At first glance the answer seems obvious—no. But not everyone sees things that way. Here’s Bloomberg:
Biden will also ask lawmakers — as he did in last year’s budget request — to impose the 21% minimum on multinational corporations, which the White House says would result in substantial new taxes on pharmaceutical companies. He also wants to quadruple the tax companies must pay when they buy back their own stock to 4% from 1%. Democrats have proposed buyback taxes as a way to encourage companies to invest in workforces and equipment over share repurchases.
Corporations have several different ways of rewarding investors. One method is dividends. Another approach is to use a stock buyback, which leads to capital gains. Many investors prefer to receive capital gains, which are generally treated more favorably than dividends in the federal tax code (partly because the gains are not taxed until the stock is sold.) By taxing stock buybacks, the government would be raising the effective tax rate on capital formation.
These taxes do not encourage investment—just the opposite. Instead, they tend to push investment into less productive areas. Thus suppose company A can earn a 5% rate of return on capital and company B can earn a 10% rate of return. Ideally, profits earned by company A would be paid out to owners, who would redirect funds to investments made by company B. This tax provision seems motivated by the desire to make each company more self sufficient, relying on its own internal funds for capital investment. But an economy where each organization is self-sufficient is much less efficient than an economy structured around specialization and trade.
Perhaps there is some other motivation for this proposed tax change. If so, I cannot imagine what it is.
READER COMMENTS
BC
Mar 18 2024 at 1:55am
“stock buyback, which leads to capital gains”
It’s not obvious to me why this would be the case (unless you mean more capital gains compared to paying a dividend of the same amount). A buyback decreases the number of shares outstanding, but it also decreases the assets of the firm because the firm must pay cash for the shares. The two would seem to cancel out. For example, suppose a firm has a market cap of 100B with no debt for simplicity. If it buys back 1% of its shares, which are worth 1B, then the firm will need to spend 1B in cash. The pre-buyback firm is equivalent to the post-buyback firm plus 1B in cash, which suggests that immediately after the buyback, the firm will have a market cap of 99B. The 1% decline in market cap exactly offsets the 1% decrease in shares outstanding, so share price remains unchanged. Maybe, the best example of this is a mutual fund redemption, in which the fund “buys back” shares at their NAV. That has no effect on mutual fund share price.
This CFA Institute material states: “A share repurchase is equivalent to the payment of a cash dividend of equal amount in its effect on total shareholders’ wealth, all other things being equal” [https://www.cfainstitute.org/en/membership/professional-development/refresher-readings/analysis-dividends-share-repurchases]. A dividend has zero impact on shareholder wealth because the stock price drops by the amount of the dividend on the ex-div date.
Both dividends and share buybacks (and mutual fund redemptions) are ways to return shareholders’ own cash to them, which is why they have zero impact on shareholder wealth. Taxing them is indeed a tax on capital formation.
Chris
Mar 18 2024 at 9:13am
Dividends are taxed as income – stock buybacks are taxed (eventually) as capital gains – this is true even assuming that they are of equivalent value.
Tom P
Mar 18 2024 at 9:13am
You are overthinking this one. Sumner didn’t say buybacks will cause the stock price to appreciate. The buyback will compel some investors to sell their shares to the company that is buying them back. If those shares are held at a gain by a taxable investor, then there will be taxable capital gains.
Scott Sumner
Mar 18 2024 at 10:07am
That’s right, but I should have been more clear. Due to the EMH, there’s no first order effect on the stock price at the announcement (except to the extent the market prefers buybacks to dividends.)
Jose Pablo
Mar 18 2024 at 9:20pm
On the other hand, if you believe that share prices can significantly differ from their “intrinsic value” (or even worse, if you are an stake deserving heretic and believe that prices are defined by offer and demand for those shares, independently of a totally academic arbitrariness like “intrinsic value”) then, share buybacks, by themselves, can affect prices.
Warren Buffett, a well-known ignorant on matters of valuation, believes that buying back shares at prices above their “intrinsic value” reduces the value of the company (and the other way around).
