What a tax on stock buybacks would, and wouldn’t, mean for the bull market

In 2016, a notable member of the Democratic Party took to the Op-ed section of the Wall Street Journal to explain how “short-termism” was bad for the economy.

“The notion that companies forgo long-run investment to boost near-term stock price — is one of the greatest threats to America’s enduring prosperity,” wrote then vice-president Joe Biden. “Private investment — from new factories, to research, to worker training — is perhaps the greatest driver of economic growth … Yet all too often, executives face pressure to prioritize today’s share price over adding long-term value.”

Biden criticized buybacks on 2020 campaign trail, too, and now, Democrats have a plan. But it is not from the White House and it stops far short of a ban: a 2% excise tax on stock buybacks proposed in the Senate as part of the corporate tax proposals to help pay for Biden’s still-evolving trillions in spending.

Buybacks continue to be a polarizing way to view corporate influence over the economy. To critics of buybacks, the 2% tax does not go nearly far enough. To investors like Warren Buffett, buybacks are a good thing you can never get enough of — one of the many reasons he is the No. 1 investor in the market’s No. 1 share repurchasing company, Apple. To many free-market economists, buybacks were never the problem nor any regulation targeting them an economic solution.

But the 2% tax proposal could, in fact, have an influence on companies’ willingness to buy back shares in the future, and that would have consequences for the stock market. Just how much, though, isn’t clear.

Over half (55%) of U.S. CFOs surveyed by CNBC say that the 2% stock buyback tax would cause
their company to buy back less of their own shares, while 40% of U.S. CFOs say that such a tax would have “no impact” on their buyback plans. That’s according to the CNBC Global CFO Council Q4 2021 survey, conducted among 20 U.S.-based CFOs between Sept. 20 and Sept. 29. The CNBC Global CFO Council represents corporations with a combined market value of roughly $4.5 trillion.

The division among CFOs is a good starting point for understanding where buybacks go from here. Buybacks have had a huge impact on the market, with record-low interest rates in recent years leading companies to even issue debt to buy back shares and, in particular, after the 2017 tax cuts freed up a lot of corporate capital, record buyback years in 2018 and 2019. That’s a talking point buyback critics have focused on, especially as supply chain bottlenecks around the globe intensify the political and economic debate over the reshoring of industry.

Jurrien Timmer, director of global macro at Fidelity Investments, recently noted that since 2004, U.S. companies have spent $11 trillion on buybacks.

The biggest players in corporate buybacks don’t appear to be slowing down. Microsoft recently authorized a one-third increase in its total buyback program, from $40 billion to $60 billion. But as the most mature, cash-rich companies, including Apple, Microsoft, and Alphabet dominate this era of buybacks — in Q1 and Q2 2021 they accounted for over 31% of all S&P 500 buyback activity, though that was down from over 40% previously — and the overall numbers are bouncing back from Covid lows, others look at buyback phenomenon and say its best, or at least biggest, days may already be in the past.

Buybacks have been up in recent years in the aggregate amount, but that is not the correct way to look at it, according to Dan Clifton, head of policy research at Strategas Research Partners. Buybacks as a percentage of U.S. market cap is a better way to look at, he said, and that presents a picture of slowing buyback power over the market.

“The rapid run in stocks in recent years has increased U.S. market capitalization and buybacks have not kept up accordingly,” Clifton said, noting a three-year decline in this metric.

“We are in a declining trend of buybacks heading into this tax bill,” Clifton said. “The tax bill will add another set of headwinds.”

The headwinds he refers to, as a whole, explain why Clifton thinks the buyback tax actually would have some teeth, even at just 2%.

If the corporate tax rate increases from 21% to 25%, and multinational income and other changes to international taxation rise, companies will have less cash from their foreign subsidiaries to repatriate back to the U.S. — that was a key mechanism for funding record buybacks after the 2017 tax cuts.

Staff for Ohio Democratic Senator Sherrod Brown, sponsor of the buyback excise tax proposal along with Oregon Democratic Senator Ron Wyden, said in an email response to questions from CNBC that the 2017 tax law “was a betrayal of workers” which didn’t result in better jobs or better wages.

