March 09, 2023
The Biden administration is getting a lot of grief over its proposal to tax share buybacks at a 4.0 percent rate. They are being denounced as economic illiterates, and worse. I’m going to side with the economic illiterates, and say Biden is very much on the mark with this proposal.
To be clear, I have written before that I don’t agree with most of the complaints directed against buybacks. It makes little difference as a practical matter whether companies pay out money to shareholders as buybacks or dividends.
The one area where there is a clear difference is the tax treatment, but even here the case is overstated. Most people who hold stock have it in 401(k)s or other retirement accounts. For those of us in this group, it doesn’t make an iota of difference whether money is paid out as dividends or buybacks.
When we withdraw money after retiring, it will be taxed as ordinary income, regardless of whether the accumulation was due to rising share prices or dividends. (The same story applies to Roth IRAs, where the payout is tax free in both cases, since the money was taxed going in.)
This point is actually worth emphasizing for a moment, since politicians (mostly Republican politicians) often lie about it. When they claim to be helping middle class stockholders by reducing the capital gains tax, this is largely a lie. Few middle-class people own much stock outside of their retirement accounts. Since lowering the capital gains tax has no impact on the tax paid on retirement accounts, cuts in the capital gains tax will affect few middle-income people.
There is the issue of taxes on stock held outside of retirement account. Share buybacks have the advantage to these shareholders that they can defer the taxes on their gains to when they choose to sell their stock, whereas the tax on dividends is paid in the year the year dividend is paid.
But even here the impact can be overstated. Most people cannot afford to hold stock forever. Maybe they will sell it a year or two down the road, and at that point they will pay the tax. (Those of us who want financial transactions taxes, in part to reduce the rate at which stocks turn over, can’t also complain about stock being held forever.)
Of course, we do have some very rich families, the Waltons have volunteered to be the poster children, who have tens of billions in stock that they literally can hold forever. For these families, having companies pay out profits as buybacks rather than dividends does make a difference.
Insofar as the Biden tax proposal encourages companies to shift more of their payouts to dividends, this is a good thing. We will effectively be raising the tax rate on the very rich.
FWIW, I don’t accept the idea that companies are foregoing good investment opportunities by buying back shares. I’m generally inclined to think that companies invest where they see profitable opportunities. I really don’t want to encourage them to throw money away on silly projects. Do we want Elon Musk to have more money to spend on his Boring Company, which has mostly dug lots of holes to nowhere?
To my view, the great virtue of Biden’s proposed tax on share buybacks is that it is a way to raise the corporate income tax, taking back part of the cut that Trump gave the corporations in 2017. For whatever reason, Biden was able to get people like senators Joe Manchin and Kyrsten Sinema, who would not go along with raising the corporate income tax, to sign on to a tax on share buybacks. I won’t try to explain their thinking, but if this is how we get to raise the corporate income tax, do it. And, if we can make it 4.0 percent rather than the current 1.0 percent, that’s even better.
I’m going to confess to an ulterior motive here. I have argued for switching the basis for the corporate income tax from profits to returns to shareholders (capital gains and dividends). The logic is that we don’t see corporate profits directly, corporate accountants tell us what their companies’ profits were. This provides enormous opportunity and incentive for tax gaming. Enormous resources are wasted in this process and we collect far less in taxes from corporations as a result.
By contrast, returns to shareholders are completely transparent. We can get the data on the increase market capitalization and annual dividend payouts from dozens of financial websites. This would make it possible to calculate the tax liability of all publicly traded companies on a single spreadsheet (that is all companies’ taxes could be calculated on the same spreadsheet). (Privately traded companies pose a problem, but we can worry about that later.)
Anyhow, I have long been a big fan of establishing facts on the ground. We can spend forever arguing over what is best in theory, but when we see something in practice, it is harder to argue over.
I am quite confident that the tax on share buybacks will be just about the most efficient tax in history, in the sense that the amount of money spent to enforce it will be trivial compared to the revenue collected. After all, if Apple spent $25 billion on share buybacks last year, it owes the government $250 million at the 1.0 percent tax rate. What is there to argue over? Is Apple going to say that all those press reports of share buybacks were lies?
This will be true for every company. They have to publicly disclose their share buybacks. Once this is done, we know how much tax they owe: full stop.
If the public sees this, then maybe we can get policy types to get a little bit interested in designing a corporate income tax that we can actually collect. And, in the process, we can put the tax gaming business out of business.
Let’s hear it for Dark Brandon!