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: share buybacks. The cost of the 1% tax on repurchases will be borne by companies such as Apple (AAPL), which added $90 billion to its share buyback plan in April.
Impact of the buyback tax on Apple and S&P 500 earnings
The tax on such a massive Apple share buyback could amount to as much as $900 million a year, once the tax takes effect in 2023.
Consider what that could mean if the tax were in place now: A $90 billion share buyback would boost Apple’s earnings per share by about 3.5% thanks to a lower share count. However, a $900 million tax would reduce the buyback boost to EPS to around 2.5%.
For the S&P 500 as a whole, which is on track to hit $1 trillion in share buybacks this year, the combined hit to earnings could reach $10 billion a year if that pace continues.
One caveat: The proposed share repurchase tax would be reduced by any share issuance, even as compensation, during the same period. In recent years, that would have reduced Apple’s bill by 10%.
That will raise an estimated $74 billion over a decade. Goldman Sachs has estimated that it could reduce earnings per share of the S&P 500 by 0.5%.
With the buybacks remaining tax-free until 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.
Share buybacks are not going away
Still, the move is unlikely to significantly reduce the momentum for share buybacks, which contributes to higher share prices.
Last fall, Senate Democrats proposed a 2% tax on buybacks. But even that move wouldn’t “move the needle very much,” Gregg Polsky, a tax law professor at the University of Georgia, told IBD at the time.
By that, Polsky meant that the size of the tax would not be enough to cause a significant shift from buybacks to dividends.
Polsky and New York University law professor Daniel Hemel helped get a share buyback tax on the agenda. They pushed the idea of taxing share buybacks to the same extent as dividends. They figured doing so could raise an amount equal to about 7% of the value of buybacks over a decade.
The 1% tax proposal agreed to by Democrats largely maintains the incentives that have skewed capital distributions toward buybacks over dividends.
In 2021, Apple repurchased $85.5 billion worth of AAPL stock and issued $14.5 billion in dividends. google-parent Alphabet (GOOGLE) announced a $70 billion buyback in April, but never issued a dividend. facebook-father Metaplatforms (GOAL), which said on July 27 that it had $24.3 billion remaining on its repurchase authorization, notes in its 10-K that company officials “do not expect to declare or pay cash dividends in the foreseeable future.”
How Stock Buybacks Affect Stock Prices
Share buybacks are generally positive for share prices for two reasons. First, unlike dividends, corporate cash spent on buybacks boosts earnings per share by reducing the number of shares.
Second, buybacks offer a way to distribute capital while allowing shareholders to defer, or avoid, paying taxes. Instead of tax dollars going to the government, they stay in the stock market.
For shareholders who don’t redeem their shares, buybacks can result in a higher capital gains tax bill, but only when they sell their shares, if at all. Additionally, while foreign investors pay an average 17% tax rate on dividends, they face no US capital gains taxes.
That’s no small feat, as the proportion of publicly traded US stocks held by foreigners has tripled to 30% since the late 1990s, according to Steve Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center. .
During the same period, the value of share buybacks met and then exceeded corporate cash spent on dividends. In 2021, S&P 500 buybacks totaled $883 billion, 73% more than the $511 billion distributed as dividends.
S&P 500 saved from big tax hikes
Wall Street, after winning big from President Trump’s 2017 tax cuts that lowered the corporate income tax rate from 35% to 21%, has largely escaped much retribution under President Trump. Biden. That’s not for lack of trying.
Biden sought more than $2 trillion in tax increases earmarked for corporations and wealthy investors. Raising the corporate tax rate to 28% would have raised $900 billion. Biden proposed raising the top tax rate on capital gains and dividends from 23.8% to 43.4%, raising $400 billion. Tax increases on foreign corporate income could have raised $1 trillion in the first decade.
But with all 50-50 Senate Democrats holding an effective veto, Sen. Joe Manchin ruthlessly crushed Biden’s $2 trillion-plus wish list at an estimated cost of $430 billion. Concerned that further government profligacy would exacerbate the inflationary threat, Manchin recast the bill as the Inflation Reduction Law.
In a worst-case scenario, Wall Street strategists said S&P 500 earnings could take an 8% cut, but thought a 3%-4% hit was more likely. In the end, Goldman Sachs estimates that S&P 500 earnings will shrink by 1.5%. The buyback tax will reduce profits by 0.5% and the minimum 15% corporate tax by 1%.
The corporate minimum tax targets large companies like Amazon (AMZN), which paid a 6% tax rate on U.S. income in 2021. However, even that provision was lowered in last-minute negotiations, which preserved the accelerated depreciation tax advantage for equipment purchases. Citigroup analysts believe the 15% minimum tax will cut profits by just 0.4% next year.
Follow Jed Graham on Twitter @IBD_JGraham for coverage of economic policy and financial markets.
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