“Instead what we saw was an explosion in stock buybacks lining the pockets of corporate shareholders,” Brown’s staff wrote.

In a market context, the net impact of all the proposed tax changes is a reduction in S&P 500 earnings — of around 4%, in a Strategas estimate based on current proposals. Less earnings means less cash companies have for investment, buybacks, dividends, M&A, and paying down debt. What’s more, any raise in the capital gains and dividend tax rates lowers the after-tax rate of return on stocks and dividends, and makes buybacks and dividends more costly.

“Now add in the buyback tax,” Clifton said. “Companies are already facing a $72 billion hit from the corporate tax changes next year and now on the margin you add $16 billion more.”

That $16 billion figure is based on a recent run rate in annual buybacks of $600 billion to $800 billion. Senator Brown’s office said it estimates the excise tax would raise about $100 billion over 10 years.

“The change on the margin will be important. This will favor dividends over buybacks,” Clifton said.

If so, that’s a change that would occur just as buybacks were coming back. In Q2 2021, S&P 500 share repurchases were $198.8 billion, according to S&P Dow Jones Indices, up 124.3% from Q2 2020 low, and only 11% off the record high reached in 2018 at $223 billion.

How companies spend their capital has been given added weight during a period of unprecedented supply chain shortages including key technology such as semiconductors and amid a geopolitical and economic battle between the U.S. and China.

The semiconductor industry is lobbying for $52 billion to build out the domestic chip industry — a measure already passed by the Senate in June but not taken up in the House, which Commerce Secretary Gina Raimondo is out stumping for now — and many of the signatories from the industry association are companies that conduct hundreds of billions of dollars in buybacks.

And then there’s Apple, with the biggest share repurchase program of all, and a customer of Taiwan Semiconductor Manufacturing Company, which has started construction on a $12 billion plant in Arizona.

“Apple is spending six times that in one year on buybacks,” said William Lazonick, professor emeritus of economics at University of Massachusetts and co-founder and president of the Academic-Industry Research Network — and a fierce critic of buybacks. “Apple could have made 20 fabs in the past decade.”

The tech industry is showing some signs of awareness. In May, the new CEO of Intel, Pat Gelsinger, said in an interview on “60 Minutes” that one condition of him taking the CEO post at Intel was an agreement from the board to not have as much focus on buybacks. “I had never heard any sitting CEO say that,” Lazonick said.  

Intel is building two new chips plants in Arizona and did not buy back any shares in the second quarter.

Sen. Brown’s office says, “The bill will raise revenue to put workers over Wall Street and it will help curb stock buybacks.”

But Allen He, who studies buybacks for FCLTGlobal, a non-profit focused on long-term investing, says the 2% tax is far too low to deter buyback activity based on his analysis of similar efforts in other tax regimes around the world.

Taxing buybacks has been used effectively, He said, but “a 2% tax is quite small in comparison.”

In India, buybacks became popular after a 15% tax was placed on dividends in 2017. Then, it took a 20% tax on buybacks in 2019 to return to pre-2017 levels.

“Taxes can be effective in this area but at far greater rates than the current proposal. Many companies will view the flexibility that buybacks provides as well worth the cost,” He said.

Forty percent of CFOs in the Q4 CNBC CFO survey said the tax would have no impact on their buyback activity.

Lazonick noted that Biden is on record as having said the country needs to do something about buybacks. “I met with him a few times when he was V.P. and he was going around the country saying we have to do something about these buybacks. … said the future of the economy depends on reining in buybacks.”

That history leaves Lazonick perplexed by the excise tax.

“If they wanted to make a statement about buybacks, you wouldn’t come up with 2%. And if you want to raise revenue, you wouldn’t leave it at 2%. It’s too low,” he said. After the 2017 tax cuts and the record buybacks, he noted that current leaders on Capitol Hill became more vocal, especially once the pandemic hit and corporate bailouts were back in the government spending picture. “[Chuck] Schumer was saying workers first, no more buybacks, but somehow, in power, it’s not happening.”

There is one definition of the purpose of an excise tax under which Lazonick says it makes sense to include buybacks. Excise taxes are often designed to deter activity which society deems harmful, such as tobacco. “If you treat buybacks as toxic to the economy, which I think lots of Democrats think they are, maybe they want to treat them like cigarettes. … you can make that tax almost prohibitive, and that is one extreme if you’re not going to ban them.” But he added, “2% is not a tax that treats them as such.”