And many companies’ shareholders/management seems to believe the same since buybacks mandates frequently include a maximum price above which the buybacks are not authorized (a totally redundant clause if shares would be always priced at their “fair value”)
Vivian Darkbloom
Mar 18 2024 at 4:36am
One common reason for share repurchases is to acquire shares for delivery to employees excercising stock options rather than issuing new shares. By repurchasing outstanding shares the company avoids share dilution and thus EPS going forward (often an important metric for investors and management compensation) . One effect of an even higher tax on share repurchases is likely to increase the issuance of new shares rather than buybacks for this purpose. A stock option holder needs to pay for those shares. If funded through a share-buyback, the company would generally pay current FMV and receive cash equal to the option price, the difference representing net cash leaving the corporate solution. If financed through newly issued shares, it would “raise capital” equal to the exercise price, but at the cost of diluting existing shareholders.
In one sense such a policy does encourage capital formation (or perhaps, better, “de-formation”) in that it discourages a company from distributing cash via stock repurchases to fund option plans and stock repurchases that are made for other reasons (returning excess cash to shareholders). The problem with respect to both is that it interferes with an overall *efficient* allocation of capital among firms which, on net, is likely a negative feature. But, that’s a negative feature of all corporate and shareholder taxes. I don’t understand the fixation on stock buybacks as an “evil” corporate practice that needs to be addressed through yet another tax. Perhaps the political reason is that it focuses solely on first-order effects and the rest isn’t visible to the vast majority of voters.
Vivian Darkbloom
Mar 18 2024 at 4:39am
(“or perhaps, better *discourage* “deformation”)…
Craig
Mar 18 2024 at 9:12am
Personally don’t support taxing corporate share buybacks, but just curious if you see much of a difference between doing a share buyback from shareholders less interested in company than those who decide not to sell vs paying a general dividend and those less interested take the money and run and sell their shared vs those getting the dividend and dripping it back into their holdings? Is there THAT much of a difference?
Vivian Darkbloom
Mar 18 2024 at 9:29am
Kind of hard to parse that paragraph; but, if we are talking about a general buyback rather than a buyback to fund options, there are differences between a buyback and a dividend. From the perspective of a corporation, they may believe their shares are undervalued. Thus, a share buy-back reduces the number of outstanding shares and potentially increases EPS going forward. Warren Buffet has often used this reasoning to support his buybacks. (We could have an interesting discussion as to whether this is some sort of “insider trading”, but I’ve never heard this used as a reason to tax buybacks) Also, to keep their shareholders happy, as further explained in the following paragraph.`
Share buy-backs almost always occur in the open market. If you are a shareholder, you don’t need to sell. While the tax rates are the same for a LTCG and a qualified dividend, you may very well be better off selling shares than a dividend because if you don’t want to sell, you are not taxed. And, if you do sell, you may have offsetting capital losses. Or, you may designate those shares with the lower basis that you sell, thus reducing your gain. So, there is a certain amount of planning around share buybacks for the shareholder that is not available with a dividend.
As far as being “less interested in the company”, I view this as part of the market process. Ultimately, it is also part of the process of allocating capital not only from the point of view of the corporation, but also the shareholder. If a shareholder believes that there are better opportunities elsewhere, he may offer his shares for sale and invest the proceeds elsewhere. Of course, there is always a market for shares, but buybacks probably increase liquidity. Perhaps I don’t get the logic of taxing share buy-backs but it strikes me as government central getting a bit too involved in how capital should be allocated.
Craig
Mar 18 2024 at 9:46am
Sorry was on my first Monday cup.
option A: corp buys back shares, those who sell area the ones less interested, the ones who don’t sell tend to be more interested in future prospects of company. Those who sell pay capital gains on whatever gain is recognized, if any.
option B: corporation, discouraged by the share buyback tax, pays a general dividend instead. All shareholders pay tax on the dividend. Those less interested still sell and keep dividend. Those more interested keep their shares and set their stock to DRIP so that the dividend becomes additional shares. They ALSO pay tax on dividend.
