Their stock buyback levy will hurt shareholders far more than it will CEOs.
by The Wall Street Journal Editorial Board, August 5, 2022
What Sen. Kyrsten Sinema giveth, she taketh away. That’s the main conclusion from the tax bargain she struck Thursday with Sen. Chuck Schumer over changes to Mr. Schumer’s tax-and-spend deal with Sen. Joe Manchin. Some tax provisions in the misnamed Inflation Reduction Act were improved, although as always with the current Congress at considerable economic cost.
Ms. Sinema nixed tax changes on carried interest that would have hit private-equity investors, and she moderated the damage of the 15% minimum tax on book earnings by allowing for accelerated depreciation of business investment. This is an improvement and offers a reprieve for U.S. manufacturers in particular, as we’ve been writing.
In exchange, however, she and Senate Democrats are imposing another bad idea—a levy on share buybacks. This new tax would apply at 1% on the market value of shares that companies buy back from their shareholders, with limited exceptions such as buybacks intended to prevent dilution of existing owners when employees exercise stock options.
Details of the new proposal are still scarce, but Mr. Schumer said Friday it would raise $74 billion. That would more than offset the $55 billion in putative revenue Mr. Schumer says the Democrats are foregoing by allowing accelerated depreciation and other tweaks to the book tax.
Progressives and some conservatives with a shaky grasp of economics are fixated on buybacks, because they believe share purchases are a tool for fat-cat executives to goose earnings per share while starving their companies of investment. It’s more like the opposite.
Companies use buybacks to return cash to shareholders for which they don’t have a better use. Shareholders who sell shares back to the company can invest the proceeds elsewhere. That beats letting the cash sit on corporate books earning interest while CEOs get complacent or decide to buy a business they don’t understand how to run.
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.