Roger Lowenstein on Share Buybacks: What About Taxes?

September 18, 2021

Roger Lowenstein had a piece in the NYT’s DealBook section defending share buybacks. I actually agree with much of what he wrote (I can’t see the virtues of paying out money as dividends rather than buybacks), but Lowenstein does miss an important point that can be used to justify the tax proposed by Democrats. There is a fundamental asymmetry in the tax treatment of money paid out as dividends and money paid out to shareholders as buybacks.

Suppose a company pays out $2 billion in dividends to its shareholders. If we say roughly half of its stock is held by rich people, outside of tax-sheltered accounts (as opposed to institutional investors like pension funds or 401(k) type accounts), then the government will collect $200 million in taxes on these dividends, since most of these people would face a 20 percent tax rate on dividends.  (That compares to a 37 percent tax rate if dividends were taxed as normal income.)

By contrast, if the company pays out $2 billion to shareholders through buybacks, it is likely to collect considerably less tax revenue. The people selling the stock will have to pay taxes on their capital gains, but the incremental capital gain (the higher capital gain that people get as a result of the buyback, as opposed to the gain they would have received if there had been no buyback) will almost certainly be less than $2 billion.

Furthermore, all the people who did not sell their stock had an increase in the value of their shares roughly equivalent to $2 billion in dividend payouts, but they have to pay zero taxes on this rise in value, in contrast to the taxes they would have paid if the money had been paid out as dividends. As I’ve said before, this benefit can be exaggerated, since shares do trade frequently and even the very rich probably have to sell shares from time to time to maintain their living standards, but it is almost certain that we get less tax revenue from money paid out through buybacks than money paid out as dividends.

For this reason, the Democrats’ plan to impose a 2.0 percent tax on buybacks makes sense in that it tries to treat buybacks and dividends as equivalents from the standpoint of the tax system. Even if buybacks are not the great evil that some have claimed, there is no reason for the government to be encouraging them with its tax policy. It’s reasonable to argue whether the approach the Democrats are looking to is the best route (I would just have the per share expense of buybacks attributed as dividends to shareholders for tax purposes), but trying to equalize the tax treatment of dividends and buybacks is good policy.  


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