The tax policy is reportedly will appear in President Biden’s State of the Union address tonight, but instead of offering a vision of how the tax code could be simplified or reformed to address current economic challenges, the president will outline three proposals that will add to the maze increasing number of complex tax rules and specific objectives.
Increase tax on share repurchases
For businesses, Biden will propose quadrupling the new 1 percent excise tax on share buybacks. A novel tax idea within the Reducing Inflation Act signed into law in August 2022, President Biden will propose increasing the buyback tax rate to 4 percent.
Share buybacks are one way that companies return value to their shareholders. Companies can return profits to shareholders by issuing dividends (i.e., cash payments) or with share buybacks (purchasing shares of their own company).
Critics of share buybacks argue that they are a drain on investment: if a company uses its profits to buy back shares, then it is not using those profits to finance new investment. This perspective, however, is static and does not understand why companies often use share buybacks. As much as 95 percent the money returned to shareholders from share buybacks is later reinvested in other public companies. Ultimately, companies do not initiate buybacks as an alternative to new investment; instead, companies pursue buybacks once they have exhausted their own investment opportunities. Shareholders can then reallocate the money to other investment opportunities throughout the economy.
The new share buyback tax is only a month old and the Treasury has yet to issue regulations, interim guidance only. The quadrupling of the tax rate would likely discourage companies from seeking share buybacks, which could tip toward more dividend issuances, and could discourage investment. The Tax Foundation estimates that quadrupling the tax rate would generate $185 billion in revenue from 2023 to 2032. The estimate does not take into account the change in behavior from buybacks to dividends, which would also change the individual income tax basis of earnings from capital to dividends.
Imposition of a multi-million dollar minimum tax
Biden is also expected to request another limited tax increase: a “billion dollar minimum tax” intended to tax unrealized capital gains from assets such as stocks, bonds or private companies of high net worth individuals. The president initially proposed the idea last year, but it was not included in the Inflation Reduction Act, nor were other major changes to capital gains taxes proposed.
Under the proposal, households with net worth greater than $100 million would pay a minimum effective tax rate of 20 percent on an expanded measure of income that includes unrealized capital gains. Households would calculate their effective tax rate for the minimum tax, and if it fell below 20 percent, they would owe additional tax to bring their effective rate to 20 percent. In other words, households would owe capital gains tax each year, even if the underlying asset had not been sold, and the amounts paid would be treated as prepayments of future capital gains tax liabilities.
The minimum tax proposal would be a very complicated new tax regime, creating hardship for a currently overwhelmed Internal Revenue Service and complexity for taxpayers. The tax code already contains a flawed individual alternative minimum tax, which carries high compliance costs for taxpayers. In addition, to stop taxing profits at the moment of their realization goes in the opposite direction to international norms. In fact, most Organization for Economic Co-operation and Development (OECD) countries tax capital gains when they are realized and at lower rates than the US, and tax capital income generally at rates lower average taxes.
Furthermore, the political appeal of the tax seems much weaker than it was a year ago. The stock market was on the rise in early 2022, and many prominent billionaires had gotten substantially richer thanks to appreciation of the stock market. But the rest of 2022 was a different story: famous CEOs and corporate founders saw big losses as the stock market had a bad year. Such volatility highlights how a tax on unrealized gains would be an unstable source of revenue.
The third proposal is to extend an expansion of the Child Tax Credit (CTC), as the March 2021 American Rescue Plan (ARPA) expansion has expired. Under this expansion, the maximum benefit increased from $2,000 to $3,000 for children ages 6-17 and $3,600 for children under age 6. Low-income or no-income households could receive the full amount of the expanded credit, rather than the credit being phased in with earned income. . Finally, half of the credit was made available to families throughout the year in the form of advanced monthly payments.
Since its expiration, consensus on additional changes to the child tax credit has been elusive, largely due to disagreements over the purpose of the policy.
Extending credit along the lines of ARPA’s design would be expensive. The Tax Foundation estimates it would cost more than $1.6 trillion over 10 years, with an annual cost exceeding $200 billion by the end of the budget window.
The CTC change also removes the work incentives created by current phase-in with earned income. Eliminating the phase-in would increase after-tax income for lower-income households, but at the same time it would increase marginal tax rates on labor and discourage labor supply. For example, the Tax Foundation estimates that a permanent ARPA-style CTC expansion would eliminate 38,000 full-time equivalent jobs and reduce GDP in the long run (although the GDP impact is quite small).
Another drawback is that the benefit is difficult for the Internal Revenue Service to administer and for taxpayers to comply with. For example, taxpayers had to reconcile the advance monthly payments they received in 2021 when they filed their 2021 tax returns, and the National Taxpayer Advocate reported taxpayers made a high rate of errors in that reconciliation process (which also included the Recovery Refund reconciliation). As of November 2022, the IRS had sent out more than 17 million math error notices during the year due to taxpayers making errors reconciling their credits. And that’s on top of pre-existing problems, like payment errors, created by the complex swath of family-related tax provisions in the current tax code.
Today, the CTC serves as an adjustment for household size in the tax code, social support for families with children in general, specific support for working-class and poor families, and a work incentive all at the same time. Additional support for families and children is a laudable goal, but it is best achieved through a more streamlined and targeted policy.
It is worth keeping the scale of the budgetary impact of the three proposals in context. While a permanent expansion of ARPA CTC would cost more than $1.6 trillion over 10 years, increasing the share buyback tax would raise $185 billion over 10 years, and the president budget in 2022 he estimated that the multi-billion dollar minimum tax would raise $360 billion over 10 years. In other words, the two proposed tax increases would not come close to paying for a full ARPA-style CTC expansion on a permanent basis.
Given the divided government, the prospects of major tax changes becoming law are very low. But these proposals indicate how President Biden thinks about tax policy, and unfortunately the picture that emerges is one of a highly complex and targeted tax code rather than one that is simple, efficient and pro-growth.
