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Tax stock buybacks?

from Peter Radford

Taking a short break from my crusade to get information taken more seriously in economics …

Yesterday’s Financial Times includes, on page 9 of the print edition, one of its regular “Market Insights” columns.  This is the space the FT allocates to sundry financial market types to opine on subjects of general interest to other financial market types.  It’s always a good read if you want to gain insight into how our magnificent financiers talk to themselves whilst allocating capital appropriately around the economy.  Well that’s what they see themselves doing, so let’s not nitpick.

The column yesterday was written by a luminary of the investment community, someone who sat on the board of a popular retirement fund, and who has written extensively on subjects related to finance, investing and so on through the years.  The subject was the possibility of eliminating the new tax that Congress just established on stock buybacks.  The new tax, all of 1% and thus hardly onerous, has stirred up a ton of ire in the corporate world where stock buybacks are viewed as a centerpiece of good “stewardship”.  That is if you consider stewardship to be centered purely on making shareholders happy.

Stock buybacks have become a go-to method for boosting stock prices at appropriate moments — dare I say just before the CEOs allocation of stock vests?  No that’s me being too cynical.  They have also become accepted as part of the arsenal of good governance of a modern corporation.  Excess capital ought, in the absence of new internal investment opportunities, be returned to the shareholders so that they can then re-allocate it in their portfolios to higher return projects.  It sounds so anodyne when you say it out loud that way.  And from within the hermetically sealed bubble of high corporate finance it is extremely sensible.

Except.

Let’s face it, it’s a tax dodge.  The corporation could pay the cash back as a dividend instead,  But that’s subject to a different tax rate.  Share buybacks make more sense.  They are “tax efficient”.  What an ugly and laden term.

So, the article’s author says, as the cash flows pile up and there are apparently no great opportunities for managers to use it within the day-to-day business, why not give it “back” to the shareholders?  And that new 1% tax is simply an unnecessary dabbling in management by an ungrateful and perhaps spiteful Congress.  Besides, gasp, it might make American business uncompetitive.  If all it takes is a paltry 1% tax on stock buybacks to make American business uncompetitive, then I suggest there are bigger problems to remove.

What the author doesn’t consider are alternative uses for that excess cash.  In his mind it is either retained within the corporation or it is “returned” to the shareholders.  I have other suggestions — I am trying to be helpful here.

How about lowering prices in order to reduce excess cashflow?  Pass the benefit along to consumers.  That would be one option.  It’s one that economics text books like.

How about raising wages?  Or, if you want to be conservative, paying out bonuses to your workers?  That would be another option.  The economics textbooks wouldn’t like this one unless each workers marginal productivity has gone up.  But we can try.

I am just trying to be helpful!

Either of those might get rid of the awful headache of having too much cash on hand.  Both might garner more support and/or enthusiasm for the corporation.  Just think: if people and workers look more kindly on the business they might be more apt to consider those alternative new products that the corporations is currently shelving.  You never know.  The business might grow and gobble up that excess cash.

Who knows?  It’s worth try.

Now, about the scare quotes I put around a couple of words up above.

I object to the trope that corporate cash is the property of shareholders and thus could be given “back” or “returned” to them.  Very very few of the current shareholders have ever contributed cash to a modern corporation.  They have simply bought paper in a secondary market.  They do not “own” the corporation’s cash.  That cash is the property of the business to use as it sees fit.  Like pay workers more.  The idiotic notion that good corporate governance begins and ends with the relationship the business has with the owners of whatever paper it issued in the past is one of the reasons that the economy is less vibrant than in the past.  Good governance extends beyond that.  Way beyond.  The error of blind attachment to the concept of shareholder value is a tragic one for workers, consumers, and society at large.

So let me repeat: yes, there are options for the use of the excess cash beyond stock buybacks.  Like lower prices or higher wages.

That a doyen of the investment community doesn’t comprehend that, or acknowledge it, is a sign of how far we have to travel if we are to rebalance the economy and society away from the real excess: our over-emphasis on finance.

