Stock Buyback Tax Will Harm State & Local Pensions

The growth trajectory of the largest national entitlement programs — Social Security, Medicare, and Medicaid — has many concerned, understandably so. But state and local unfunded pension liabilities must also be counted among the major challenges to U.S. fiscal health.

According to Pew research, unfunded state pension liabilities reached a combined $1.25 trillion in 2019. Other projections that assume more modest investment returns find total unfunded state pension liabilities today in excess of $8 trillion. The trillions of dollars in growing unfunded public pension liabilities, for which taxpayers are ultimately on the hook, is a problem that could soon be exacerbated by a new federal tax in the Inflation Reduction Act (IRA) that will diminish state and local pension plan returns.

“We should not increase taxes, and we did not increase taxes,” Senator Joe Manchin (D-W.V.) said about the IRA on NBC’s Meet the Press. Yet that statement is false. According to the bipartisan congressional Joint Committee on Taxation, enactment of the IRA will increase federal tax collections by hundreds of billions over the next 10 years. What’s more, enactment of the IRA will result in a net tax hike on millions of Americans with income below $400,000.

This would seem to be a problem for President Joe Biden, who campaigned on a promise to not raise taxes on anyone making less than $400,000 annually. “If you make under $400,000, you will not pay a penny more in taxes when I’m president,” Biden tweeted during his campaign. Biden has reminded people about his tax pledge since being elected, doing so as recently as his March State of the Union address, during which he asserted that “under my plan, nobody earning less than $400,000 a year will pay an additional penny in new taxes.”

Households at every income level will be hit with higher taxes under the IRA, according to the JCT’s analysis. Even those with income below $10,000 would experience an average tax hike from 7.3% to 7.6%. The White House has made clear the pledge-breaking tax increases in the IRA will not deter the President from signing the bill when it gets to his desk, which is on track to happen in the coming week. Perhaps President Biden is confident that media outlets will help the White House falsely tell people that the IRA doesn’t raise taxes on anyone making less than $400,000, as the Associated Press did on August 8.

Among the tax hikes that will fall on households making less than $400,000 is the IRA’s new 1% excise tax on the value of stock buybacks. The stock buyback tax was included in the IRA in exchange for scrapping the tax increase on carried interest, a move made to secure Senator Kyrsten Sinema’s (D-Ariz.) support. Though members of his caucus are falsely claiming the IRA doesn’t raise taxes, Schumer has since boasted that the new stock buyback excise tax, which will raise $74 billion over the next decade, is more than five times larger than the carried interest tax hike for which the stock buyback tax was traded.

“I hate stock buybacks,” Schumer said, adding, “I think they are one of the most self-serving things that corporate America does.”

Not everyone agrees with Schumer. According to the non-partisan Tax Foundation, “research shows that the common view of stock buybacks is misguided, and that taxing them would not be the right policy solution to encourage long-term investment or lift wages.”

“Stock buybacks are one way corporations can return value to shareholders,” writes Erica York, a senior economist at the Tax Foundation. “Buybacks do not displace productive investments and do not come at the expense of workers—so they should not be targeted for a tax increase based on those misperceptions.”

Among the shareholders who benefit from stock buybacks are state and local government pension plans. Not only will the cost of the stock buyback tax be borne by households making far below $400,000, it will reduce pension plan returns for millions of retired state and local government workers. In doing so, the stock buyback tax will worsen the multi-trillion dollar unfunded pension liabilities that cities and states across the country must tame in the coming years, putting taxpayers on the hook for a larger unfunded liability than would be the case without a new federal tax on stock buybacks.

“When Congress slaps additional toll taxes on defined contribution retirement plans, defined benefit plans, mutual funds, IRAs, 529s, etc. they make middle class investing more difficult,” said Ryan Ellis, president of the Center for a Free Economy and an IRS-enrolled agent. “The 1% stock buyback tax will result in less capital for shareholders—which means lower dividends and lower stock prices. It hurts anyone counting on the stock market to help pay for their retirement or their kids’ college tuition.”

Critics of the IRA’s stock buyback point to India, which became less attractive to investors after the recent adoption of a stock buyback tax. “Overall, average investor return is likely to decline by around 1% due to this tax,” HSBC Bank researchers forecasted in 2019.

Recent years have seen governors and legislators in numerous states pass reforms seeking to rectify unfunded government pension liabilities. There is now bipartisan consensus in many places that the first step toward reining in the growth of unfunded pension liabilities is to move state and local government workers from defined benefit pension plans to defined contribution pension plans.

In Pennsylvania, for example, Governor Tom Wolf (D) signed legislation approved by the commonwealth’s GOP-run legislature in 2017 moving all new state workers to defined contribution pension plans. More than a dozen other states have enacted legislation moving government workers to defined contribution pension plans, reducing taxpayer risk and mitigating the growth of unfunded pension liabilities. While lawmakers in some states, like Pennsylvania, have enacted hard-fought reforms that will reduce pension liabilities for taxpayers, other states are seeking to delay the day of pension reckoning. Government officials and union leaders in California, for example, are seeking to takeover local EMS systems currently run by private providers in an effort to generate new revenue with which to cover rising pension costs.

Whether lawmakers in a given state have enacted meaningful entitlement reform like in Pennsylvania, or papered over rising pension liabilities like in California, a new federal excise tax on stock buybacks will counteract the efforts of state legislators and make the problem of unfunded pension liabilities more difficult to address in all 50 states.

North Carolina Treasurer Dale Folwell, who is responsible for one of the world’s largest pools of public money, explains that in his role as “keeper of NC’s public purse,” he is “totally against the federal government telling capitalists how to allocate capital.”

“The choice to pay down debt, expand, or reinvest in their current business have always been an option,” Treasurer Folwell added. “That is true yesterday, today and should be true tomorrow.”