Report Shows Stock Buyback Taxes Could Do More Harm Than Good

The idea that stock buybacks are a manipulation by executives to benefit themselves at the expense of shareholders may be true for a small number of firms but not the vast majority, therefore implementing buyback taxes in an attempt to curb such profits are no replacement for broader tax reform, according to a new report from Rice University’s Baker Institute for Public Policy.

In his Feb. 7 State of the Union address, President Joe Biden called for quadrupling the tax on stock buybacks. John Diamond, director of the Baker Institute’s Center for Public Finance, and Joyce Beebe, fellow in public finance, argue that the financial system should not incentivize nor restrict the distribution of corporate profits, because actions that raise the cost of capital — such as taxation — tend to lower investment and may lead to worse outcomes.

“Buybacks are favored over dividend payments due to tax and financial advantages,” they wrote. “The tax advantages stem largely from the deferral of tax payments on capital gains, with much of this advantage related to the avoidance of capital gains taxes at the time of death.”

Tax policy issues are often interrelated with corporate financial policy. For example, major changes in the taxation of corporate profits held abroad have led American companies to direct money from Europe to the U.S., which has contributed to increases in corporate payouts in the last two decades, Diamond and Beebe wrote.

“We should abstain from using the tax system as a tool to solve regulatory issues related to other policy failures, such as potential linkages between stock buybacks and executive pay packages,” they wrote. “Instead of imposing a stock buyback tax, we should look at broader tax reform that eliminates the taxation of dividends and gets rid of the double taxation of corporate income.”