  1. Patrick Newman
    August 25, 2022 at 12:46 pm

    Would it be the end of the world if it was 5% instead of 1%?

  2. John Jensen
    August 29, 2022 at 1:28 am

    I’m assuming that stock buy-backs are prompted by excessive profits or other leftover cash which has no better use and due to accidental increases in profit margins and hence unlikely to persist from one quarter to the next. And, at the same time there is no better use for it than to pay it out. Using it as buy-backs does not reduce taxes to the corp. and it it does not create immediate taxes for the shareholder but it’s still results in double taxation. It would be more tax efficient to give employees a bonus as that lowers the net tax to the corp – or even split the windfall equally with all stakeholders – including customers and suppliers. But, that’s all up to Governance to decide, of course.

    Tax has to be fair and more or less fairly distributed and not opportunistic, punitive or designed to reduce productivity. If you follow the money in the corp. then a 1% tax on share buy backs is just another tax on net profits and therefore better handled as an “excessive profits tax”, perhaps using the amount paid as an annual “profits sur-tax” that can be used as a tax credit in future years when profits are low – like we do with capital losses and operating losses – we transfer them as a tax reduction to other tax periods. In reality a buy-back is a pre-taxed bonus paid by consumers to shareholders that is taxed again at the personal income level of each of the shareholders, If it’s distributed to suppliers, employees or customers it results in lower taxes on profits for the corporation and transfers the tax burden to these other stakeholders except consumers. . Only distributions to shareholders wind up paying double taxes (once within the corp. and again on personal income) so in reality the most tax efficient route is not shareholders it’s consumers. The only group of stakeholders that are doubled taxed are shareholders – once within the corp. which lowers share value and again within shareholder income. Taxing within the corp., in any manner before a buyback, paying out dividend or capital refunds to any stakeholder group has to be paid out of after tax income which is just the same as an additional tax on profits so that 1% is nothing less than a surtax on profits depending on what governance decides to do with it. It’s obviously a punitive tax designed to punish one group of stakeholders – shareholders. A bonus to employees increases the cost to operate, the profit margins go down and corporate taxes decrease. Same for suppliers. So the 3 alternatives to no share buy-backs are more tax efficient but it doesn’t benefit the more influential group.

    This all assumes that the capital gains tax, the dividend tax is equal to the average personal income tax of employees, shareholders and suppliers. Only refunding consumers would be the most tax efficient because it reduces corporate profits taxes and lowers costs for consumers and leaves more after tax income in their pockets. It’s more tax efficient to refund extra profits to consumer groups and the worst tax efficiency is paying shareholders with after tax income as buy-backs – but, due to lower taxes on shareholder income for capital gains is it considered more tax efficient by that group and hence why corps don’t lower costs to consumers – it’s shareholder greed.. .

    A 1% tax on share buy-backs increases the tax on profits and later decreases the unrealized capital gain on shareholder dispositions (by 1% fewer buy-backs) so that part is fair to shareholders. But, it’s far more fair and transparent if a buy-back is first taxed as an “excessive profits tax” like what was done in the 1950s on war profiteers during and after the war. Since shareholders are obviously a preferred class of stakeholder it would make sense if capital gains income is taxed at the same rate as dividends and at the same rate as CEO salaries. Tax should all be equal for all types of income no matter how the corporation distributes a windfall but it’s least efficient if paid to shareholders as there is no offsetting deduction to net profits for buybacks and dividends. So, whoever is promoting that 1% idea is just biased against one particular group of stakeholders but doing it the wrong way. I agree that rich shareholders should be singled out for more tax but then it makes more sense to raise their income tax rates as well as equalize taxes on all types of income and at the same time raise the tax credit for donating either income or equity to a charity. That would encourage “trickle-down” and the rich giving back to the society that made them rich.It’s time for them to share with their good fortune with the rest of us.

    “The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities.” (Adam Smith, 1776)

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