In her mini-budget, Chrystia Freeland announced the introduction of a tax that is making people talk. A tax that would target the rich, in principle, but whose effects are far from being as obvious as it seems.
Essentially, the Minister of Finance will tax one of the favorite channels for companies on the stock market to redistribute their excess profits, namely the repurchase of shares.
The tax will amount to 2% of the sums distributed to shareholders in this form, specifies the economic statement of last Thursday, with details to be specified in the next budget. The federal government expects to recover 2.1 billion over the next 5 years.
Before continuing, a parenthesis, a question of fully understanding the concept of share buybacks.
A company that has a surplus of profit must decide what to do with this money and, even more, choose the vehicle with the best return.
Does the company have a project in the pipeline that promises a big return? Does it have a debt to repay whose interest rate is relatively high, given the risks? Does it have an acquisition in sight whose price is interesting, given the synergies of a possible merger?
Once these options are on the table, the directors must ask themselves if it would not be more profitable for its shareholders to return these excess profits to them, in the form of dividends or a share buyback.
A share buyback, in particular, has the effect of reducing the volume of shares outstanding and therefore increasing earnings per share. This higher multiple generally drives up the stock price.
Critics of stock buybacks say they contribute to unfairly enriching shareholders and increasing inequality. Share buybacks would also be harmful because they would encourage executives to think in the short term, since their compensation based on options, among other things, would climb more quickly with share buybacks.
End of parenthesis.
Freeland’s tax is not out of a hat. On the one hand, it imitates that recently implemented in the United States by the Democratic administration (which is nevertheless limited to 1%). The government hopes the tax will incentivize companies to “reinvest their profits back into their workers and their business”.
On the other hand, the tax comes in a context where share buybacks have multiplied lately.
In the past year, large Canadian companies (S&P 60) have spent $67 billion to buy back their shares, which is as much as the sums distributed in the form of dividends, according to a statement from the Globe and Mail.
Five years ago, not only was this sum smaller (26 billion), but it was also half the amount of the dividend payment.
The oil sector is targeted. Many have spent billions of their profits — which came with the rise in oil prices and the war — to buy back stocks. This transfer of funds seems fiscally more advantageous, it must be said, than the payment of dividends.
The distribution of billions of profits from oil companies is criticized in the context of their business being threatened by the 2050 carbon neutrality objective. Shouldn’t they keep the money to invest more in the decarbonisation of their activities or in projects green energy?
The debate may seem simple, but precisely, some believe on the contrary that a 2% tax will slow down productive investments in the economy rather than the reverse.
“If the goal is to tackle corporate underinvestment, the tax is on the wrong track,” Raphaël Duguay, assistant professor of accounting at Yale University, told me.
Why, then ? Because the shareholders to whom the profits are paid are often large funds or pension funds, which reinvest the money in more profitable sectors than the projects put on ice by the companies distributing the profits.
In an article in a journal of the Columbia Business School, consultants Greg Milano and Michael Chew argue that every year about $250 billion of profit distributed to shareholders of American companies is rightly reinvested in smaller companies, which do not not part of the S&P 500.
“In other words, buyouts and dividends from more mature companies are recycled back to the companies that have been the source of most job creation in recent years. Why would we want to stop this virtuous circle? “, they write.
National Bank chief economist Stéfane Marion does not believe either that the tax will increase investment, on the contrary.
As for the short-term benefits that leaders would derive from it, he argues that “things have changed since the financial crisis. With the new rules, it is much more difficult today to make a short-term bonus with stock options than before the 2007 crisis,” he says.
Harvard University researchers Jesse Fried and Charles Wang go even further. According to them, a pile of cash lying dormant in a company inflates its value, which increases the pay of bosses, linked to the size of the organization, they explain in an analysis published in The Wall Street Journal.
Another criticism of the Freeland tax, on the left as on the right: it will only come into force in January 2024, which gives companies time to multiply share buybacks in 2023 and avoid the tax before the fateful date.
Not so clear, in short, that the Freeland tax will increase investment. The new 30% tax credit on clean technologies, also modeled on Uncle Sam, will probably have more effects. To be continued.