Is there ultimately THAT much of a difference between the two scenarios?
Vivian Darkbloom
Mar 18 2024 at 12:28pm
@Craig
Well, I think I’ve identified the main differences and you have as well in the query. Whether this is a “big difference” can be debated; however, it is a difference.
The difference between paying a general dividend and a share repurchase is that in the former, the share price will decrease by the amount of the payout (you see this often on the x-dividend date). The company pays cash and gets nothing in return (except a good reputation, perhaps). With a share re-purchase, the share price should not go down (or up); however, the shareholders opting not to sell get a larger pro-rata share of future profits (I assume the re-purchased shares remain Treasury shares or are retired) without doing anything.
Obviously, in the former case, all shareholders are taxed on the dividend. If I want to re-invest through a DRIP or the normal market, one is in effect re-investing after-tax money. Giving shareholders a greater ability to time their income is a plus for them but apparently not in the view of those who want to be able to gore that ox right away.
In order for this re-allocation to occur with respect to a dividend, everyone has to pay tax first. From the perspective of someone who wants to get tax now, that’s perhaps attractive and the reason for the proposal. Giving corporations and their shareholders flexibility is a plus for them. In my view, the proposal is not likely to increase the formation of capital in the long run because some of the funds that would constitute capital are siphoned off to Uncle Sam. But, again, I think it does also throw some sand into the gears of an efficient allocation of capital system.
My general impression is that companies that engage in share buybacks also pay dividends so that there is, in the end, something for everyone.
Craig
Mar 18 2024 at 8:59am
Taxes on C Corps, that which is seen. That which is unseen are the C Corps that were never formed. I’ve been in business now for over two decades and I would be EXTREMELY reluctant form a C corp and never have and likely never will. I believe the stats do show a substantial majority of business formation is pass thru entities.
Brandon Berg
Mar 18 2024 at 10:03am
The motivation is to pander to the base, of which, we might optimistically assume, 5% has any idea how to even begin thinking through these issues in an intelligent manner.
And Biden himself wasn’t the sharpest tool in the shed even in his prime, much less as today. The real question is whether he’s ignoring his economic advisors, or they’re just telling him what he wants to hear.
Scott Sumner
Mar 18 2024 at 10:09am
It’s clear that economic policymaking has become less and less based on the advice of economists, under both Trump (trade) and Biden (many areas.)
jensen
Mar 18 2024 at 10:35am
Would much prefer larger taxes on inheritance – which probably has a smaller impact on incentives and capital formation than income or corporate tax. Seems dumb that we have structured society to disincentivize the children of the most successful people from working.
Craig
Mar 18 2024 at 11:33am
Sure there’s Musk and Bezos and they have so much over the limits you’re probably right that estate/inheritance taxes might not disincentivize them very much, but there’s millions of people who are sitting just below the current thresholds or just above them and they’re sitting in middle aged status with a bit of hypertension, fighting and losing the Battle of the Bulge to the Germans and then they listen to ‘Bernie Sanders’ discussing lowering thresholds and then, you know what? Why should I bust my butt to pay 56% of my income to the people’s republic and then if I drop dead I might have the government show up to the wake for a cut?
“Sanders’ bill would only apply to the wealthiest 0.2 percent of Americans. It would establish a 45 percent tax on the value of an estate between $3.5 million and $10 million” -=- https://www.sanders.senate.gov/press-releases/sanders-introduces-estate-tax-reform-to-combat-inequality-2/ [And this is obviously NOT the law at the moment but its where the left WANTS to go]
And then you look at the deficits and the debt and the leftist culture and if you have two neurons left you quickly realize that Leviathan is going to be hungry and if you’re sitting there with between 3.5-10mn, which at the moment would be below thresholds, you’re ALREADY discouraged because you’ve experienced leftist incrementalism your entire life.
I think I’d rather go to the gym and pump some iron and figure out how to bury the silver before Genl Sherman rolls through town.
jensen
Mar 18 2024 at 11:43am
I imagine that most people will not be severely disincentivized by takings after they die.
