08.09.22: The US Senate passed the Inflation Reduction Act over the weekend along party lines with Vice President Kamala Harris casting the tiebreaking vote. According to The Wall Street Journal, the legislation:

  • Raises more than $700 million in revenue over 10 years by imposing a 15 per cent minimum tax on large, profitable corporations and enhancing collection efforts at the Internal Revenue Service by adding 87,000 new employees
  • Empowers Medicare to negotiate lower prescription drug prices and cap out-of-pocket drug costs for seniors enrolled in Part D to $2,000/year
  • Imposes a one per cent tax on stock buybacks
  • Allocates more than $400 million toward incentives for companies and individuals to reduce their carbon emissions
  • Extends subsidies for health insurance under the Affordable Care Act
  • Extends the $10,000 cap on the deduction of state and local taxes from federal income taxes by one year through 2026

A minimum corporate tax rate and a buyback tax could reshape the way companies invest and return capital to shareholders. No longer would large companies calculate two sets of books, one for shareholders and one for tax reporting. Companies reporting profit to shareholders would be subject to a minimum 15 per cent tax. The new minimum tax would apply to corporations reporting annual income in excess of $1 billion. Cresset estimates the tax would apply to about 150 companies in the S&P 500 whose current effective tax rate is less than 15 per cent. The average income reported by those companies to shareholders was nearly $9 billion, yet their average effective tax rate was 1.1%, according to The New York Times. The 15 per cent floor would encourage companies to defer recognizing income into future years.

Graph 1, Market Update 8.9

What does this mean for shareholders? The minimum corporate tax would affect fewer than 150 companies in any given year. The technology sector comprises 41 companies with an effective tax rate of less than 15 per cent as of last year. Health care is next at 31. Most real estate companies (REITs) will likely be unaffected by the 15 per cent floor since most don’t report more than $1 billion in annual profits. Higher taxes would tamp down valuations, but we believe it would manifest as a one-time reset.  Apple, whose effective tax rate last year was 13.3 per cent, according to Bloomberg, dropped in price by less than one per cent in Monday’s trading.

The one per cent buyback tax could have a more meaningful impact on corporate behavior. The buyback tax applies to the net number of shares bought back, after accounting for our new issuance. Companies repurchased about $2.5 trillion worth of stock between 2019 and 2021, according to Barron’s. By retiring a portion of shares outstanding, companies can boost their earnings per share and their share price. Investor beneficiaries, meanwhile, are not subject to taxes until they eventually sell their shares.  A buyback tax could prompt management to return dollars to shareholders as dividends that would be taxed in the year they’re received. In the meantime, expect to see a flood of buybacks this year, since the tax wouldn’t go into effect until January 1, 2023. Already, more than $20 billion of buybacks have been announced over the first three days of August.

Graph 2, Market Update 8.9

The S&P Buyback Index is trailing the S&P Dividend Aristocrat index this year as investors place a premium on cash in hand in a rising interest rate environment. Dividends are outpacing buybacks by about five percentage points this year. The Inflation Reduction Act news is hampering buyback companies today. While higher corporate taxes are never without cost from a shareholder perspective, we believe neither the 15 per cent corporate tax floor, nor the one per cent buyback tax, will meaningfully impair equities.

Graph 3, Market Update 8.9