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A Major Change Is Coming to Wall Street and Corporate America

President Biden is set to sign a measure that will displease investors and financiers. But the bill also addresses a practice that's been severely criticized.
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It's a masterstroke that went almost unnoticed on Main Street. 

But it has not escaped the attention of Wall Street, which will not be pleased with this move by the Democrats.

In President Joe Biden's bill addressing climate change and health care, the Inflation Reduction Act, companies for the first time face a tax on stock buybacks.  

Companies will pay a 1% excise tax on purchases of their own shares, a kind of financial penalty for this move, which is intended to return cash to shareholders and boost share prices. For example, a company buying shares valued at $1 billion will pay $10 million of taxes. 

The goal is to encourage companies to increase the wages of their employees and to invest in the companies themselves rather than favoring shareholders -- and more particularly activist shareholders in search of quick returns.

Biden will is set to sign the overall bill on Aug. 16, and the buyback tax will be effective beginning Jan. 1. The excise tax is projected to bring the government an additional $74 billion in revenue over 10 years.

Share-Buyback Frenzy

Democrats hope this new tax will be the catalyst for a major change in corporate behavior. 

Companies in the benchmark S&P 500 index bought a record $881.7 billion of their shares in 2021, up 70% from $519.8 billion in 2020, according to a recent report from S&P Dow Jones Indices.

The previous record was $804.6 billion in 2018.

"Current indications are that companies have maintained their buybacks through the recent downturn, which means they'll be getting more shares for their expenditures and reducing share count even further, resulting in higher [earnings per share]," said Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.

He added: "Given the strong base buying, expected earnings, even with a potential consumer slowdown and lower margins, buybacks could set another record in 2022."

Big Tech is one of the most popular sectors for share buybacks. It is followed by companies in the financial, energy and communication services sectors. 

Apple  (AAPL)  is considered the poster child for share repurchases. In 2021 alone, the iPhone maker spent $88.3 billion on buybacks, up from 2020's $81.5 billion. 

To buy back shares, the Cupertino, Calif., tech giant has spent $360.2 billion over five years and $510.7 billion over 10 years. If the tax had been implemented, Apple would have paid just over $5 billion in additional taxes to the IRS.

Among the top five companies that bought their shares the most in 2021 are four technology firms and one bank -- Bank of America.  (BAC)

Besides Apple, Meta Platforms  (META)  (Facebook, Instagram and WhatsApp), Alphabet  (GOOGL)  and Microsoft  (MSFT)  are among the big users of stock repurchases.

Much of the compensation in tech is equity-based, including options, performance shares and restricted stock. That's noncash pay offered to employees. By boosting their share prices, tech companies hope to retain talent.

Good or Bad for Wages?

Share buybacks, also called stock repurchases, are one of the ways in which a company shares its financial success with shareholders. 

In a buyback, as the name suggests, a company buys its own shares in the market. Such moves reduce the company's shares outstanding and increase the proportionate stakes of the shareholders.

Unlike dividends, share buybacks lift earnings per share by reducing share counts. They also allow investors to defer or avoid paying taxes.

If the new tax is not generally well received in business circles, some voices have come out to support it, including the entrepreneur Mark Cuban.

"I think a tax on buybacks is a good idea, actually," the billionaire told CNBC in a phone interview on Aug. 11. The "Shark Tank" star, who sharply opposes share buybacks, says he would have even doubled the tax to 2%.

Cuban says share buybacks reward shareholders who want to sell all or part of their holdings: "It's a response to pressure from big investors, to CSuite who want to engineer EPS [earnings per share], to try to goose the stock, to hit bonuses," the billionaire blasted out.

Among the critics of buybacks are Sens. Elizabeth Warren (D-Massachusetts) and Bernie Sanders (I-Vermont).

Jesse Fried, professor at Harvard Law School and expert in corporate governance, says share buybacks are necessary for more fairness in corporate wages.

"Tax is based on misunderstanding of capital flows and will have pernicious effects, especially if buyback-hating Congress raises rates once tax mechanism is in place," Fried warns.

He adds that: "Buybacks part of equity-pay issue cycle. If you like equity pay, as I do, you need buybacks."