Potential New Tax on Stock Buybacks and What it Could Mean for the Financial Markets
President Biden‚Äôs latest spending bill could result in a new tax on corporate stock buybacks. In its most recent incarnation, the Senate version of the plan includes a two percent excise tax on stock buybacks. Still, this isn‚Äôt enough for many critics of stock buybacks, who claim they incentivize short-term behavior in lieu of long-term investment.
Stock buyback programs have long been criticized for giving a short-term boost to share prices with funds that could have been used for long-term investment instead. Critics, including the current president, believe stock buybacks come at the expense of capital investment in new or updated factories, research, worker training, etc. These critics believe this type of long-term investment is the key to sustainable growth.
Changing Behavior with Taxes
Some critics advocate for an outright ban on stock buybacks, but they are in the minority. Instead, the recent Senate bill proposes a two percent tax on stock buybacks. This tax has a dual purpose. First, it aims to discourage buybacks and encourage longer-term investment. Second, it's a revenue generator to help fund the trillions in new spending in the bill.
Will the Two Percent Tax be Enough to Matter?
While a two percent excise tax on buybacks may not be draconian, it appears to be significant enough to drive a change in behavior. In a CNBC poll, more than half of CFOs indicated the two percent tax is enough for them to curtail their buyback program. Only 40 percent said they would not change their buyback program plans (CNBC Global CFO Council Survey).
Impact on the Capital Markets¬†
Stock buybacks have had a significant impact on the markets. Not only are companies using excess cash to buy back shares, but with interest rates so low for so long, many companies have even taken on debt to buy back shares. Still, excess cash that can't just sit on the corporate balance sheet is the main driver of the largest buyback programs. Established, cash-flush tech companies such as Apple, Alphabet, and Microsoft are the dominant players, accounting for nearly one-third of all buyback activity in the first half of 2021.
Given the recent run-up in the markets, buyback programs have not kept up. Couple this with the proposed increases in corporate tax rates from 21 percent to 25 percent, and there‚Äôs even less cash to fund buyback programs. Generally, most experts believe these macro-economic factors combined with the new two percent tax will cause a shift toward dividend payouts as they will be more favorable to shareholders.
The main idea behind the proposed two percent excise tax on stock buybacks is to both raise revenue and encourage corporate investment. Critics of stock buyback programs believe this is better for the economy and workers, whereas buybacks favor corporate shareholders at their expense. While a two percent tax might not be enough to create wholesale change, when combined with corporate tax rate changes, it appears to have enough teeth to change most public company CFOs.