The last thing America needs in a recession is tax increases, as any politician will tell you. Unfortunately, despite pledges by Democratic Senators and congressmen that their recently passed tax and spending package contains no new taxes and merely closes “tax loopholes,” last-minute changes to the bill include a new tax that will harm retirees and distort investment. With the House approving the Senate’s change, this tax will weaken the U.S. economy at a time when economic growth should be the number one priority for Democrats and Republicans alike. It will be Americans and retirees who pay for this tax through lower economic growth and lower returns on their investments.
One of the biggest changes to the so-called “Inflation Reduction Act” was a last-minute addition of a stock buyback tax. Starting in 2022, this new measure will be a one percent tax on the value of shares that any publicly traded company repurchases from its shareholders — a move companies make sometimes to boost their stock price when they feel their stock is undervalued, other times to fend off hostile takeovers.
Stock buybacks are good for the economy in multiple regards. First, they allow shareholders, 30 percent of whom are retirees, to exit their investment at a premium. Corporations often have to offer a higher price to induce their shareholders to sell their stock. Stock buybacks, therefore, put more money in the hands of retirees and allow them to reinvest their earnings in potentially higher-growth companies or to simply liquidate with a premium. This allows retirees to make more money and boost the economy by giving higher grossing companies, many of which are startups, more capital.
The buyback tax may seem small — what’s the harm in one measly percent, right? But when companies engage in billion-dollar stock buybacks, that tax becomes quite large. As a result, it’s sure to decrease the number of buybacks and the economic benefits that come with them. Retirees and other shareholders are unlikely to receive premiums, which means they are less likely to sell their stock — even if their money could otherwise be invested in a company yielding higher returns. This stock lock keeps Americans' investments in less economically efficient companies.
The tax will also distort the merger and acquisition market. Corporations often engage in stock buybacks to fend off unfriendly takeovers of their corporations. By buying back shares, companies boost the price of their own stock, making it more costly for an unfriendly purchaser to buy the company. Corporations may not want to partake in the merger because they believe their current directors and managers can run the company better than the potential purchaser.
This new tax makes this protective action more costly and may result in harmful mergers that ruin companies, resulting in massive layoffs for affected workers and destroying shareholder and retiree wealth.
Mergers and acquisitions should take place when they are economically advantageous, not simply because a new tax makes it more expensive to fend off a takeover.
While supporters of the tax claim the tax is good because it will increase dividend payments, they ignore these critical economic distortions. They also ignore that a simple and pro-growth way to increase dividend payments would be to eliminate the double tax on corporate profits by excluding dividends from taxable income or to give shareholders a tax credit for the corporate taxes already paid on the distribution.
A stock buyback tax will result in lower returns for investors, a distorted merger and acquisition market that could spell disaster for companies, and less economic growth. It’s bad for shareholders, retirees, workers, and the economy. House Democrats should have considered other methods for raising revenue and considered other ways to increase dividend payments before voting on the Senate’s bill. Unfortunately, they did not, and repealing this harmful tax should be a top priority for the next Congress.
