Biden Falls Short With His Single-Digit Stock Buyback Excise Tax

Stock buybacks are big business—they’ve regularly exceeded dividends per quarter since 2010 and hit a record $1.26 trillion last year. The Inflation Reduction Act introduced a 1% excise tax on corporate stock buybacks beginning in 2023. From the start, proponents of the tax have been vocal about it being insufficient to deter buybacks. For context, ordinary dividends are taxed at normal income tax rates, and qualified dividends are taxed up to 20%.

In last week’s the State of the Union address, President Joe Biden called for quadrupling the tax to 4%. But the excise tax should be much higher to push corporations to invest in research and development or labor, or to issue dividends and have shareholders be taxed accordingly.

Despite advocates calling the rate insufficient, opponents predicted all manner of market catastrophe. The tax has little chance of coming to fruition because Republicans control the House. But the question remains: Is it sound policy? It might be worthwhile to first lay out the counterarguments against an excise tax on stock buybacks. Here goes:

• It will reduce the liquidity in the stock market;
• It hampers a corporation’s abilities to manage their capital and return value to shareholders;
• It will push corporations toward issuing more dividends, and;
• It’s administratively unworkable.

Corporations are racing each other to incur debt and cut jobs to boost flagging stocks. As stock buybacks increase in prevalence, the price of a stock is less reflective of market value and more keyed to what the corporation would like to see its market value perceived as. They’re all on eBay bidding on their own auctions. Maybe a 4% excise tax on their right to do so doesn’t go far enough?

The major alternative to stock buyback programs is issuing dividends, which are taxed at varying rates but are higher than stock repurchases in virtually every scenario. For the sake of laying out the range of rates, the lowest tax bracket for ordinary dividends is 10%. Qualified dividends are taxed at capital gain rates, and most taxpayers pay less than 15%.

Just as a 1% excise tax on stock buybacks is exceedingly unlikely to push corporations in the direction of dividends, a 4% tax likely won’t do so either. There’s certainly some administrative overhead to rolling out a stock repurchase program, so the argument can be made that the excise tax needn’t be raised to 10% to see a move toward dividends—but a savings of more than half on a tax on the transaction is still a pretty good deal for the corporation.

And it’s a really good deal for the shareholders, who are often executive employees cashing out on the inflated stock price stemming from the announcement of the selfsame buyback. Some might say that’s too good of a deal.

There is a problematic push-pull inherent in the stock buyback. If purchasing a stock and seeing it increase in price is payment for investing in a growing company, that company repurchasing those shares—and the previous shareholder seeing a profit—is payment for divesting in said company. When the company has financed the buyback through courting other investors via the corporate bond market, an image of a house constructed only of cards begins to manifest in one’s mind.

Photographer: Stock photo/Perry Gerenday/Getty Images

In terms of administrative workability, it can carry substantial administrative costs on both the corporate and government side. This is part of a broader argument that often seems to arise when a new tax is floated—it goes something like, “There are open questions as to how this would be administered, so you should just do away with it entirely.” However, it can be a massive source of revenue and has headroom to do so without forcing the market to move toward preferring dividends.

But the general argument for the excise tax reducing liquidity is that corporations, being buyers in the market, enhance liquidity by acting as a sponge—absorbing stocks as institutional investors need to sell for reasons other than corporate sentiment. If the excise tax disincentivizes corporations from engaging in buybacks, presumably the size of that metaphorical sponge is somewhat reduced.

The net effect would be increased stock price volatility—where opponents of the tax would invoke the plight of the sympathetic “retail investor” stuck riding out the storm. The high-level thought, then, is that disincentivizing a major buyer of stocks in the market will lead to increased price fluctuation.

This dovetails nicely with the argument that it hampers a corporation’s ability to manage their own financial affairs. The general idea is that it’s the corporation’s money, and who is the government to tell them what to do with it?

On that first bit, the general obscures the specific. Often, the buybacks are funded by corporate bonds. In 2016 and 2017, the percentage of buybacks funded by debt hit 30%. The most notable recent massive buyback program has come from Meta Platforms Inc., which boosted share buyback authorization by $40 billion and slashed 11,000 jobs this month—after having sold $10 billion in corporate bonds earlier this year, earmarking a portion of the proceeds for stock buybacks.

A sufficiently high excise tax on stock repurchase programs would reduce the administrative overhead by reducing the prevalence of said programs. This would further the joint goals of reducing income inequality and holding corporations to account in the stock market by depriving them of a tool to synthetically boost their share prices. And it just might stave off the next financial crisis.

This is a regular column from tax and technology attorney Andrew Leahey, principal at Hunter Creek Consulting and a sales suppression expert. Look for Leahey’s column on Bloomberg Tax, and follow him on Mastodon at @andrew@esq.social.