The Biden administration’s new stock repurchase tax will have little effect on the overall stock market. It might actually help her. I’m referring to the new 1% selective tax on stock buybacks that went into effect January 1st.
This tax has set off alarm bells in some corners of Wall Street, based on the theory that buybacks have been one of the biggest pillars of the bull market of the past decade — and anything that weakens that support can send prices much lower.
More alarms went off after President Joe Biden cabled his intention to quadruple federal taxes on buybacks, to 4%.
is reading: BIDEN’S STATE OF THE UNION: Here are key suggestions from his speech
While this proposal is considered dead on Capitol Hill, the focus on the possibility of this tax being increased from 1% makes it less likely that it will be repealed anytime soon.
The tax applies to net buybacks
However, speculators should not worry about the stock market rally. One reason is that the new excise tax – whether it’s 1% or 4% – is applied to net buybacks – buybacks in excess of the number of shares a company may issue.
As has been widely reported for years, the shares that many companies buy often are barely enough to compensate for the new shares they issue as part of the company’s executive compensation. As a result, the net buybacks – which will be charged with the new tax – is an order of magnitude smaller than the total buybacks.
The chart below provides historical context. He is charting SPX for the S&P 500,
The divisor, which is the number used to divide the combined market capitalization of all of its constituent companies to arrive at the same index level. When more shares are issued than the shares repurchased, the divisor rises; The inverse causes the divisor to fall.
Note from the graph that although there is some year-to-year fluctuation in the divisor, the level of the dividend at the end of 2022 is almost unchanged from where it was at the top of the dotcom bubble.
There is a lot of irony in applying the excise tax to net buybacks. Much of the political rhetoric leading to the creation of the tax was based on the complaint that companies were buying back their shares simply to reduce the share dilution that would otherwise have occurred when executives had been awarded shares as part of their compensation packages. But precisely when the share buybacks equal the issue of shares, the tax will not apply.
A buyback tax may encourage a higher dividend
The reason why a new tax on share buybacks might actually help track the stock market is because of the impact it could have on corporate dividend policy. Until now, the tax code provided an incentive for companies to buy back shares instead of paying dividends when they wanted to return cash to shareholders. By at least partially removing this incentive, companies may move forward more to dividends than they previously would. the Tax Policy Center estimates that the new 1% buyback tax would result in “an increase of approximately 1.5 percent in corporate dividend payments”.
This could be good news because a high dividend yield has more upside consequences than a high buyback yield. (The buyback yield is calculated by dividing the buybacks per share by the stock price.) To show this, I compared the predictive capabilities of any yield. I analyzed quarterly data in the early 1990s, which is when the overall volume of market buybacks started to matter.
The accompanying table shows the regression boxes in which different returns are used to predict the return of the S&P 500 over the next 1 or 5 year period. (The r-square measures the degree to which one data series explains or predicts another.) Note that the r-squares are significantly higher for the dividend yield than for the buyback yield
|When projecting the return of the Standard & Poor’s 500 in one subsequent year
|When projecting the return of the Standard & Poor’s 500 over the next five years
The bottom line? While the new buyback tax isn’t likely to have a significant impact on the stock market, it may have more positive than negative impact.
Mark Hulbert is a regular MarketWatch contributor. Its Hulbert rating tracks investment news releases that you pay a flat fee to review. It can be accessed at email@example.com
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