Senate Banking Committee Chairman Sherrod Brown (D-Ohio) and Senate Finance Chairman Ron Wyden (D-Ore.) want to impose a new tax on stock buybacks. This proposal is based on the flawed assumption that buybacks only benefit CEOs and corporate executives and comes at the expense of R&D and workers.
If passed into law, it would hamstring an important tool public companies use to provide equity to shareholders, like Americans with retirement accounts, and potentially smaller companies.
The Stock Buyback Accountability Act would apply a 2 percent tax of the “value of any securities” involved repurchases starting in 2022. The tax applies to all domestic publicly held companies and foreign publicly held companies with U.S. subsidiaries. U.S. subsidiaries that are majority-owned by foreign companies will be taxed based on revenue made in the United States as a percentage of global revenue from the parent company.
The proposed 2 percent tax would reduce incentives to provide cash distributions to shareholders and force companies to retain earnings that will be used for less economically beneficial purposes. A tax on stock buybacks harms all shareholders and employees with an individual retirement account or 401k.
Buybacks and dividends provide the same economic benefit to shareholders—both actions provide a distribution of cash to shareholders. This is a boon for employees’ IRAs, 401ks, and pension funds, who reap the benefits of higher share prices from buybacks.
Individuals who do not actively work in the financial sector still have extensive exposure to the stock market. Retirement accounts hold the largest portion of corporate stock in the United States. In 2015, retirement accounts held37 percent of the outstanding $22.8 trillion in U.S. corporate stock. In 2017, corporate-sponsored funds made up $4.45 trillion in market value; union-sponsored funds accounted for $409 billion; and public-sponsored funds, which benefits teachers and police officers, added up to $4.25 trillion.
When corporations perform stock buybacks, these individual investors are the ones who will benefit. A tax on buybacks could dissuade companies from conducting this action at all.
For investors, the payout from buybacks allows them to invest in other companies where the rate of return might be higher than the returns of the company that conducted the buyback. Retaining earnings is only beneficial if the company can produce higher returns from further CAPEX and R&D investments. According to an article written by Daniel J. Hemel and Gregg D. Polsky in the Yale Journal on Regulation, “shareholders should prefer for the corporation to distribute rather than retain earnings if the corporation’s after-tax rate of return is lower than the shareholder’s after-tax rate of return. That condition plausibly exists today for pension plans, tax-exempt institutions, and individuals investing through tax-preferred retirement accounts—all of whom face a tax rate of zero on investment income.”
Buybacks are also not an automatic windfall for corporate executives. Hemel and Polsky highlight that executive compensation does not necessarily benefit from buybacks. Notably, buybacks reduce cash flow and can lower executives’ compensation if tied to market capitalization. Hemel and Polsky contend that, “CEO compensation tends to increase in tandem with market capitalization, so in buying back shares, CEOs potentially shrink their own salaries” and that “Substantial free cash flow potentially allows managers to pursue pet projects, purchase plush corporate jets, redecorate their own offices ornately, and so on. Distributing cash to shareholders thus may come at the expense of executive perquisites.”
Firms that buy back stock also outperform their peers, negating the belief that buybacks add no benefit to the company as a whole. Economist Alex Edmans cited a study that found that companies that perform stock buybacks “outperform their peers by 12.1% over the next four years.”
Additionally, shareholder payouts via buybacks are not draining companies’ investment in R&D. In fact, according to an article by Jesse M. Fried and Charles C.Y. Wang in the Harvard Business Review, R&D as a percentage of revenue is now at levels “not seen since the late 1990s.
Stock buybacks also benefit non-S&P 500 public companies and nonpublic companies. According to Fried and Wang, from 2007-2016, the equity shareholders receive from buybacks accounted for $407 billion in net shareholder inflows to non-S&P 500 public companies. Additional cash distributions result in a redistribution of equity into companies backed by private equity firms, which “employ almost 70% of U.S. workers and, and generate nearly half of business profits.”
The Brown-Wyden bill is yet another hastily thrown together piece of legislation to finance the Democrats’ monstrosity of a social spending bill. This is not about punishing the top one percent but is about instituting a cultural shift in the United States so that no one can earn more or perform better than one’s peers.
• Bryan Bashur is a Federal Affairs Manager at Americans for Tax Reform and executive director of the Shareholder Advocacy Forum