I never understood the negative attention stock buybacks have received relative to dividends. They do basically do the same thing, but nobody is offended when companies pay a dividend.
If you hold stock options, a dividend doesn't benefit you. You need to hold shares to get the dividend. In fact, the dividend can cause the share price to fall (if it was not already anticipated) as the company's capital gets drained to pay shareholders.
On the other hand, buybacks (causing a sudden, surprising increase in share price) are most impactful on those who hold options. Proportionally speaking, they increase the value of options much more than the value of shares. The share price might go up 2%, and the options 200%.
Executive compensation packages tend to consist of stock options. So buybacks benefit corporate insiders more than shareholders.
For me, it makes a lot more sense to tax realized profit, or better yet consumption, than wealth itself.
I don't think it is desirable to force realization just to increase tax revenue.
It is true that buybacks are more tax efficient than dividends, which is why companies generally do buybacks instead of dividends.
The US tax on capital gains is definitely a mess though.
Let's take someone with a 53% marginal income tax, living in NYC. The person has stock with a basis of $0.0 with a current value of $10, and has held the stock for less than a year (short term capital gains = ordinary income rates). Separately, they have $1,000,000 of income.
Scenario 1) Donating the stock would produce a $10 tax deduction, worth $5.3.
Scenario 2) Selling the stock would produce $10 of returns - $5.3 in income tax = $4.7
In this scenario, donating the stock produces higher returns compared selling the stock. It's a fairly obtuse scenario, since it's rare for the cost-basis to be so low, time-span to be so short, and to have a good use for a tax deduction. It becomes much more likely when a completely illiquid & price inflated stock is donated. If a large chunk of illiquid stock is sold, it'll crash. But donating an inflated chunk of stock would lock in the tax deduction.
Donating shares of a stock when a person knows insider information is called 'insider giving', and is highly prevalent & largely unenforced. https://dlj.law.duke.edu/article/insider-giving-avci-vol71-i....
Obviously the latter leans towards tax evasion, but that's exactly the point - stock buybacks aren't necessarily tax evasion but they can certainly assist in it.
They can be spent if you have a low interest LOC at a bank backed by your assets like stocks.
For an example of how much the IRS theoretically cares about not being able to kick income down the road - basically the entirety of retirement savings regulations revolve around the controlled ability to do just that.
Why not tax all of that simultaneously? That's what the Dutch do.
> I don't think it is desirable to force realization just to increase tax revenue.
And yet various governments are doing or are planning exactly that.
Do you have a source?
I wasn't aware of any western countries which have wealth taxes, but I was surprised to find that Norway, Spain, and Switzerland do have some.
https://taxfoundation.org/net-wealth-tax-europe-2022/#:~:tex....
Summary: https://en.wikipedia.org/wiki/Taxation_in_the_Netherlands#Bo...
https://www.belastingdienst.nl/wps/wcm/connect/en/income-in-...
The article you linked to refers to a recent court ruling against that system. (A bunched of pissed citizens sued the government because interest saving rates have been 0% or even negative for many years now.) The government is now scrambling to update the tax code, but AFAIK no change has been implemented yet. Last year's net wealth was still taxed at assumed (rather than realized) investment returns in this years income tax assesment.
It isn't. Under the current systen they make bo distinction, they just look at total worth per the market value. They treat 200k in savings the same as 200k in stocks.
See my reply above.
“In 2001, the legislature assumed that everyone could easily earn a 4% return on their assets in Box 3 – regardless of how they were invested – without taking any risk, but this has certainly not been the case since 2008. Savings rates have yielded much less interest, as have bonds, with interest rates as low as 0%. At the moment, we’re even seeing negative interest rates. But the legislature never adjusted that assumed 4% return. This resulted in a situation where, for many years, the wealth tax people paid far exceeded their actual income from wealth"
https://home.kpmg/us/en/home/insights/2022/05/tnf-netherland...
