Facing an unexpected revenue hole to finally push their climate and health care bill across the finish line, Democrats took aim at one of their longtime favorite rhetorical targets: stock buybacks. The cost of the 1% tax on buybacks will be borne by companies like Apple, which added $90 billion to its share repurchase plan in April.
Buyback Tax Impact On Apple, S&P 500 Earnings
The tax on such a massive Apple stock buyback could amount to as much as $900 million a year, once the tax takes effect in 2023.
Consider what that might mean if the tax were in effect now: A $90-billion stock buyback would raise Apple earnings per share by about 3.5% thanks to a lower share count. However, a $900 million tax would shrink the buyback's boost to EPS to about 2.5%.
For the S&P 500 as a whole, which is on pace to reach $1 trillion in stock buybacks this year, the combined hit to earnings could amount to as much as $10 billion a year if that pace continues.
One caveat: The proposed stock-buyback tax would be reduced by any stock issuance, including as compensation, over the same period. In recent years, that would have cut Apple's bill by about 10%.
That will raise an estimated $74 billion over a decade. Goldman Sachs has estimated that it could reduce S&P 500 earnings per share by 0.5%.
Since buybacks will remain tax-free through the end of this year, some analysts are expecting something of a buyback frenzy, which could support the S&P 500 at a volatile time.
Stock Buybacks Aren't Going Away
Still, the measure is unlikely to significantly reduce the impetus for stock buybacks, which contribute to higher share prices.
Last fall, Senate Democrats proposed a 2% tax on buybacks. But even that measure wouldn't "move the needle much," Gregg Polsky, professor of taxation law at the University of Georgia, told IBD at the time.
By that, Polsky meant, that size of the tax wouldn't be enough to cause a significant shift away from buybacks to dividends.
Polsky and New York University law professor Daniel Hemel helped put a stock buyback tax on the agenda. They pushed the idea of taxing stock buybacks to the same extent as dividends. They figured that doing so could raise an amount equal to about 7% of the value of buybacks over a decade.
The 1% tax proposal settled on by Democrats largely keeps incentives in place that have skewed capital distributions toward buybacks over dividends.
In 2021, Apple bought back $85.5 billion in AAPL stock, while issuing $14.5 billion in dividends. Google-parent Alphabet announced a $70 billion buyback in April but has never issued a dividend. Facebook-parent Meta Platforms, which said on July 27 that it has $24.3 billion left in its buyback authorization, notes in its 10-K that company officials "do not expect to declare or pay any cash dividends in the foreseeable future."
How Stock Buybacks Impact Share Prices
Stock buybacks are generally a positive for stock prices for two reasons. First, unlike dividends, corporate cash spent on buybacks buoys earnings per share by reducing share counts.
Second, buybacks offer a way of distributing capital while allowing shareholders to defer — or avoid — paying taxes. Instead of the tax dollars going to the government, they stay in the stock market.
For shareholders who don't redeem their shares, buybacks may result in a bigger capital gains tax bill, but only when they sell their stock — if they sell. Plus, while foreign investors pay an average 17% tax rate on dividends, they don't face U.S. taxes on capital gains.
That's no small thing, since the share of publicly traded U.S. stocks held by foreigners has tripled to 30% since the late 1990s, according to Steve Rosenthal, senior fellow at the Urban-Brookings Tax Policy Center.
Over the same period, the value of stock buybacks caught up to and then soared past corporate cash spent on dividends. In 2021, S&P 500 buybacks totaled $883 billion, 73% more than the $511 billion distributed as dividends.
Biden Approval Hits New Low, Despite Democrats' Winning Streak
S&P 500 Spared From Big Tax Hikes
Wall Street, after winning big with President Trump's 2017 tax cuts that cut the corporate income tax rate to 21% from 35%, has largely escaped a big payback under President Biden. That's not for lack of trying.
Biden sought over $2 trillion in tax hikes aimed at corporations and wealthy investors. Hiking the corporate tax rate back to 28% would have raised $900 billion. Biden proposed hiking the top tax rate on capital gains and dividends to 43.4% from 23.8%, raising $400 billion. Tax hikes on foreign corporate income might have raised $1 trillion in the first decade.
But with every Democrat in the 50-50 Senate owning an effective veto, Sen. Joe Manchin relentlessly squashed down Biden's wish list from well over $2 trillion to an estimated cost of $430 billion. Worried that more government profligacy would exacerbate the inflation threat, Manchin recrafted the bill as the Inflation Reduction Act.
In a worst-case scenario, Wall Street strategists said S&P 500 earnings could take an 8% haircut, but figured a hit of 3%-4% was more likely. In the end, Goldman Sachs estimates that S&P 500 earnings will be trimmed by about 1.5%. The buyback tax will pare earnings 0.5% and the 15% minimum corporate tax 1%.
The corporate minimum tax targets big companies like Amazon, which paid a 6% tax rate on U.S. income in 2021. Yet even that provision was shrunk down in 11th-hour negotiations, which preserved the tax advantage of accelerated depreciation for equipment purchases. Citigroup analysts think the 15% minimum tax will cut earnings by just 0.4% next year.
Please follow Jed Graham on Twitter @IBD_JGraham for coverage of economic policy and financial markets.
