Democrats set to tax stock buybacks, in a new adverse market

  • Democrats plan to put a 1% tax on stock buybacks, as part of a deal to save Joe Biden’s agenda.
  • Share buybacks have supported the market in recent years, with companies spending huge sums on their own shares.
  • Analysts said the tax could be another headwind, but said companies were likely to increase their dividend spending.

Democrats have agreed to introduce a 1% tax on stock buybacks as part of President Joe Biden’s climate and tax bill, which analysts say could create another headwind for investors in shares.

Arizona Sen. Kyrsten Sinema, a moderate Democrat and recalcitrant former Democrat, agreed to move forward with what the party calls the Cut Inflation Act Thursday night.

To gain his approval, Democrats scrapped a provision that would have cut tax breaks on the profits of hedge funds and private equity firms, known as “carried interest.” Instead, they inserted a 1% excise tax on the controversial practice of stock buybacks, a person familiar with the matter told Insider.

Analysts said the new tax would not be welcomed by investors, just as they grapple with runaway inflation and rising interest rates. They said buybacks have supported stock markets this year.

“Anything related to buyouts is always a concern,” Ben Laidler, global market strategist at eToro, told Insider. “I think it’s going to generate a lot of nervousness, just because buyouts are a big deal.”

However, Laidler said the tax would likely push companies to increase their dividends as they cut buybacks. He said that might be preferable to many retail investors, who prefer a steady stream of income.

A buyout occurs when a company buys back its own shares in the market. The practice makes money for investors by increasing the stock price. It is also likely to reduce the number of shares outstanding, thereby boosting key performance indicators such as earnings per share.

American companies have spent colossal sums to buy back their own shares over the past two years, after periods of strong profits left them with too much cash. S&P 500 companies are expected to spend about $1 trillion on buyouts this year, analysts say, after buying a record $882 billion in 2021.

Derren Nathan, head of equity research at brokerage Hargreaves Lansdown, told Insider that the 1% tax proposed by Democrats will impact corporate thinking.

“This move may make board members think twice about pulling that lever,” he said. “1% may not sound like a lot, but with buyout programs often running into billions of dollars, the impact on cash flow and profits should not be underestimated.”

A person familiar with the matter told Insider that the 1% redemption tax would bring in significantly more money than the now-removed deferred interest provision, which was expected to bring in around $14 billion.

The redemption tax aims to limit a practice criticized by many politicians and analysts. Opponents say the takeovers enrich shareholders and company management and discourage future investment in workers and machinery.

Tech companies, whose stock prices took a beating in 2022 after surging during the pandemic, are among the biggest takeover practitioners. Apple announced a massive $90 billion takeover program earlier this year, and Microsoft unveiled a $60 billion plan in September last year.

Laidler said that while the 1% levy may not be welcomed by investors, companies are still likely to pay the same amount by increasing dividends.

“I think the impact here is going to be more about how we cut the pie of shareholder returns, rather than any material changes in the company’s investment,” he said.

Stock market investors and corporate boards have bigger concerns right now, he said. Including soaring inflation, Federal Reserve rate hikes and the threat of recession. US markets were little changed on Friday morning, with S&P 500 futures trading slightly in the green.

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