Faced with an unexpected revenue stream to finally get their climate and healthcare bills across the finish line, Democrats aimed for one of their long-time favorite rhetorical targets: stock buybacks. The cost of the 1% repurchase tax is borne by companies such as Apple (AAPL), which added $90 billion to its stock repurchase plan in April.
Impact of the buyback tax on Apple and S&P 500 earnings
The tax on such a massive Apple buyback could total as much as $900 million a year once the tax goes into effect in 2023.
Consider what that might mean if the tax were in effect now: A $90 billion share buyback would boost Apple’s earnings per share by about 3.5% thanks to a smaller share count. However, a $900 million tax would reduce the increase in earnings per share from the buyback to about 2.5%.
For the S&P 500 as a whole, which is set to hit $1 trillion in share buybacks this year, the combined earnings decline could be as high as $10 billion a year if this pace continues.
One caveat: the proposed share buyback tax would be reduced by any share issue, including compensation, over the same period. In recent years, that would have cut Apple’s bill by about 10%.
That will bring in an estimated $74 billion over a decade. Goldman Sachs has estimated it could cut S&P 500 earnings per share by 0.5%.
With buybacks remaining tax-free through the end of this year, some analysts are expecting a buyback frenzy of sorts that could prop up the S&P 500 at a volatile time.
Stock buybacks aren’t going away
Still, the measure is unlikely to materially reduce the momentum for share buybacks, which contribute to higher share prices.
Last fall, Senate Democrats proposed a 2% tax on buybacks. But even that measure “wouldn’t make much difference,” Gregg Polsky, a professor of tax law at the University of Georgia, told IBD at the time.
By that, Polsky meant the size of the tax would not be enough to cause a significant shift away from buybacks and into dividends.
Polsky and New York University law professor Daniel Hemel helped put a stock buyback tax on the agenda. They pushed the idea of taxing share buybacks at the same rate as dividends. They estimated that this could yield an amount equivalent to about 7% of the value of buybacks over a decade.
The 1% tax proposal agreed by Democrats largely maintains stimulus that has skewed capital distributions toward buybacks versus dividends.
In 2021, Apple repurchased $85.5 billion worth of AAPL stock while paying $14.5 billion in dividends. Google parents alphabet (GOOGL) announced a $70 billion buyback in April but has never issued a dividend. facebook parents meta platforms (META), which said on July 27 that it has $24.3 billion remaining in its buyback authorization, notes in its 10-K that company officials “do not expect to declare or pay cash dividends anytime soon.”
How share buybacks affect share prices
Stock buybacks are generally positive for stock prices for two reasons. First, unlike dividends, corporate cash spent on buybacks increases earnings per share by reducing the number of shares.
Second, buybacks offer a way to allocate capital while allowing shareholders to defer — or avoid — paying taxes. Instead of taxpayer money going to the government, it stays in the stock market.
For shareholders who don’t redeem their shares, buybacks can result in a higher capital gains tax bill, but only if they sell their shares — if they sell. Also, while foreign investors pay an average tax rate of 17% on dividends, they don’t have to pay U.S. taxes on capital gains.
That’s no small feat, given Steve Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center, that the proportion of foreign-owned US public stocks has tripled to 30% since the late 1990s.
During the same period, the value of share buybacks caught up with and then exceeded the cash expended by companies on dividends. In 2021, the S&P 500’s buybacks totaled $883 billion, up 73% from the $511 billion paid out in dividends.
Biden approval hits new low despite Democratic win streak
S&P 500 spared from large tax hikes
After winning big with President Trump’s 2017 tax cuts that cut the corporate tax rate from 35% to 21%, Wall Street has largely avoided a big payback under President Biden. It’s not because of a lack of effort.
Biden called for over $2 trillion in tax hikes for corporations and wealthy investors. Increasing the corporate tax rate to 28% would have brought in $900 billion. Biden proposed raising the top tax rate on capital gains and dividends from 23.8% to 43.4%, raising $400 billion. Tax hikes on foreign corporate income could have netted $1 trillion in the first decade.
But with every Democrat in the 50-50 Senate having effective veto power, Senator Joe Manchin has relentlessly trimmed Biden’s wish list from well over $2 trillion to an estimated cost of $430 billion. Concerned that further government profligacy would exacerbate the risk of inflation, Manchin rewrote the bill as the Inflation Reduction Act.
Worst-case scenario, Wall Street strategists said the S&P 500’s gains could take an 8% discount, but thought a 3% to 4% decline was more likely. In the end, Goldman Sachs estimates that S&P 500 earnings will fall about 1.5%. The buyback tax is 0.5% of the profit and the minimum corporate tax of 15% is 1%.
The corporate minimum tax is aimed at large companies such as Amazon (AMZN), which paid a 6% tax rate on US income in 2021. But even that provision was cut in 11 hour negotiations, preserving the tax benefit of accelerated depreciation for equipment purchases. Analysts at Citigroup believe the 15% minimum tax will cut revenue by just 0.4% next year.
Please follow Jed Graham on Twitter @IBD_JGraham Reporting on economic policy and financial markets.
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