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A Stock Buyback Tax Is Added to the Inflation Bill. What That Means for Apple, Meta, and Microsoft.

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Arizona Democratic Sen. Kyrsten Sinema

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Democratic party leaders struck a deal with moderate holdout vote Sen. Kyrsten Sinema, moving their climate and healthcare bill one step closer to fruition. The agreement, however, could spur key changes in corporate taxation, especially on stock buybacks.

Sinema, the Democratic senator from Arizona, said she was ready to “move forward” with the legislation, called the Inflation Reduction Act, once it has been approved by the Senate parliamentarian.

But Sinema’s compromise could come with important revisions to the bill’s tax provisions — the main source of funding for the act’s climate, healthcare, and deficit reduction initiatives.

Democrats may agree to scale back elements of a proposed 15% minimum tax on large companies, according to reports. They may also remove a provision that would close the carried interest loophole, which allows private-equity partners to pay the lower capital-gains tax rate on income rather than ordinary income-tax rates.

To compensate, Democrats may add a 1% excise tax on stock buybacks for publicly traded companies, The Wall Street Journal reported, citing a person familiar with the matter. In the midst of what looks to be a record year for U.S. buybacks, the measure could raise more money than the provisions being removed from the bill.

This isn’t the first time Democrats weighed adding a tax on stock buybacks. The provision was a central one of the Build Back Better act, the party’s trillion-dollar social spending initiative that fizzled out in November after party leadership failed to come to a compromise with moderate Sen. Joe Manchin of West Virginia. At the time, the administration estimated that a 1% repurchase tax could generate about $125 billion in revenue over 10 years. For comparison, the carried interest loophole would have raised $14 billion in taxes.

“The excise tax on stock options stood out on the shelf because it was the one corporate raisers from BBB that the business community wasn’t contesting aggressively,” wrote Capital Alpha Partners analyst James Lucier.

A buyback tax could also incentivize companies to shift to dividend payouts. Studies estimate that a 1% tax rate on share repurchases could induce about a 1.5% increase in dividend payouts, wrote Tax Policy Center senior fellow Thornton Matheson.

Stock repurchase plans have gained traction over the last few decades, outpacing dividend growth. Because of the way taxes are currently structured, shareholders have to pay a larger amount of tax on a dividend distribution than on a sale of stock, according to the Congressional Research Service, making it a popular way for companies to return value to stock holders.

“Since share buybacks help avoid investor-level taxation, the buyback tax is a reasonable way to reduce their tax advantage,” Matheson wrote last year. “It raises significant revenue and could trigger an increase in dividend payouts.”

Critics of stock buyback plans argue that companies are using share buybacks as a way to avoid investor-level taxes on corporate earnings, and that companies should instead use profits to reinvest and grow productivity. In 2019, Sen. Elizabeth Warren said buybacks created a “sugar high” for corporations, boosting prices in the short run without investing in long-term performance.

Proponents, on the other hand, pointed to evidence suggesting that companies only consider buybacks when they have exhausted other investment opportunities.

“Buybacks do not displace productive investments and do not come at the expense of workers — so they should not be targeted for a tax increase based on those misperceptions,” wrote Tax Foundation Senior Economist Erica York.

Democrats still need to wait for the Senate parliamentarian’s final seal of approval before moving forward with the bill. Voting is expected to begin this weekend. The measure could also still undergo several revisions as it winds its way through Congress.

Write to Sabrina Escobar at sabrina.escobar@barrons.com

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