Lawmakers in Washington appear set to impose a new excise tax on stock buybacks to fund President Biden’s social spending program, but investors shouldn’t expect it to weigh too much on share repurchases, according to an analysis by Goldman Sachs.
While a new tax on buybacks may dissuade companies in the S&P 500 index
from repurchasing shares at the margin, “we expect the potential headwind to buybacks from the proposed 1% tax would be small and we still forecast positive growth,” Goldman analysts, led by Ryan Hammond, wrote in a Friday note to clients.
“Companies could allocate more cash to dividends, but investors would expect those to persist in the future,” Hammond said.
“Companies could also allocate more cash to [capital expenditures and research and development], but those projects tend to be multi-year in nature, spending decisions are generally driven by expected returns on investment and cash balances remain extremely high.” Companies could also use cash to acquire other firms, but increased regulatory scrutiny related to mergers and acquisitions could dissuade executives, Hammond added.
The Goldman analysis predicts that cash spending by companies on capital expenditures, research and development, cash acquisitions, share repurchases and dividends will grow by 22% in 2021, followed by an 8% increase next year. Hammond and his colleagues expect share buybacks to also grow by 8% to $872 billion next year and remain the single largest spending category for S&P 500 companies.
The overall tax and spending package Congress is considering, however, could weigh on large companies ability to deploy cash more broadly. Democrats are strongly considering a new 15% corporate minimum tax for companies with more than $1 billion in profits, along with new limits on interest expensing and other deductions that could raise many S&P 500 companies’ effective tax rates.
“An increase in the effective corporate tax rate, even if the domestic statutory rate is unchanged, would mean less S&P 500 cash spending will likely occur than would otherwise be the case,” Hammond wrote, predicting that if the proposed tax increases are enacted cash spending would grow by only 2% next year rather than 8%.
Large companies will have the benefit of already large cash reserves to blunt the impact of higher taxes, however. “Following the initial cash crunch in the pandemic, companies took advantage of the low rate environment to issue debt and experienced improving cash flows, all helping to shore up corporate balance sheets,” Hammond added. “Cash balances have surged by 16% during the last 12 months, compared with 6% for debt.”