Share buybacks have never been particularly popular with the Left (#understatement). They are perceived as a device that can be played by unscrupulous executives wanting to ramp up their company’s share price and as a handy tax-avoidance scheme.
A return of capital to shareholders in the form of dividends is taxable, while its de facto equivalent in the form of a share buyback is not (it is, too simplistically, assumed). Another complaint? Companies are using buybacks to return capital to their shareholders, rather than put that capital to productive use.
Strangely, the argument that management might have decided that that productive use does not exist, and that it would be better (directly or indirectly) to return capital to the company’s shareholders — which is to say its owners — so that they can deploy it elsewhere generally goes unmentioned.
All that said, I’ve never been a great fan of share buybacks. To me, they represent too much of a bet by the company’s management on where a firm’s share price is going. I’d rather that decision was left to investors as they weigh whether to buy, sell, or hold. I prefer dividends. But yes, it is certainly true that share buybacks are more tax-efficient for shareholders who pay tax on dividends, a category that excludes, incidentally, investors who hold their shares or mutual funds in their 401(k)s.
And all that said, I am not a fan of either banning or taxing share buybacks.
But (via Reuters):
The $430 billion Inflation Reduction Act bill would impose a new excise tax on stock buybacks…
The tax will be levied at a rate of 1 percent.
Senate Finance Committee Chairman Ron Wyden said that the goal of the buyback tax is to curb share repurchases and to encourage companies to invest in their businesses, rather than buying back shares to boost stock prices.
“Unless you take some steps to check it, it’s never gonna get checked,” Wyden told reporters Saturday. “What’s wrong with reinvesting that in new equipment, for example, that could reduce carbon emissions?”
What’s wrong with that, Senator, is two-fold. Firstly, a company management is probably best placed to decide how the firm’s capital is best invested. Secondly, that management has a duty to the company’s shareholders, not, in the absence of legislation to the contrary, to the socio-political agenda of certain senators or some other section of the ruling class. The rules might be different under a corporatist regime, but that is not yet where we are. Not yet, anyway.
Buybacks aren’t tax free: Owners who sell shares back to the company realize a taxable capital gain. Any boost in the share price contributes to a higher taxable gain for remaining owners when they sell their shares in the future.
Why not pay dividends instead? Companies and shareholders might prefer buybacks in some instances, such as if the company is disbursing a one-time lump sum or shifting the balance of equity and debt on its books. For the economy overall, buybacks have the effect of distributing capital specifically to those owners who choose to participate because they believe they have a more productive use for it. Capital flows from companies that don’t need it to companies that do.
Sen. Sinema’s 1% levy represents a climbdown from the 2% rate Senate Democrats tried to include in the Build Back Better plan last year. But don’t think the rate will stop at 1% once Democrats create this new tax, and don’t assume there are no economic costs even at the 1% rate. This is still a tax on capital and investment by a different name, and it will hit share values and your 401(k).
America needs fewer tax impediments to the free and productive flow of capital to investors and entrepreneurs, as Sen. Sinema recognized with her other changes to the Schumer-Manchin plan. Alas the progressive demand for more revenue, and to punish business, is insatiable, so any tax gimmick they can conjure up to cobble together 50 Senate votes will do.
Note: Updated with the sentence “I prefer dividends”, just to make absolutely clear that I have (as ought to be obvious) no objection to dividends, which as I see as a preferable way of not only providing investors with a current yield, but, under certain circumstances, returning ‘excess’ capital to shareholders.