The Inflation Reduction Act’s buyback tax restrains public company growth

The Biden administration and a Democratic-controlled Congress imposed a new tax on corporate stock buybacks as part of the Inflation Reduction Act passed in 2022. It hasn’t gone well.

Corporations use stock buybacks to grow. Buybacks signal to a company’s shareholders that the company’s investments are in demand and that the firm is in good financial health. That incentivizes investors to want to buy more shares of the firm’s stock, which they can sell back to the company in exchange for cash.

Buybacks also help a company grow because they empower a firm to reinvest excess cash back into the company itself to improve its overall worth on the market. The firm is then able to increase its short-term stock value and makes itself more attractive to potential investors.

In addition, buybacks enable a company to reduce outstanding shares on their balance sheets while retaining a consistent margin of profitability, thus increasing the firm’s earnings per share. With the enhanced share price, firms can then resell them into the open market for the potential of generating future profits. In turn, investors receive greater returns from a company that improved its own value.

But when you tax something, you get less of it.

It’s no surprise that in the year after the new tax was imposed, corporate buybacks declined in 2023, despite a record year in 2022. That’s bad for companies and bad for shareholders. The sharp decline in U.S. share repurchasing has undermined a critical avenue for corporate growth and weakened investor return in the public markets. At a time when fewer companies are going public, the buyback tax only provides further regulatory incentive for private firms to avoid touching public markets.

The buyback tax further destabilized the tax planning benefits that companies and their shareholders enjoyed with repurchase programs. If companies pay dividends from the corporate treasury, shareholders are taxed immediately. But if these firms instead use that money to buy back company shares, shareholders can defer taxes on the gain in value until they are ready to sell some or all of their shares. Thus, investors, including many middle-class savers, can hold on to a stock for years and decide when to pay taxes on the realized gains according to their financial needs.

Another drawback of the buyback tax is it puts U.S. companies at a distinct disadvantage in the global economy. European companies have continued to enjoy record buybacks, marking a competitive advantage against U.S. markets. Recent years have seen large European firms repurchase their shares at an aggressive pace while enjoying notable market benefits.

The problems don’t end there.

Read the full article at the Washington Examiner.