"The box 3 tax rate is assessed against a hypothetical yield. You are not taxed for capital gains or actual rental income. Instead, the Dutch tax office assumes that you enjoy a yield of up to 5.69% over your total asset value, irrespective if any actual gains are higher or lower(!)."
Note that actual savings interest rates were close to zero or even negative.
The value gained by the other shareholders is not taxed until they sell themselves.
"Excessive dividend payouts, however, can undercut investment in productive capabilities in the same way that buybacks can."
[0] https://hbr.org/2020/01/why-stock-buybacks-are-dangerous-for...
Stock buybacks are basically attempts to shirk leashes, freeing execs/other shareholders from the ongoing influence of exiting shareholders.
Dividends on the other hand, are straightforward returns on what was a commitment to sink risk. An ongoing source of income for the shareholder as a result of the company thriving. It's a straight up payment of a coupon off a bond. There is no need to exit/re-enter required. Your # of shares do not move. Therefore your relative investment stays as it was, whereas with the buyback, you're handing back your ongoing leash and influence on the company.
Stock buybacks are therefore not equivalent in any way to paying of dividends. I don't know why this is so hard to understand.
They are extremely similar. The differences are around timeline and tax advantages, none of which you covered.
In a buyback, your percent ownership in the company will go up and the price will go up (barring other factors). You can sell some stock to keep your percentage flat and get some cash, making it like a dividend. Or, you can make a dividend like a buyback by reinvesting the dividend. Your percentage of ownership will go up.
This is trivial. They just buy it on the open market. This is public stock, people are always buying and selling.
> Regardless, you realize no gains if you do not exit your interest on that stock.
This is the big advantage of buybacks for shareholders! It is taxed as capital gains, and you can completely defer taxes by not selling. And "exit your interest" makes it sound like you have to sell all of it. You can just sell a small portion to make it like a dividend. You don't seem to be getting this.
> The exit is non-optional, and often not reenterable from.
Nonsense. It is optional. You can choose to keep it as stock or turn it into cash. And you can totally re enter. It's public stock.
Are you mixing up publicly traded stock buybacks with something in private companies?
Dividends are nothing like bond coupons. Coupons are guaranteed, tax treatment for both payor and payee is quite different.
We don't need the SEC, we just need to force companies to perform stock splits!
Point I'm making is that you can't declare a mechanism where you gain money but must exit as equivalent to you gain money, but no effect on your position as equivalent things.
What if a company buys back 50% of the shares and simultaneously performs a 1:2 stock split so that there are exactly the same number of shares available?
Imagine a company has 100 shares and I own 10. If they company buys back 50, the stock price will double, and my % ownership goes up from 10 to 20%. I can sell down to 10%, the same control I had before to take my profits.
What am I missing here?
Probably the smallest reason is that buybacks can save investors money on their taxes.
A much bigger reason is that buybacks are viewed as one time events. When a company starts paying a dividend investors often expect that dividend to be paid regularly. If the company chooses to stop paying a dividend or decreases the dividend the share price drops.
Finally, there is executive compensation. Let's say my compensation package let's me buy shares at $100 each. If the share price is currently $110 and the company does a $10 dividend then the share price goes to $100 and my options are worthless. If the company does a stock buyback then the share price goes up and my options are worth more. As CEO which do you push for?
It seems that it benefits stockholders and CEOs alike. Stockholders get the same value as a dividend without the immediate taxable income, and CEOs and other option holders like employees get some of the value when their options mature.
Stock price can double with the same market cap if you reduce the number of outstanding shares by half.
Is it the CEO? The board? The chairman? Or are the stocks cancelled from the total?
Apple is a classic case. Around 2010, the company had 26 billion shares outstanding. They've spent the last decade buying them back, and now have about 16 billion shares. This contributes significantly to the increase in stock price. The portion of the company 1 share represents is 60% larger today than it was in 2010 because there are fewer of them
This should make it clear why stock buybacks would be preferred. Fewer people with standing to sue if they don't agree with management's direction.
I'm not sure how you get that more shares means more owners. Doesn't really seem like the limiting factor.