March 13, 2024
President Biden’s budget calls for quadrupling the tax on share buybacks to 4.0 percent. This is a great way to raise revenue, since it is probably the most efficient tax ever devised.
The neat thing about taxing share buybacks is that they are publicly announced. Companies have to tell shareholders that they are buying back shares.
If management lies, they don’t just have to worry about the government, they have to worry about their own shareholders. Management would then both face serious civil and criminal penalties. They might be willing to rip off shareholders to fatten their own paychecks, but few CEOs will risk their own wealth, as well as jail time, to save their company a few dollars on taxes.
The Biden administration projected that increasing this tax would raise $160 billion over the next decade. This is not huge in terms of the federal budget (it’s a bit more than 0.2 percent of projected spending), but on an annual basis, the $16 billion it would raise is roughly one-fourth of the amount at stake in Biden’s aid request for Ukraine.
While some have demonized share buybacks, it is hard to see why they are any worse than paying out money to shareholders as dividends. Insofar as this tax changes corporate behavior it will most likely be to get them to pay more money in dividends and use less for share buybacks. That’s fine, but no one should expect an investment boom from taxing share buybacks.
The big benefit from the buyback tax is that it can be a step towards shifting the basis of the corporate income tax from profits to returns to shareholders (dividends plus capital gains). The reason why this is such a big deal is that this shift would effectively put the tax gaming industry out of business.
The I.R.S. can’t see corporate profits directly, they have to rely on corporate accountants to tell them what their companies’ profits are. These accountants have an enormous incentive to find ways to game the tax code to make their taxable profits look less than their actual profits.
The accountants and their lawyer accomplices have developed hundreds of elaborate schemes to hide profits with various tricks and maximize the value of every loophole. Tens of billions of dollars is wasted every year running these schemes with much investment shifted for no reason other than to reduce tax liabilities.
If instead the basis for the corporate income tax was stock returns, we don’t have to care what the accountants say or do. This information is publicly available on dozens of financial websites. The I.R.S. could in a matter of minutes calculate the tax liability of every publicly traded corporation in the country on a single spreadsheet.
The only way to get out of paying the tax a company owes would be for the management to cheat their shareholders. Again, that is not likely to be a very promising path, since they could end up paying large fines and going to jail. Rich shareholders don’t like to be cheated.
There are some issues, but they are trivial compared to the current system. We would probably want to allow some sort of averaging so that a company whose stock suddenly surged would not face a huge tax liability in that year. On the other hand, if the surge proved enduring, they would have a high tax bill, which is appropriate. (If they don’t have a lot of cash on hand to pay their taxes, they could always sell shares.)
There is also an issue of allocating the returns across countries. This is the same problem we have now with the profits-based tax. The obvious solution is to divide the tax among countries in accordance with their share of revenue from each one. That may not be perfect, but there will never be a perfect tax system.
Note that this switch says nothing about tax rates, we can make the tax rate 5.0 percent or 35.0 percent, the point is that whatever rate we set, we can know that we will collect it. And we know that companies will not waste huge amounts of resources trying to avoid or evade the tax because they won’t be able to do it.
This switch would be a huge victory for those who want to see a fair and efficient tax system. The tax on buybacks is a big step down this path, with a bit of luck we will be able to go the rest of the way.
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