Apple‘s (AAPL) $90-billion stock buyback, announced in April, would have triggered a $1.8-billion tax penalty under a 2% excise tax proposed by Senate Democrats on Friday. The tax measure would help pay for the big social-spending package moving through Congress. If the stock buyback tax was in place over the past year, it would have cost Warren Buffett’s Berkshire Hathaway (BRKB) about $600 million tied to $30 billion in share repurchases.
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Stock Buyback Tax: False Advertising
Ohio Sen. Sherrod Brown and Senate Finance Committee Chair Ron Wyden, D-Ore. are pitching their Stock Buyback Accountability Act as a way “to prioritize real investment in the economy over Wall Street shareholder giveaways in the form of stock buybacks.”
“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,” Wyden said in a statement.
The good news for investors is that Wyden’s statement isn’t accurate: Their bill would preserve most of the preferential tax treatment for stock buybacks.
Meanwhile, the case that stock buybacks detract from capital investment is a weak one. Big share repurchasers reinvest an above-average share of revenue in R&D and capital spending, a 2019 Goldman Sachs analysis found.
Stock Buybacks Outgrow Dividends
Taxing stock buybacks hasn’t been among President Joe Biden’s proposed tax hikes to offset expanded government health care support, fund paid leave and free community college, extend a more generous child tax credit, boost electric-vehicle subsidies and more.
Two professors, Daniel Hemel of the University of Chicago and Gregg Polsky of the University of Georgia, helped put the idea on the agenda with their proposal to equalize the tax treatment of dividends and buybacks.
There’s some rationale for doing so. Up until the late 1990s, S&P 500 companies spent more on dividends than on buybacks. But in 2019, buybacks totaled $729 billion, 50% more than the $485 billion distributed as dividends.
Over the same period, foreign ownership of publicly traded U.S. stocks tripled to 30%, according to Steve Rosenthal, senior fellow at the Urban-Brookings Tax Policy Center.
Foreigners pay an average 17% rate on dividends issued in the U.S., but they don’t pay any U.S. taxes on capital gains. That means much of the tax advantage of stock buybacks is accruing to foreigners, arguably at a cost of revenue to the federal government.
Corporate cash spent on buybacks buoys earnings per share by reducing share counts, contributing to higher stock prices. For those who don’t redeem their shares, buybacks will result in a bigger capital gains tax bill, but only when they sell their stock — if they sell.
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Warren Buffett Loves Buybacks, Hates Dividends
That ability to defer taxes is likely the biggest reason that buybacks have become the preferred way of distributing capital to shareholders for many of America’s biggest and most successful companies.
Apple spent more than five times as much on Apple stock buybacks ($72.5 billion) in fiscal 2020 as it paid out in dividends ($14.1 billion). Buffett’s Berkshire Hathaway hasn’t declared a dividend since 1967. Meanwhile, Buffett has cheered on Apple stock buybacks as one of the iPhone maker’s top shareholders via Berkshire.
In August, Goldman Sachs strategist David Kostin raised his year-end S&P 500 target to 4,700. Key to his bull case was an estimated $726 billion in stock buybacks this year. Corporations “will rank among the largest buyers of U.S. equities this year,” supporting stock valuations, he wrote.
Buyback Tax Impact On Buffett, Apple
Could the Brown-Wyden stock-buyback tax weaken bull market support from buybacks ? Probably only slightly.
A 2% excise tax “won’t move the needle much,” meaning there won’t be a significant shift away from buybacks to dividends, Polsky told IBD.
Polsky and Hemel estimated that taxing buybacks at the same effective rate as dividends would boost federal revenue by 7% of total spending on buybacks. The 2% excise tax still leaves the bulk of the tax advantage in place.
Still, a stock buyback tax could pinch earnings growth. Take Apple. Retiring $90-billion worth of stock won’t change earnings but it should raise forward earnings per share by 3.7%. However, if earnings are reduced by the $1.8-billion stock buyback tax, EPS would only rise 1.7%, an IBD analysis finds. Similarly, a $600-million tax on Buffett’s $30-billion in Berkshire stock buybacks would have yielded a 2.7% EPS increase instead of a 5% rise with no tax.
One caveat: The proposed stock-buyback tax would be reduced by any stock issuance, including as compensation, over the same period. In recent years, that would have cut Apple’s bill by about 10%.
Any conclusions now are premature. The proposal for a stock-buyback tax could grow stiffer, if other revenue sources prove more controversial, or it might get dropped entirely.
Please follow Jed Graham on Twitter @IBD_JGraham for coverage of economic policy and financial markets.
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