A tax on share buybacks would hurt investment and innovation

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The Inflation Reduction Act (IRA) passed by the Senate provides for a new 1% excise tax on stock buybacks, arguing it would be better for the economy if companies invested their excess cash in the business, rather than returning that value to shareholders. However, research suggests that buyouts do not hinder investment opportunities and in fact help support a vibrant economy.

When companies have excess cash, they can either keep it or return it to shareholders. One method of returning this value to shareholders is through the payment of a dividend, which is usually paid at a scheduled frequency. However, companies can also buy back the shares of the shareholder. Typically, when companies choose to return value to shareholders, it is because they have exhausted all potential investment opportunities. In other words: companies do not distribute money in place investment, but rather after they have already made their investments. This is why older, mature companies tend to pay dividends, while younger, growth-oriented companies are more likely to reinvest earnings.

Shareholders who receive income from a stock buyback can use their money either for consumption or to pursue new investment opportunities. This is the engine of economic growth. In this sense, share buybacks allow investors to fund small businesses and start-ups where the opportunities for growth and innovation may be far greater than those of established companies.

Research indicates that most stock buybacks are recycled into other investments, with one study finding that nearly 95% of funds from buybacks are reinvested in other public companies. One reason may be the widespread use of retirement accounts, which hold the majority of company stock. As early withdrawals from these accounts are often subject to tax penalties, much of the cash received by shareholders tends to be reinvested rather than used to fund immediate consumption.

The new tax on share buybacks could potentially interrupt or distort this rather efficient and beneficial process of recycling investable funds, depending on how companies react to the tax. One potential reaction is for companies to increase their dividend payouts instead of buying back a stock. Based on economist James Porteba’s research on corporate payout policies, the Tax Policy Center estimated that a 1% tax rate on stock buybacks could increase dividends by about 1. 5%. To the extent that total payouts to shareholders are not affected, the new tax may have little impact on the efficient allocation of capital.

Such a shift from redemptions to dividends could have an impact on the income-generating possibilities of this policy. Currently, we estimate that the stock buy-back tax would generate approximately $55 billion in revenue over the next decade. However, to the extent companies shift to paying dividends instead of share buybacks, the tax could generate even less revenue over time, especially if those dividend payouts are largely paid into retirement accounts. fiscally advantageous. This would reduce the IRA’s long-term ability to reduce deficits.

Overall, the new redemption tax introduces uncertainties and potential drawbacks in terms of efficient capital allocation. With inflation still high and the economy showing signs of slowing down, now is not the right time to try a new tax of this nature.

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