Democrats have targeted the stock market safety net by taxing buybacks
Democrats are planning a 1% tax on stock buybacks, as part of a deal to salvage Joe Biden’s agenda.
Share buybacks have fueled the market in recent years, as companies have spent huge amounts of money on their shares.
Analysts said the tax could be a new headwind, but said companies will likely increase spending on dividends.
Democrats have approved a 1% tax on stock buybacks as part of President Joe Biden’s climate and tax bill, in a move analysts said could create further headwinds for stock investors.
Arizona Senator Kirsten Senema, a moderate Democrat and former candidate, agreed to move forward with what the party calls an inflation-reduction law Thursday night.
To get her approval, Democrats dropped a provision that would have reduced tax credits on the profits of hedge funds and private equity firms, known as “carried interest.” Instead, they included a 1% selective tax on the controversial practice of share 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 rampant inflation and rising interest rates. They said buybacks have supported stock markets this year.
“Anything that touches on buybacks is always a concern,” Ben Lidler, global markets analyst at eToro, told Insider. “I think it’s going to generate a lot of stress, just because buybacks are such a big deal.”
However, Leidler said the tax is likely to cause companies to increase their dividends because it reduces buybacks. That may be preferable to many retail investors who prefer a steady income stream, he said.
A buyback is when a company buys back its shares in the market. This practice returns money to investors by increasing the share price. It is also likely to reduce the number of shares outstanding, thus enhancing key performance metrics such as earnings per share.
US companies have been spending huge amounts of money to buy back their stock over the past two years, after periods of strong earnings left them with surplus cash. Analysts say the region’s S&P 500 companies are likely to spend $1 trillion on buybacks this year, after buying $882 billion in 2021.
Derren Nathan, head of equity research at broker Hargreaves Lansdown, told Insider that the Democrats’ proposed 1% tax would affect companies’ thinking.
“This move could make board members think twice about pulling that leverage,” he said. “1% may not sound like a huge amount, but with buyback programs often running into billions of dollars, the liquidity and profit impact should not be underestimated.”
A person familiar with the matter told Insider that the 1% repurchase tax would raise much more money than the interest provision now charged, which was expected to generate about $14 billion.
The buyback tax is intended to curb a practice that has been criticized by many politicians and analysts. Opponents say buybacks enrich company shareholders and executives and discourage future investment in workers and machinery.
Tech companies, whose stock prices took a hit in 2022 after soaring during the pandemic, are among the biggest practitioners of buybacks. Apple announced a massive $90 billion buyback plan earlier this year, and Microsoft unveiled a $60 billion buyback plan in September last year.
Lidler said that although a 1% tax would not be welcome by investors, companies would likely pay the same amount by increasing their dividends.
“I think the impact here will be more about how to lower shareholder returns pie, rather than making any major changes to the company’s investments,” he said.
He said stock market investors and corporate boards have bigger concerns right now. Not the least of which is rising inflation, raising Fed rates, and the risk of a recession. US markets were little changed on Friday morning, with a slight dip in S&P 500 futures.
Read the original article on Business Insider