If we could take more from people after they die and use it to pay back the deficit or lower income taxes (which have a much stronger incentive effect), that would be a win to me. There is a massive amount of wealth that is inherited (some estimate as much as 50% of private wealth in the US is from inheritance flow) and preserving this basically just distorts the economy towards providing for children who don’t work at the expense of having a proper incentive system that encourages more production. Yes, it will somewhat discourage people who are trying to save a ton so their kids never have to work – but more than made up for by lowering income taxes.
Craig
Mar 18 2024 at 11:55am
“I imagine that most people will not be severely disincentivized by takings after they die. ”
That’s true, once somebody is dead of course, but it absolutely impacts the incentives to accumulate wealth once people start looking ahead and start to see less in front of them than behind them. So if you’re middle aged should you spend a material amount of time building a business so that you can drop dead and give 40% of it to the government?
Yeah, no thanks. The leftist agenda ITSELF, before its even the law is already disincentivizing people and causing them to convert wealth into forms that are more difficult for government to track and tax.
jensen
Mar 18 2024 at 12:50pm
I would certainly prefer 40% from after I die to the 40%+ marginal I currently experience as I live. Maybe I’m unusual in this respect.
Craig
Mar 18 2024 at 1:41pm
“I would certainly prefer 40% from after I die to the 40%+ marginal I currently experience as I live. Maybe I’m unusual in this respect.”
No, no, its going to be 65% while you live and then 40% when you die and you’ll get to that threshold because they’re going to inflate you into it, trust me this isn’t an either/or situation.
Vivian Darkbloom
Mar 18 2024 at 12:45pm
That appears to me to be a pretty dishonest press release.
“Sanders’ bill would only apply to the wealthiest 0.2 percent of Americans. It would establish a 45 percent tax on the value of an estate between $3.5 million and $10 million”
I don’t think it was true in 2019 that only the top 0.2 percent of Americans had a net worth of $3.5 million or above (the bill would reduce the basic gift/estate tax exclusion to $3.5 million). My best guess woiuld be today that approximately the top 5 percent of Americans would have a net worth above that threshold. Also, while this wouldn’t affect many twenty-five year-olds, an even greater percent of those actually dying would be affected by that proposed bill.
From the same source:
“Sanders’ legislation, the For the 99.8% Act, would raise $2.2 trillion from the nation’s 588 billionaires.”
I doubt that, but it’s pretty amazing how he smoothly goes from taxing relatively small millionaires to focus solely on those 588 billionaires.
The elephant in Bernie’s office also doesn’t mention that those thresholds are not indexed for inflation…
jensen
Mar 18 2024 at 12:52pm
I don’t have the numbers in front of me but I strongly doubt that the 95th wealth percentile is as high as 3.5 million. Of people of near-death age, perhaps – but not overall.
Craig
Mar 18 2024 at 1:37pm
https://www.kiplinger.com/personal-finance/605075/are-you-rich
People with the top 1% of net worth in the U.S. in 2022 had $10,815,000 in net worth.
The top 2% had a net worth of $2,472,000.
The top 5% had $1,030,000.
The top 10% had $854,900.
The top 50% had $522,210.
Of course I come from NJ where the exemption at the state level was 675k. Christie abolished that after I emigrated to FL, but does anybody trust them not to reimpose that at some point. Its also a signpost of where they’re going. Indeed people are (dis)incentivized by what they ANTICIPATE tax rates will be in the future.
Vivian Darkbloom
Mar 18 2024 at 2:32pm
Estimates vary. This source shows to be at the 95th percentile one needs nearly $3.8 million, household.
https://dqydj.com/net-worth-percentiles/
That’s probably closer than Bernie’s estimate that only 0.2 percent would be hit by his $3.5 million (non-inflation adjusted) threshold.
Don’t worry. The estate tax threshold will go down signficantly in 2025 without Bernie having to convince anyone. Time to call Jim Glass….
