February 13, 2023
Federal Policy Analyst
February 13, 2023
During his State of the Union address last week, President Biden proposed increasing the new excise tax on corporate stock buybacks from 1 to 4 percent. There are a number of reasons why Congress should move forward with this proposal, we note in a new brief released today.
1. It would reduce the tax disparity between dividends and buybacks
Stock buybacks should not receive favorable tax treatment over other methods of distributing capital to shareholders, namely dividends, which achieve the same thing as buybacks. Both are effectively ways to distribute a corporation’s cash holdings to shareholders.
People who receive dividends have to pay income tax the year they receive them, most often at a rate between 15 and 23.8 percent. Foreign investors (who own about 40 percent of U.S. corporate stock) may pay a rate up to 30 percent, though it is typically reduced to 15 percent through tax treaties. For buybacks, if shareholders sell their shares during a buyback, they have to pay capital gains taxes – typically at a rate of 15 to 23.8 percent for U.S. shareholders. Foreign shareholders who sell their shares owe taxes on their capital gains according to the income tax system of their country of residence—potentially very low or zero.
The disparity arises mostly when shareholders choose not to sell shares during a buyback and instead hold the subsequent rise in share value as unrealized capital gains, which are untaxed. By holding onto their shares, shareholders can defer paying income tax for years or decades, allowing them to generate more wealth, income, and purchasing power – all tax-free. And if the shareholder never sells the assets, the capital gains will escape taxation completely due to the stepped-up basis rule, which allows unrealized gains passed to heirs to be untaxed.
This tax disparity between buybacks and dividends creates corporate tax maneuvering and deprives the public of necessary revenue. While the President has proposed raising the tax on buybacks to 4 percent, the rate to eliminate the disparity is likely at least 10 percent.
2. It would raise more revenue for productive public investments
Stock buybacks are an acknowledgment that there are few productive investments within the corporation to spend the cash on. Of course, a corporation could always raise workers’ pay and benefits, but this is rarely the favored approach of executives and shareholders when they can receive a tax-favored distribution of the cash through buybacks.
On the other hand, the public certainly has productive uses for the tax revenue that a tax on buybacks can generate, like infrastructure and schools that create value for the entire economy. Initial estimates suggested that the 1 percent excise tax on buybacks would generate $74 billion in new revenue over 10 years. Increasing the tax to 4 percent would most likely increase it by a substantial amount.
3. It would recoup some of Trump’s corporate tax cuts that went to wealthy shareholders
Even with the new 1 percent excise tax in place, this year is shaping up to be another blockbuster year for stock buybacks. In January alone, $132 billion in planned buybacks were announced, more than triple the amount announced in January of last year. This continues the trend we’ve seen in the first four years after former President Trump’s corporate tax cuts went into effect in 2018 as part of the Tax Cuts and Jobs Act, when the largest corporations collectively spent more on enriching their shareholders through stock buybacks ($2.72 trillion) than on investments in plants, equipment, or software that might have created new jobs and grown the economy ($2.65 trillion).
A higher excise tax rate on buybacks is completely reasonable. Quadrupling the rate, as the President proposes, would raise more revenue, cut into the tax advantage over dividends, and slow the pace of buybacks more generally.