The Tax Foundation — which bills itself as an independent policy organization though its president touts his role in the 2017 tax cuts, as well as Bush tax cuts and the 1990s Republican Party’s “Contract with America” — argues that the “determent” goal of an excise tax makes no sense when applied to buybacks.

“An excise tax is an inappropriate policy because stock buybacks do not create a negative externality that requires an excise tax to internalize, nor is there an argument for a user fee to apply to stock buybacks,” said Erica York, an economist with the Center for Federal Tax Policy at the Tax Foundation. “And given that excise taxes are designed to discourage an activity, using an excise tax approach also creates tension if the goal is revenue generation.”

“They got to do something,” Lazonick said. “Maybe they said, ‘here’s this inconsequential tax.’ … Certainly, I think Biden knows better.”

Senator Brown’s staff said the rate in his bill is the one that can become law while both deterring buybacks, and raising revenue from corporate buybacks, “if CEOs and executives still insist on padding their pockets instead of investing in their workforces.”

Senator Brown is, in a sense, trying to thread the needle, setting the tax at a rate that generates revenue for the government but doesn’t serve as a de facto ban on the activity, either. Higher tax, less buybacks, less government revenue.

“It’s a quick fix,” Lazonick said, but he worries that can have long-lasting consequences. Legislation can “trivialize” a bigger problem, he said, and seem like it is accomplishing a goal but a decade later, it didn’t do much. The $100 billion cited by Sen. Brown’s office is not much in the grander scheme of government spending and taxing. “It does more than delay a day of reckoning, it makes it seem like something is being done about something when nothing is being done,” Lazonick said. 

There may be another reason Brown didn’t go further in his proposal. Washington D.C. being Washington, D.C., there is the chance that nothing happens at all with buybacks, and that is actually the bet Clifton is most inclined to make.

“Full disclosure, we don’t believe the buyback tax will make it into law. It’s a new idea, has not gone through Committee, is not in the House bill, and there is lack of agreement among Senate Democrats of what should be in the bill itself,” he said.

Brown’s staff stressed that even if enacted, it is not the end of the buyback debate. “Should the caucus want to go further at some point in the future, having this excise tax in place is a good place to start,” it wrote via email.

Wisconsin Democratic Senator Tammy Baldwin and her staff have been pressing a strong approach to buybacks, including outright bans, since 2018, in the Reward Work Act, which would also put rank-and-file workers on corporate boards. Her office did not provide a response to questions about the current Democratic buyback excise tax proposal.

The real winner in all of this, at least in the short-term, may be capital investment in 2022. That is because the Trump tax cuts allowed for companies to write off 100% of their capital investment purchases through the end of 2022, so next year is the last year that program is available at 100%. “If a company’s corporate tax rate goes up, expensing can help keep their rate low,” Clifton said. “And if Congress is making buybacks and dividends more expensive, capex becomes a more preferred alternative. We would not be surprised if companies pull forward their capex into 2022 to take advantage of this benefit.”

• A super-majority of U.S.-based CFOs “totally support” the Biden Covid vaccine mandate.
• The U.S. was the only region in the world whose economy was described as “improving.”
• The euro zone and U.K. were downgraded from “improving” to “stable.”
• No global region is currently viewed as having an economy that is “declining.”
• The recent run in bond yields has influenced CFOs: Most CFOs say that the yield on the U.S. 10-yr Treasury bond will be between 1.5% and 1.74% on Dec. 31, 2021; more than double the number of CFOs made the prediction this quarter than last.
• U.S. CFOs are less bullish than global counterparts about the future path of the Dow Jones Industrial Average, with 40% saying it will next reach 40,000 for the first time, but an equal 40% of CFOs expecting a decline to below 30,000 first.
• 45% of U.S. CFOs said the labor market concerns them more than inflation or the supply chain, more than double the level of concern about hiring from EMEA-based and Asia-based financial chiefs.
• 90% of U.S. CFOs say their firms are spending more on cybersecurity than a year ago.