Michael Sandifer
Mar 18 2024 at 12:29pm
Scott,
You’re seeing the glass as half-empty. Sure, this is dumb policy, but at least there’s a recognition that there’s a need to raise revenue at the current level of spending.
After Trump, anything is better. Lower your expectations, and you’ll be happier.
robc
Mar 18 2024 at 4:58pm
You have it backwards. We need recognition that there’s a need to lower spending at the current level of revenue.
Michael Sandifer
Mar 20 2024 at 8:42am
That’s just a value judgement on your part and besides, there’s no political desire to cut spending in a meaningful way. Social Security, Medicare, and military spending cuts aren’t on the table and probably won’t be in my lifetime.
Jose Pablo
Mar 18 2024 at 8:20pm
Using $100 in share buybacks is exactly the same (in a taxless world) than the company paying $100 in dividends and some of the shareholders using this dividend to buy shares worth $100 (at pre-dividend values) from other shareholders.
So, the company paying $100 in dividends and some of the shareholders buying $100 worth of shares from other shareholders should reduce the company investment exactly in the same way that share buybacks do.
The “Democrats” in the Bloomberg article are assuming that “investing in its business” makes more sense for companies that share buybacks. And they could even be right, but:
a) the debate is who should make that decision, Congressmen or the management of the company?
And b) They have the very same reasons to believe that “investing in their business” makes more sense than paying dividends. So, the 4% tax, if it makes sense at all in order “to encourage investment in their business”, should apply equally to dividends too.
Now, what results in more taxes collected by the government, the share buybacks or the payment of dividends, is a completely different question that depends on a significant number of variables.
a) the average tax rate on dividends for the shareholders collecting the dividends (qualified, non qualified dividends, total net income distribution among shareholders, etc…)
b) the capital gains incurred by the shareholders selling their shares in a share buyback and the average tax rate for this shareholders (amount of capital gains, term of the capital gains, total net income distribution, non-taxable accounts …).
You have to make a lot of assumptions before knowing which course of action results in more taxes collected.
[For instance, let’s imagine that dividends are qualified and that the average shareholders tax rate is 10%, some of the shareholders have a 0% rate and some have 15%, then $10 will be collected out of the $100 paid in dividends. If the shareholders selling in the $100 share buyback realized a capital gain of 60% of the selling price, think of Nvidia shareholders, and pay a 25% tax rate on capital gains, for some of the selling shareholders,the capital gains were long term, but for some were short-term an so, taxed as ordinary income, them, $15 will be collected as a consequence of the share buybacks. A 50% more]
Jose Pablo
Mar 18 2024 at 8:47pm
And also, if share buybacks should be taxed at the proposed 4% tax rate there is no reason on earth why M&A activities (aka the buying by the company of “other companies’ shares”) should not also be taxed at the same 4%.
If the management devoting money to buying shares of their own company makes less sense than investing “in their business” (whatever than means in the Congressmen’s minds), them the management devoting money to buy the shares of “other company” should make even less sense and so be even more taxed. Afterall, the ability of the average company manager to destroy value in M&A activities is very well known.
Why, for the sake of the common good, buying a business you know well should be taxed but buying a business you barely know shouldn’t, is a mystery to me.
Jose Pablo
Mar 18 2024 at 8:32pm
Seems dumb that we have structured society to disincentivize the children of the most successful people from working.
It is more that we have incentivized the most successful people to work not only for themselves but also for their children.
Incentivizing the most successful people to work “more than otherwise” makes much more sense than incentivizing their, in most cases, less brilliant children to “work more than otherwise”.
Afterall the “marginal effort” of the not-so-brilliant children is, very likely, much less valuable to society than the “marginal effort of the brilliant fathers” (which is extremely valuable to society. That’s the very reason why they are successful).
robc
Mar 19 2024 at 9:08am
I said once that if I ever ran for office (I wont), my platform would come straight from a CS Lewis essay:
To live his life in his own way,
to call his house his castle,
to enjoy the fruits of his own labour,
to educate his children as his conscience directs,
to save for their prosperity after his death
I bolded the last plank because it was fitting to this discussion.
