybacks altogether, according to Erica York, economist at the Tax Foundation.
“They’re proposing this as a way to raise revenue and it will have the effect of increasing the marginal tax rate on corporations,” she said. “We may see fewer buybacks on the margin, but it’s not set at a rate that would have a drastic impact.”
York pushed back on the claim that buybacks take company funds away from investments in workers or productivity. “Companies do buybacks out of an excess of cash when they’ve exhausted investment opportunities,” she said. “Some evidence shows they can supplement investment because it shifts capital away from older firms to new, innovative firms.”
The buyback excise tax was not included in a recent draft proposal circulated by Democrats on the House Ways and Means Committee, but much negotiation remains between now and passage of a final bill.
Ben Koulton, director of research at Beacon Policy Advisors, said in an interview that whether or not the buyback excise tax makes it into Democrats’ final spending bill will depend on what revenue raising proposals are most palatable to conservative Democrats in the Senate like West Virginia Sen. Manchin.
“I’m sure there will be plenty of opposition to this, but is there more opposition to it than raising the corporate rate another point?” Koulton said. “There’s certainly a desire by some Democrats to take on capital gains accrued by the super rich.”
