TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. policy will reportedly be featured in President Biden’s State of the Union Address tonight, but rather than offer a vision of how the tax code could be simplified or reformed to address today’s economic challenges, the President will outline three proposals that will add to the ever-growing maze of complex, narrowly-targeted tax rules.
Raising the Tax on Stock Buybacks
For businesses, Biden will propose quadrupling the brand-new 1 percent excise tax on stock buybacks. A novel tax idea within the InflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. Reduction Act enacted in August 2022, President Biden will propose raising the buyback tax rate to 4 percent.
Stock buybacks are one way businesses return value to their shareholders. Companies can return earnings to shareholders by issuing dividends (namely cash payments) or with stock buybacks (purchasing shares of their own company).
Critics of stock buybacks argue that they’re a drain on investment: if a firm uses its earnings to buy back stock, then it is not using those earnings to fund new investment. This perspective, however, is static and misunderstands why firms typically use stock buybacks. As much as 95 percent of the money returned to shareholders from stock buybacks subsequently gets reinvested in other public companies. Ultimately, companies do not initiate buybacks as alternatives to new investments—instead, firms pursue buybacks once they have exhausted their own investment opportunities. Then, shareholders can reallocate the money to other investment opportunities across the economy.
The new stock buyback tax has only been in effect for one month, and the Treasury hasn’t issued regulations yet, only interim guidance. Quadrupling the tax rate would likely discourage firms from pursuing stock buybacks, potentially tilting toward more dividend issuances instead, and could discourage investment. Tax Foundation estimates quadrupling the tax rate would generate $185 billion in revenue from 2023 to 2032. The estimate does not account for behavioral shifting from buybacks to dividends, which would also shift the individual income tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. from capital gains to dividends.
Imposing a Billionaire Minimum Tax
Biden is also expected to call for another narrow tax increase—a “billionaire minimum tax” aimed at taxing the unrealized capital gains from assets such as stocks, bonds, or privately held 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 proposed changes to capital gains taxA capital gains tax is levied on the profit made from selling an asset and is often in addition to corporate income taxes, frequently resulting in double taxation. Capital gains taxes create a bias against saving, leading to a lower level of national income by encouraging present consumption over investment. es.
Under the proposal, households with net wealth exceeding $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, would owe additional taxes to bring their effective rate to 20 percent. In other words, households would owe taxes on capital gains each year, even if the underlying asset had not been sold, and amounts paid would be treated as prepayments of future capital gains tax liability.
The minimum tax proposal would be a highly complicated new tax regime, creating difficulty for a currently overwhelmed Internal Revenue Service and complexity for taxpayers. The tax code already contains a flawed individual alternative minimum tax, which comes with high compliance costs for taxpayers. Moreover, shifting from taxing gains upon realization goes in the opposite direction of international norms. In fact, most countries in the Organization for Economic Co-operation and Development (OECD) tax capital gains when they are realized and at lower rates than the U.S., and tax capital income overall at lower average tax rates.
Additionally, the political appeal of the tax looks much weaker than it did a year ago. The stock market was riding high at the beginning of 2022, and many prominent billionaires had gotten substantially richer thanks to stock market appreciation. But the rest of 2022 was a different story: famous CEOs and corporate founders saw huge losses as the stock market had a bad year. Such volatility highlights how a tax on unrealized gains would be an unstable revenue source.
Expanding the Child Tax CreditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly.
The third proposal is to extend an expansion of the Child Tax Credit (CTC)The federal child tax credit (CTC) is a partially refundable credit that allows low- and moderate-income families to reduce their tax liability dollar-for-dollar by up to ,000 for each qualifying child. The credit phases out depending on the modified adjusted gross income amounts for single filers or joint filers. , as the March 2021 American Rescue Plan (ARPA) expansion has lapsed. Under this expansion, the maximum benefit rose from $2,000 to $3,000 for children ages 6 to 17 and $3,600 for children under 6. Households with no or low income could receive the full amount of the expanded credit, rather than the credit phasing in with earned income. Finally, half the credit was made available to families throughout the year in the form of advanced monthly payments.
Since its expiration, consensus on further changes to the child tax credit has remained elusive, in large part due to disagreements over the policy’s purpose.
Expanding the credit along the lines of the ARPA design would be expensive. Tax Foundation estimates it would cost more than $1.6 trillion over 10 years, with the annual cost exceeding $200 billion by the end of the budget window.
The CTC change also eliminates work incentives created by the current phase-in with earned income. Eliminating the phase-in would boost after-tax incomeAfter-tax income is the net amount of income available to invest, save, or consume after federal, state, and withholding taxes have been applied—your disposable income. Companies and, to a lesser extent, individuals, make economic decisions in light of how they can best maximize after-tax income. for lower-income households, but at the same time would hike marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. s on labor and discourage labor supply. For example, Tax Foundation estimates a permanent expansion of the ARPA-style CTC would eliminate 38,000 full-time equivalent jobs and reduce long-run GDP (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 instance, 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 mistakes in that reconciliation process (which also included reconciliation of Recovery Rebates). As of November 2022, the IRS had sent out more than 17 million math error notices for the year as taxpayers made mistakes reconciling their credits. And that’s on top of pre-existing issues, like payment errors, created by the complex swath of family-related tax provisions in today’s tax code.
Today, the CTC serves as an adjustment for household size in the tax code, social support for families with children broadly, targeted support for working class and poor families, and a work incentive—all at the same time. Additional support for families and children is a commendable goal, but a goal best achieved through a more simplified and targeted policy.
It is worthwhile to keep the scale of the budget impact of the three proposals in context. While a permanent ARPA CTC expansion would cost more than $1.6 trillion over 10 years, increasing the stock buyback tax would raise $185 billion over 10 years, and the President’s budget in 2022 estimated the billionaire minimum tax would raise $360 billion over 10 years. In other words, the two proposed tax increases would come nowhere close to paying for a full ARPA-style CTC expansion on a permanent basis.
Given divided government, the prospects of major tax changes becoming law are very low. But these proposals signal how President Biden thinks about tax policy, and, unfortunately, the picture that emerges is one of a highly complex, narrowly targeted tax code rather than a simple, efficient, and pro-growth one.