Jose Pablo
Mar 19 2024 at 9:56am
I’ll vote for you, robc!
Or even better, anybody elected for office should have to respect these principles. Or incur the ire of the SCOTUS.
And yes, taxes should definitely take a “Ricardian approach” to wealth. It totally makes sense. “Society” (whatever that is) wants to extract as much as it can from brilliant successful people. The money “society” gives them in return for what “it” gets from them is a wonderful bargain! Even if it looks like a lot of money to some … in fact, much more so when it looks like a lot of money to some.
Rajat
Mar 18 2024 at 9:51pm
Scott, you explained well why this thinking is wrong. But I think the reason why many people (not just in the US) think this is contained in the above sentence from the article. People don’t understand the difference between savings, transfers and investment. Stock buybacks do not represent spending in the way that a firm buying new equipment or hiring more labour involve spending. Rather, share buybacks are a transfer of savings from firms with accumulated profits to shareholders. The buyback payments can then be used by shareholders to spend or save elsewhere, like in your example. For the same reason, people in Australia (and elsewhere) who claim that high house prices represent ‘unproductive investment’ don’t realise that they have backwards – the high prices reflect insufficient investment in new houses and people trading ever more-in-demand assets. The high prices paid can be used by sellers to save or spend (including consume or invest in equipment) elsewhere. As you once said, money doesn’t ‘sit on the sidelines’ and then ‘move into markets’; money flows through markets.
Scott Sumner
Mar 19 2024 at 12:47pm
Good analogy.
Thomas L Hutcheson
Mar 18 2024 at 9:52pm
What about the positive investment offset (compare to not taxing at all) of reducing the deficit? Certainly not as much as a consumption tax,but something is something.
Jose Pablo
Mar 19 2024 at 10:07am
Deficit is a good thing! really good! better than the alternatives
The government pays less for its debt than the individual citizens do. And individual citizens would need to incur in that very same additional debt to pay taxes.
Or even worse, they would have to sell assets. And the return on these sold-assets-to-pay-taxes is higher than the cost of government debt.
Corollary: if you (or any group you belong to) can incur cheap non-collateralized debt, that you can repay in pieces of paper that you produce yourself or, even better, you cannot repay it at all, get as much as you can of this kind of “debt”! .. it is a no-brainer!
Jose Pablo
Mar 19 2024 at 10:37am
In more “technical” terms. If the cost of government debt is lower than the opportunity cost for individuals of the money paid in taxes, why should we pay for the deficit with additional taxes (instead of using cheaper debt)?
Knut P. Heen
Mar 19 2024 at 10:15am
Taxing buy-backs and dividends is generally much worse than taxing earnings. This is money on the way from companies with deep pockets and no ideas to upstarts with empty pockets and good ideas. It is also a recipe for creating big inefficient business. Big business becomes both smaller and more efficient when they pay the money out to investors.
Jose Pablo
Mar 19 2024 at 10:34am
Even more so because manager already have the incentives to “invest in the business” instead of giving money back. Running a bigger balance will seat you at a best table at industry events and will get you invited to more hunting parties.
Managers pay dividends mostly because they believe that doing so supports (increases) share price. This poor suckers haven’t heard yet about EMH and know nothing about Modigliani-Miller!
Well, maybe about their theorem. That would explain why they are so willing to incur additional debt to pay dividends (or to buyback shares)
Jose Pablo
Mar 19 2024 at 4:43pm
Share buybacks are better than dividends. Dividends forcefully reduce investors’ position in company A. Whether they like it or not.
Share buybacks only reduce the position in company A of the investors willing to do so. Letting individual investors decide is always and everywhere a better option.
Capital gains are already taxed. If the government wants to increase the taxes collected from “getting money out of your investments“, the way to go is increasing the tax rates for capital gains or modifying the capital gains brackets or both.
The rest is “political BS”. One can only wonder why politicians love to make everything so complicated.
Comments are closed.