Share repurchases seem to be a favorite Washington scapegoat for inequality. Last December, the SEC proposed a new disclosure rule around them. The recently passed and signed CHIPS and Science Act included limits on share repurchases for firms receiving public subsidies and incentives. Now, the Inflation Reduction Act includes a one percent excise tax on share repurchases.
One percent may sound small--and may seem like it's targeting the wealthiest Americans—but it could have significant consequences for anyone with a 401(k) or pension fund or expanding a small business. Which is to say, millions of Americans. So, what are share repurchases, and why are they consistently under attack?
In 1982, the Securities and Exchange Commission (SEC), understanding the broad economic value of share repurchases, offered liability protection to companies in exchange for additional disclosure requirements. As a result, corporations began to increasingly use repurchases to efficiently distribute excess capital. Practically speaking, when a company indicates its plans to repurchase its stock it is because the company’s board and management believe the stock is undervalued. As a result of the notification the value of the stock increases. Who benefits from its increase is the source of the debate.
Unfortunately, most of the discussion around share repurchases relies on static analysis. Critics have posited numerous proposals to prohibit or restrict repurchases, including an excise tax. The prevailing rationale to impose restrictions focuses on the correlation between corporate notices to engage in share repurchases and shareholders selling shares and making a profit. Instead, say critics, corporations should use excess capital to improve employee pay and benefits.
Conversely, shareholders argue that companies should return excess capital to them by increasing the value of their shares through repurchases and increased dividends. Shareholders believe that critics overstate the increased use of repurchases, that existing regulations already protect against executives engaging in repurchases for nefarious purposes, and that an excise tax will reduce the growth potential of their investments.
This debate goes nowhere because it is zero sum, based on static analysis. Instead, policymakers should evaluate the excise tax in the Inflation Reduction Act and the proposed SEC disclosure rule on share repurchases under a dynamic approach. As discussed in a recent Bipartisan Policy Center report, a dynamic approach would take into consideration the best ways to ensure the most efficacious use of capital in the U.S. economy. When repurchases are analyzed not merely as tax revenue, but rather from a macroeconomic perspective, including such a tax or further restrictions may not seem so innocuous.
The average worker with a 401(k) or pension benefits from higher share values through the increased value of their retirement account. Taxing the business practice that increases the value of someone’s retirement account indirectly taxes that account. Supporters of the new tax claim that there are restrictions on its implication so only the most profitable companies will have to pay it. However, beneficiaries presumably want their retirement accounts to grow, and the best growth opportunities are with companies that are the most profitable. So here the plan is to tax the most profitable companies—which are the same companies that beneficiaries are relying on to increase their savings.
Studies evaluating the economic effects of repurchases have shown that they impact a much larger group of beneficiaries than simply employees, shareholders, or as a revenue source. When companies redeploy capital, it can increase savings, investment, and purchasing power. As Harvard professors Jesse Fried and Charles Wang have found, capital from repurchases has historically been used to reinvest “in smaller public companies and private firms supporting innovation and job growth throughout the economy.” Further, in a recent Wall Street Journal op-ed, they indicated that including the proposed one percent excise tax will “increase corporate bloat, lead to higher CEO pay, harm employees, and reduce innovation in the economy.”
As Congress evaluates the Inflation Reduction Act, they should make sure they fully understand the consequences of suppressing capital formation for smaller companies and increasing taxes on retirement accounts. This is especially true given the S&P 500’s bear market turn in 2022. Further harming retirement accounts and undermining small business growth through a seemingly innocuous excise tax may not sit well with voters once they understand the ramifications.
