The Democrats Are Set to Tax Share Buybacks, in New Market Headwind

  • Democrats plan to impose a 1% tax on share 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 amounts on their own shares.
  • Analysts said the tax could be another headwind, but companies would likely increase spending on dividends.

Democrats have agreed to introduce a 1% tax on share buybacks as part of President Joe Biden’s climate and tax bill.

Arizona Senator Kyrsten Sinema, a moderate Democrat and former holdout, agreed to move forward with what the party calls the Inflation Reduction Act on Thursday night.

To gain her approval, Democrats dropped a provision that would have reduced tax breaks on the profits of hedge funds and private equity firms, known as “carried interest.” Instead, they introduced a 1% tax on the controversial practice of share buybacks, a person familiar with the matter told Insider.

Analysts said the new tax will not be welcomed by investors, just as they struggle with rampant inflation and interest rate hikes. They said buybacks have supported stock markets this year.

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

However, Laidler said the tax will likely encourage companies to increase their dividends as they reduce buybacks. He said this may be the preferred option for many retail investors, who prefer a steady stream of income.

A buyback is when a company buys back its own shares in the market. The practice returns money to investors by increasing the share price. It will also likely reduce the number of shares outstanding, improving key performance metrics such as earnings per share.

US companies have spent huge amounts of money buying back their own shares in recent years after periods of strong profits left them with extra cash. S&P 500 companies are likely to spend close to $1 trillion on buybacks this year, analysts say, after buying a record $882 billion in 2021.

Derren Nathan, head of equity research at broker Hargreaves Lansdown, told Insider the Democrats’ proposed 1% tax will affect how companies think.

“This move could make board members think twice about pulling that lever,” he said. “1% may not seem huge, but with buyback programs often running into the billions of dollars, the impact on cash and profits cannot be underestimated.”

An individual familiar with the matter told Insider that the 1% repurchase tax would bring in significantly more money than the now-removed provision for carried forward interest, which was expected to raise about $14 billion.

The buyback tax is intended to curtail a practice that has been criticized by many politicians and analysts. Opponents say buybacks enrich the company’s shareholders and executives and discourage future investment in workers and machinery.

Tech companies, whose stock prices have been battered in 2022 after soaring during the pandemic, are among the biggest practitioners of buybacks. Apple announced a whopping $90 billion in buyback scheme earlier this year, and Microsoft unveiled a $60 billion plan last September.

Laidler said that while the 1% levy won’t be welcomed by investors, companies will likely still pay out the same amount by raising dividends.

“I think the impact here will be more about how we shrink the pie for shareholder returns, rather than making big changes to corporate investment,” he said.

Stock market investors and corporate boards have bigger concerns right now, he said. Last but not least, rising inflation, interest rate hikes by the Federal Reserve and the threat of a recession. US markets were little changed on Friday morning, with S&P 500 futures light in the green.

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