WASHINGTON (AP) – Democrats have made a quiet first in their just-passed climate change and health care bill: introducing a stock buyback tax, a prized tool of American companies that has long seemed untouchable.
Under the bill, which President Joe Biden is scheduled to sign into law Tuesday, companies will face a new 1% excise tax on purchases of their own stock, effectively paying a penalty for a maneuver they have long used to return money to investors and to strengthen their standard price. The tax will come into effect in 2023.
Buybacks have exploded in recent years — forecast to hit $1 trillion in 2022 — as companies have bulged with cash from skyrocketing profits.
Investors, including pension and retirement funds, like the buybacks. But ardent critics of big business and Wall Street like Sens. Elizabeth Warren and Bernie Sanders abhor them, calling the practice “paper manipulation” to enrich executives and major shareholders.
Centrist Democrats like Senate Majority Leader Chuck Schumer have also long criticized buybacks.
Democrats say big companies should use the money to increase employee wages or invest in the company, rather than returning cash to shareholders. They hope the consumption tax — expected to bring the government $74 billion in additional revenue over 10 years — will make a big difference in business behavior.
However, some experts are skeptical that the tax will work as intended. They note that companies have other methods of rewarding shareholders, raising the prospect that legislation aimed at stopping one corporate stock-taking practice could instead facilitate another, with new and unpredictable implications for the economy.
How this all plays out could have implications for the future landscape of large US corporations, their employees and shareholders, as well as political staying power of one of Biden’s signature legislative initiatives and his Democratic majorities in Congress.
Where share buybacks stand if Democrat bill becomes law:
The big companies in the S&P 500 index bought a record $882 billion of their own stock last year. Their buybacks reached $984 billion in the 12 months ended March, another record.
Some of the biggest stock buybacks include big tech companies like Apple, Facebook parent Meta, and Google parent Alphabet.
Companies have poured more money into buying their own stocks despite struggling with rising inflation, higher interest rates and the potential for slower economic growth. They face higher expenses for raw materials, shipping and labor. Businesses have largely been able to pass these costs on to their customers, but higher prices for groceries, clothes, and everything else could threaten consumer spending — with consequent constrained revenue growth for many businesses. Americans are still spending, albeit at a slower pace, recent government reports show.
Buybacks can increase a company’s earnings per share because fewer shares are generally held by shareholders. The buybacks can also signal executives’ confidence in a company’s financial prospects.
WHAT HAPPENS AFTER THE TAX?
“I hate stock buybacks,” Schumer, DN.Y., told reporters as the bill passed through Congress. “I think they’re one of the most self-interested things corporate America does instead of investing in workers and training, research and equipment.”
That makes for appealing rhetoric in election year, but whether the Democrats’ aspirations will translate into different business behavior is less clear.
It’s an admirable policy goal, says Steven Rosenthal, a senior fellow at the bipartisan Urban-Brookings Tax Policy Center, who called the new excise tax on buybacks “efficient, fair and easy to administer.”
But will the goal be reached? Rosenthal noted that a wave of buybacks followed after the 2017 Republican tax law that gave the company a windfall by cutting the corporate tax rate from 35% to 21%. After the new excise tax comes into effect, companies could use some of the money they would have spent on buybacks to pay more dividends to shareholders instead, he suggested. The new tax brings buybacks closer to tax parity with dividends.
However, Rosenthal does not rule out that companies decide to put part of the saved money into wage increases or investments in the company.
Counterpoint: The tax “will not translate into higher wages for workers,” said Jesse Fried, a Harvard Law School professor and corporate governance expert. And investing money back into the company may not be an option, he said, because “investments are already at very high levels and there is no evidence that companies are not pursuing worthwhile projects because they lack the money.”
In the end, Fried expects most of the money not spent on buybacks to end up being added to the roughly $8 trillion cash pile that US companies are sitting on.
A modest hit?
Because the new consumption tax is calculated on the smaller net amount of a company’s repurchases — total repurchases less shares issued during the year — some companies may see this as a modest hit worth taking and continue to buy shares.
The tax does not apply to stocks contributed to retirement accounts, pensions, and employee stock plans.
After polling its analysts on the tax, RBC Capital Markets suggested companies may grumble about it, but “it is unlikely to affect planning”.
One thing is almost certain: With the new tax, set to take effect on January 1, companies will have a deadline to buy back their shares tax-free. That means there could be a spate of buybacks in the coming months.
Follow Marcy Gordon at https://twitter.com/mgordonap