If We Tax Share Buybacks, Can We Also Tax Stock Returns?

Dean Baker

August 12, 2022

The Inflation Reduction Act includes a remarkable innovation. If it becomes law in its current form, share buybacks will be taxed at a 1.0 percent rate. This is a huge deal, not only because it taxes money that was often escaping taxation at the individual level, but it is a move away from basing the corporate income tax on profits, to taxing returns to shareholders.

The big issue here is that corporate profits are not a well-defined concept. There are a thousand issues that arise in determining profit, which depend to a substantial extent on judgement calls by accountants. Depreciation of capital is the most obvious problem, but there are many others.

While profits are something that we cannot see, returns to shareholders can be easily seen. This is simply the increase in market capitalization, plus whatever money is paid out in dividends. This information is readily available on dozens of financial websites.

There is also nothing that corporations can do to hide the returns on their stock, unless they want to rip off their shareholders in addition to ripping off the government. If we want to have a 25 percent corporate income tax, we can simply tax the returns to shareholders at a 25 percent rate, and we know exactly what we will get. (We can allow averaging, say over five-year periods, to smooth out tax payments.)

In addition to making the corporate income tax more easily collectable, shifting the basis of the tax to returns to shareholders will radically reduce the size of the tax shelter industry. As it stands now, companies spend tens of billions of dollars each year hiring lawyers and accountants to minimize their tax burden.

These expenditures on tax dodges are a complete waste of resources and undermine the purpose of the corporate income tax. As the Modern Monetary Theory crew remind us, the purpose of taxes at the national level is to reduce demand in the economy. Insofar as companies spend large amounts of money trying to avoid paying taxes, the goal of the corporate income tax is undermined.

The tax avoidance industry is also itself a major source of inequality. Creative tax lawyers and accountants can make huge salaries by developing innovative tax dodges. We can put many of these people out of business by basing the corporate income tax on stock returns, which are completely transparent.

The taxation of share buybacks in the Inflation Reduction Act is a small but important step in this direction. It shows that we do not have to make profit the basis for the corporate income tax. After it has been in place for a few years, and we have the opportunity to see how effective it is in raising revenue, perhaps we can shift the basis for the rest of the corporate income tax to the stock returns we can all see, rather than the profit statements that are conjured up by accountants.