Rubio’s Stock Buyback Plan Sounds Sane, Even If His Reasoning Is Not
(Bloomberg Opinion) -- Senator Marco Rubio is planning to introduce a bill soon to curb stock buybacks. The Florida Republican explained on Twitter that the plan would tax buybacks in the “same way as dividends. No tax advantage for buybacks over dividends.”
The senator’s policy is probably sound. But his concern about buybacks is off base.
Since 2003, long-term capital gains and qualified dividends have been taxed at the same rate. But current tax law can create a preference for buybacks over dividends for businesses seeking to return money to their shareholders.
Take one example: A company wants to return $20 to its shareholders. If it buys back stock, owners of shares receive a capital gain, calculated based on the sale price of the stock relative to its purchase price. If the share was purchased for, say, $5, the owners would be taxed on the $15 profit from the sale. If instead the corporation issues a $20 dividend, the entire amount of the dividend is taxed.
It’s hard to know precisely what Rubio is planning without more detail, of course. And there are many complications in tax law and in how we treat capital gains (for example, realized gains versus accrued gains) that make things less simple than they are presented in this one example. But I think this likely captures the gist of what Rubio wants to do.
And it is reasonable. If a corporation wants to return cash to its shareholders, tax law shouldn’t encourage one form of distribution over another.
(Some media outlets are also reporting that Rubio wants to tax shareholders for the imputed value of the funds they would receive from participating in a buyback, even if they don’t actually sell their stock back to the firm. This seems less advisable. Again, more details are needed.)
But the senator’s reasoning for this policy is problematic, as is the broader wave of opposition to buybacks.
If a business does not have investments that are worth making, it is good for it to return money to shareholders. Doing so frees that money up for profitable investment by other businesses.
It is better for that money to find its best use — for example, helping entrepreneurs start new businesses, and increasing the productivity of other businesses — than for a businesses to forgo buying back stock in favor of, say, purchasing equipment that will be of relatively limited value. In his tweets, Rubio seems to get this exactly backward.
Remember also that shareholders own companies. Buybacks simply distribute cash from the company to the people who own the company. It is odd that this would be controversial, but our current populist moment — with its hostility to big business and Wall Street, even among some Republicans — has made it so.
And the owners don’t put the money in their mattresses. Instead, they put it back into the economy. We should be glad that managers are sending money back to shareholders to be profitably invested elsewhere, rather than retaining the money to “empire build” with relatively less productive investment.
In addition, some recent evidence does not support the view that publicly held companies are underinvesting out of pressure to return cash to shareholders. A working paper released this summer by the Federal Reserve Board asked whether public and private firms have different investment behavior. The economists found public companies invest more overall, particularly in research and development. They also found that firms dedicate more investment to research and development after they go public, and reduce those investments if they go private.
The best part of Rubio’s plan is his emphasis on increasing investment and productivity. He’s likely incorrect that discouraging buybacks will lead to a noticeable upswing in productive investment. But there’s a second component to his plan that would.
The 2017 tax law allows businesses to deduct the full cost of items like machinery and equipment from their taxable income in the year they are made, rather than over several years according to depreciation schedules.
Referred to as “full expensing,” this encourages investment because slowly deducting expenses over time means that the value of the write-off to the firm is less than the original cost of the purchased item, reducing the after-tax return on the investment.
This provision in the new tax law is temporary. After five years, it will phase out, and will be completely eliminated in 2027. Rubio rightly wants to make this provision permanent. Along with increasing investment, doing so would increase productivity and wages.
The challenge, of course, will be finding a way to pay for it. The Tax Foundation, a tax policy research group, estimates that making expensing permanent would cost $141 billion between 2023 and 2028. This is a cost worth incurring.
Along with opposing buybacks, it is fashionable today for policymakers not to worry about debt and deficits. To his credit, Rubio seems to want to use the additional revenue that would be generated from taxing buybacks as dividends to finance making full expensing permanent.
It is unclear whether this swap would leave the deficit unchanged. If it would, then Rubio’s plan reflects principles of well-designed tax reform: Remove provisions of the tax code that distort behavior, and use that revenue to encourage investment.
But if the swap would increase the deficit, the senator should look for revenue elsewhere. It would be unfortunate if Rubio’s sound idea on expensing were sullied by fiscal irresponsibility.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Michael R. Strain is a Bloomberg Opinion columnist. He is director of economic policy studies and resident scholar at the American Enterprise Institute. He is the editor of “The U.S. Labor Market: Questions and Challenges for Public Policy.”
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