The Biden administration and a Democratic-controlled Congress imposed a new tax on corporate stock buybacks as part of the Inflation Reduction Act passed in 2022. It hasn’t gone well.
Corporations use stock buybacks to grow. Buybacks signal to a company’s shareholders that the company’s investments are in demand and that the firm is in good financial health. That incentivizes investors to want to buy more shares of the firm’s stock, which they can sell back to the company in exchange for cash.
Buybacks also help a company grow because they empower a firm to reinvest excess cash back into the company itself to improve its overall worth on the market. The firm is then able to increase its short-term stock value and makes itself more attractive to potential investors.
In addition, buybacks enable a company to reduce outstanding shares on their balance sheets while retaining a consistent margin of profitability, thus increasing the firm’s earnings per share. With the enhanced share price, firms can then resell them into the open market for the potential of generating future profits. In turn, investors receive greater returns from a company that improved its own value.
But when you tax something, you get less of it.
It’s no surprise that in the year after the new tax was imposed, corporate buybacks declined in 2023, despite a record year in 2022. That’s bad for companies and bad for shareholders. The sharp decline in U.S. share repurchasing has undermined a critical avenue for corporate growth and weakened investor return in the public markets. At a time when fewer companies are going public, the buyback tax only provides further regulatory incentive for private firms to avoid touching public markets.
The buyback tax further destabilized the tax planning benefits that companies and their shareholders enjoyed with repurchase programs. If companies pay dividends from the corporate treasury, shareholders are taxed immediately. But if these firms instead use that money to buy back company shares, shareholders can defer taxes on the gain in value until they are ready to sell some or all of their shares. Thus, investors, including many middle-class savers, can hold on to a stock for years and decide when to pay taxes on the realized gains according to their financial needs.
Another drawback of the buyback tax is it puts U.S. companies at a distinct disadvantage in the global economy. European companies have continued to enjoy record buybacks, marking a competitive advantage against U.S. markets. Recent years have seen large European firms repurchase their shares at an aggressive pace while enjoying notable market benefits.
The problems don’t end there.
A chunk of the money that would have been used for buybacks has been diverted toward the construction of clean energy technology and facilities. Many politically favored firms that received millions in Inflation Reduction Act green tax credits took the bait and spent profusely ($200 billion on Inflation Reduction Act-related projects within a year) on untested and costly green energy initiatives rather than raise their firm value. In fact, the unspoken goal of the Inflation Reduction Act has been for companies to shift financial returns away from investors and toward building a massive clean energy infrastructure.
Doubling down on a disastrous policy, the Biden administration now wants to quadruple the buyback tax from 1% to 4%, seeking to generate $166 billion in corporate tax revenue. Yet this rosy projection overlooks the broader dynamic effect of tax hikes in depressing new growth, thus leading to reduced tax revenues. While President Joe Biden’s existing 1% buyback tax hauled in $8 billion in the first year, the United States suffered a 35% decline in tax revenues in the same period. Simply raising the buyback tax rate and other capital gains taxes doesn’t guarantee an increase in federal tax revenues.
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A far better policy than increasing the buyback tax would be to eliminate any tax on repurchased shares. This would incentivize firm growth while ensuring that investors have the choice to retain their investment gains without being pressured to sell them by the Inflation Reduction Act. That would have the added benefit of making public market entry more attractive to the private sector.
Preserving corporate buybacks complemented by other pro-growth tax and regulatory policies would lift all boats.
Stone Washington is a research fellow with the Competitive Enterprise Institute.