WASHINGTON — Democrats have achieved a quiet first in their just-passed climate change and health care legislation: the introduction of a stock buyback tax, a cherished tool of Corporate America that has long seemed untouchable.
Under the bill to be signed by President Joe Biden on Tuesday, companies will face a new 1% tax on the purchase of their own shares, effectively paying a fine for a maneuver they have long used to return money. to investors and their share price. The tax will take effect in 2023.
Buybacks have exploded in recent years — projected to reach $1 trillion by 2022 — as companies have grown using cash from skyrocketing profits.
Investors, including pension and retirement funds, love the buybacks. But ardent critics of big business and Wall Street, such as Senator Elizabeth Warren and Bernie Sanders, abhor them, calling the practice “paper manipulation” to enrich senior executives and major shareholders.
Centrist Democrats, such as Senate Majority Leader Chuck Schumer, have long criticized buybacks.
Democrats say that instead of giving cash back to shareholders, big companies should use the money to raise employees’ wages or invest in the company. They hope the excise taxes — which are expected to bring the government an additional $74 billion in revenue in 10 years — will trigger a major shift in corporate behavior.
But some experts are skeptical that the load will work as intended. They note that companies have different methods of rewarding shareholders, raising the prospect that legislation aimed at stopping one corporate equity practice could instead facilitate another, with new and unpredictable effects. on the economy.
How it all plays out could matter for the future landscape of major American companies, their employees and their shareholders, and for the political stamina of one of the signature legislative initiatives of Biden and his Democratic majorities in Congress.
Where the stock buyback stands as the Democratic bill becomes law:
BUY BACK BONANZA
The big companies in the SThe &P 500 index bought a record amount of their own shares last year, $882 billion. Their buybacks hit $984 billion in the 12 months ended March, another record high.
Among the biggest stock buybacks are big tech companies like Apple, Facebook parent Meta and Google parent Alphabet.
Companies have been plowing more of their money to buy their own stocks, even as they grapple with rising inflation, higher interest rates and the potential for sluggish economic growth. They have faced higher costs for raw materials, shipping and labor. Companies have largely been able to pass those costs on to their customers, but higher prices for food, clothing and everything else could threaten consumer spending – resulting in limited revenue growth for many companies. Americans are still spending money, albeit in a more lukewarm way, the latest government reports show.
Buybacks can increase the earnings per share of companies because there are fewer shares that are universally owned by shareholders. The buybacks can also signal confidence from executives about a company’s financial prospects.
WHAT HAPPENS AFTER THE TAX?
“I hate stock buybacks,” Schumer, DN.Y., told reporters as the legislative package progressed through Congress. “I think they’re one of the most selfish things Corporate America is doing, rather than investing in employees and training, research and equipment.”
That makes for appealing rhetoric in the election year, but whether the ambition of the Democrats will translate into other business behavior is less clear.
It’s an admirable policy goal, said Steven Rosenthal, senior fellow at the impartial Urban-Brookings Tax Policy Center, who calls the new repurchase tax “efficient, fair and easy to manage.”
But is the goal achieved? Rosenthal noted that in the wake of the Republican tax bill of 2017, which gave companies a cash windfall by lowering the corporate tax rate from 35% to 21%, there has been a wave of buybacks. After the new excise tax goes 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 an equal tax rate with dividends.
However, Rosenthal does not rule out the possibility that companies decide to put some of the saved money into raising employees’ wages or investing in the company.
Counterpoint: The tax “will not translate into higher wages for employees,” said Jesse Fried, a Harvard Law School professor who is an expert on corporate governance. And investing money back into the company may not be an option, he said, because “the investment is already at a very high level and there is no evidence that companies aren’t pursuing worthwhile projects because they don’t have the money.”
Ultimately, Fried expects that most of the money not spent on buybacks will eventually be added to the $8 trillion cash pile that US companies sit on.
A HUMBLE BATTLE?
Because the new excise tax will be calculated on the smaller, net amount of a company’s repurchases — total repurchases minus shares issued during the year — some companies may consider it a modest hit worth taking and continuing. by buying shares.
The tax does not apply to stock contributed to retirement accounts, pensions, and employee stock ownership plans.
After polling its analysts about the tax, RBC Capital Markets suggested that companies may be grumbling about it, but “it’s unlikely to affect schedules.”
One thing is far from certain: With the new tax coming into effect on January 1, companies have a deadline to buy back their shares tax-free. That means there could be a wave of buybacks in the coming months.
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