Biden’s buyback tax shows who really runs America

U.S. President Joe Biden speaks during a bill signing ceremony in the State Dining Room of the White House in Washington, U.S. August 16, 2022. REUTERS/Leah Millis/File Photo

NEW YORK, Aug 31 (Reuters Breakingviews) – When returning money to shareholders, companies prefer to buy back stock rather than pay dividends. For good reason: it saves some investors billions of dollars a year in tax. A new 1% levy on share repurchases recently signed into law by President Joe Biden is meant to put the brakes on buybacks. It won’t, but instead might irritate executives and investors who never benefited in the first place.

Opponents of share buybacks, including politicians ranging from Democrat Ron Wyden to Republican Marco Rubio, often claim that buying back shares diverts money away from investment in factories, jobs and research. That’s a red herring, though. If companies like Apple (AAPL.O), which announced $90 billion in buybacks in April, couldn’t buy back shares, they could distribute cash as one-off dividends.

The real problem with buybacks is the way they are taxed. For companies, there’s no economic distinction between the $882 billion that the members of the S&P 500 Index spent on buybacks last year and the $511 billion they paid in dividends. For investors, though, there’s a big difference. While dividends are taxed as income, shares sold in a buyback incur capital gains tax that applies only to the owner’s overall profit.

This doesn’t much matter for investors who pay no tax, like pension funds and nonprofit bodies. Individual investors whose dividends and capital gains are taxed at the same rate – generally 20% – are also indifferent. But it matters enormously for foreign investors, including hedge funds based in tax havens like the Cayman Islands. They generally pay no U.S. tax on capital gains, but a 30% tax on dividends. Foreign investors hold around 30% of U.S.-listed stock, according to Brookings Institution fellow Steven Rosenthal.

Imagine if companies had paid out that $882 billion as dividends rather than in buying back stock. The government would have gained up to $80 billion in extra tax revenue – around 10 times what the new buyback tax is forecast to raise per year. The true figure would be lower, since many foreign investors benefit from bilateral tax treaties that reduce their rate. But even taxed at 15%, the extra dividends would bring in five times as much as the government is set to make from the buyback levy.

THUMB ON THE SCALE

In an ideal world, buybacks and dividends would incur the same tax. It’s not complicated – the late Yale Law School Professor Marvin Chirelstein laid out a relatively simple way to tax dividends and buybacks alike in the 1960s. However, in America’s divided political system, that’s a pipe dream. Equalizing the two would break Biden’s grandstanding promise not to raise tax on households earning less than $400,000 a year by even a penny.

The 1% tax on buybacks is therefore a second-best option. It makes repurchasing shares fractionally less attractive for companies and could raise $74 billion over a decade. But its impact on corporate behavior is likely to be trifling. The annual proceeds are less than 0.5% of the S&P 500’s forecast earnings this year, according to Refinitiv estimates. Companies can also offset shares they buy back against new equity they issue, say for employee stock plans.

The tax could still create a political bang, though. The fact it’s paid directly by the company means it’s borne by all investors including those typically exempt from taxes. Proponents of the scheme argue Congress could raise the rate in future. But that would create yelps of protest from managers of retirees’ money.

A PROBLEM WITHOUT A FIX

Biden’s reforms failed to tackle the biggest problem with share buybacks, which is that they allow very wealthy Americans to amass fortunes and pass them on to their heirs while sheltering from tax.

To see why imagine the founder of a big company who wants to hand their empire to the next generation. By declining to sell whenever the company buys back shares, they amass a bigger proportion of the company’s equity. When the mogul dies, owing to a quirk of the tax system, the embedded capital gain resets to zero, relieving heirs of a big liability.

This is something tax scholars Daniel Hemel and Gregg Polsky call “the Mark Zuckerberg problem,” after the founder of Facebook. Removing that perk – which Biden proposed in 2021 but then dropped – could have raised $110 billion over 10 years, according to congressional budget scorers.

The reform drive also left untouched another even more unfair distortion. This lets private equity executives treat profits on funds they oversee as an investment taxed at 20%, rather than earnings taxable at nearly twice that rate. This feature, known as the carried-interest loophole, survived thanks to the support of Senator Kyrsten Sinema, who held the deciding vote.

For regular Americans, that was a poor trade. True, Democratic proponents of carried interest reform reckon it would have brought in just $15 billion of tax revenue over a decade. But some analysts believe closing the loophole could raise 12 times that. Supporters of a cleanup include legendary investor Warren Buffett, JPMorgan boss Jamie Dimon and even former President Donald Trump.

A future Congress may tackle these distortions. Until then, the buyback levy is better than nothing. But politicians’ failure to remove dodges so egregious that even billionaires dislike them speaks volumes about who rules America. Biden occupies the White House, but where tax is concerned a wealthy minority still calls the shots.

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(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)

CONTEXT NEWS

Companies based in the United States will pay a 1% levy on share buybacks from the end of 2022, under a law signed by President Joe Biden on Aug. 16.

The buyback tax forms part of the Inflation Reduction Act, which also provided for clean energy investment and lower drug prices. Details will be finalized by the Treasury Department.

Over 10 years the buyback levy would raise around $74 billion, based on an analysis by the Joint Committee of Taxation, a nonpartisan congressional panel.

Companies in the S&P 500 Index spent a record $882 billion on buybacks in 2021, according to S&P Down Jones Indices. They returned $511 billion to investors in dividends over the same time.

Editing by Peter Thal Larsen and Amanda Gomez

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