President Joe Biden is calling for a 4% tax on corporate stock buybacks in his State of the Union address Tuesday night, according to the White House.
The proposal would quadruple the current 1% buyback tax, which was passed as part of the Inflation Reduction Act last August and took effect at the beginning of this year. But with Republicans controlling the House of Representatives since November’s midterm elections, it is unlikely the additional tax would receive approval from the Congress.
The proposal could still resonate with the American public, which see buybacks as yet another way that companies enrich themselves and their investors while minimizing taxes. In a buyback, a company will buy its own shares, which tends to push up the price of the shares still outstanding. Until this year, stock buybacks weren’t a taxable event until investors sold the appreciated shares.
Although buybacks are an efficient way to return profits to shareholders, critics claim that they represent short-term thinking and don’t bring real value to the company. Stock gains driven by buybacks aren’t sustainable, they argue, as companies will eventually run out of cash to artificially boost prices. Instead, the money could have been used to improve employee welfare, expand the business, or invest in innovation.
Politicians have been attacking buybacks as a way of profiting executives and shareholders, while deepening social inequality. The Biden administration, for example, has been blasting the oil and gas industry for spending too much of its earnings—thanks to soaring energy prices—on buybacks instead of boosting production and lowering prices for American consumers.
(CVX), for example, recently announced its plan to repurchase $75 billion worth of its own shares and boost dividend payouts. The White House called out the oil giant: “For a company that claimed not too long ago that it was ‘working hard’ to increase oil production, handing out $75 billion to executives and wealthy shareholders sure is an odd way to show it,” spokesman Abdullah Hasan tweeted.
Oil companies aren’t the only ones buying back their own stocks. Companies typically do buybacks when they can’t find more profitable ways to deploy the extra cash and believe their shares are undervalued. Last year, when recession fears pushed the S&P 500 into a bear market, U.S. companies stepped up their repurchase plans to a record $1.2 trillion.
While the 1% buyback tax in the Inflation Reduction Act could bring the government some extra income, it is likely too low to change company behavior. In January of 2023 after the new tax went into effect, buyback announcements more than tripled to $132 billion from a year ago, surpassing the previous January record by more than 15%, according to data from Birinyi Associates.
An even higher tax rate could make repurchasing shares more expensive and make companies think twice, but it is unlikely to get Republican support. At the introduction of the 1% buyback tax last year, Republican lawmakers asserted that it would erode returns on stocks and undermine Americans’ retirement savings.
Still, the buyback spree might calm down by itself anyways if companies start to see waning profitability. Already, the latest earnings reports are pointing to lackluster numbers. As the Federal Reserve continues to tighten the monetary policy to fight inflation, the generous use of cash might even bite back at those with weak balance sheets.
strategist David Kostin forecast in November that in the event of a recession, buybacks could drop as much as 40% in 2023.
Write to Evie Liu at firstname.lastname@example.org