The collective mind of Washington can occupy itself with only so many items in a major new piece of legislation, and may be distracted to a fault by what’s left out. That’s especially true when a subsection worth noting is added at the last minute. So the new excise tax on stock buybacks in the Inflation Reduction Act (Chapter 37, for you nerds out there), which passed the Senate on Sunday, and is expected to win quick approval in the House, is not getting the attention it deserves.
Stock buybacks are a stupid gimmick that corporations use to jack up stock prices artificially without making the company itself any more valuable through less piratical real-world alternatives like investing in research, development, plant, equipment, personnel, and (God forbid) wages. By reducing the number of shares, a stock buyback automatically increases earnings per share, instantly and effortlessly making the stock more valuable.
That gratifies shareholders, the only people who matter to corporations these days. Stock buybacks drew a lot of infuriated attention (even from President Donald Trump) when they surged by $200 billion after Trump lowered the top corporate tax rate from 35 percent to a flat rate of 21 percent. Wall Street should have sent taxpayers a thank-you note.
What about the top executives? Don’t they matter to corporations too? Of course they do, and the biggest corporations demonstrated that last year by paying them a median $14.7 million. But that’s paid mostly in stock options and other “equity awards.” So when a company’s chief executive decides to repurchase stock, he enriches himself.
Wait, shouldn’t that be illegal? It should. And, in fact, it was until the presidency of Ronald Reagan. But in 1982 the Securities and Exchange Commission, whose chairman, John Shad, was a former vice chairman of E.F. Hutton, promulgated Rule 10b-18, which largely exempted stock buybacks from prosecution for stock market manipulation. The predictable result was a torrent of stock market manipulation in the form of stock buybacks. In 2003 the SEC revised the rule to state that “It is not appropriate for the safe harbor to be available when the issuer has a heightened incentive to manipulate its share price.” But this plea for corporate tycoons to behave themselves yielded little result. Perhaps new proposed disclosure rules will help.
Stock buybacks hit a record $882 billion last year, and they may reach $1 trillion this year. The biggest corporations spend the most on buybacks. Thus Apple lavished $91 billion over the previous four quarters, according to The Wall Street Journal; Alphabet (Google), $55 billion; Meta (Facebook), $53 billion; Microsoft, $33 billion; and Bank of America, $21 billion.
Until recently most buybacks were funded by corporate profits. A 2020 Harvard Business Review article reported that buybacks in 2018 gobbled up fully 68 percent of net income in the S&P 500. But even with corporate profits at record highs, earnings can no longer meet the voracious demand for buybacks. So a growing proportion of buybacks—one recent estimate put it as high as 56 percent— are now “leveraged buybacks” paid for with corporate debt. Corporations are going into hock so they can shower more cash on shareholders and their top executives.
The proposed excise tax on buybacks is only 1 percent, so its initial effect on this drunken binge will be minimal. Indeed, in the short term it will likely create an uptick in buybacks as some corporations accelerate buybacks to avoid the tax’s implementation in 2023. The initial proposal by Democratic Senators Sherrod Brown of Ohio and Ron Wyden of Oregon—Brown is the Banking Committee chairman, while Wyden leads the Finance Committee—was for a 2 percent tax on buybacks, which would have been better. Five or 10 percent would be better still.
But the excise tax’s creation establishes a beachhead. In coming years, it can and probably will be increased. In the meantime, it isn’t a bad revenue-raiser. According to Senate Majority Leader Chuck Schumer, this itty-bitty 1 percent tax will raise $74 billion over the next decade. If the outlook for the stock market improves, it will raise more. And if the excise tax is increased in the coming years, it will raise even more than that. So please join me in welcoming this new provision to the tax code. Its debut is long overdue.
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