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The Freeland tax that makes people talk

In her mini-budget, Chrystia Freeland announced the introduction of a tax that is making waves. A tax that would target the rich, in principle, but whose effects are far from being as obvious as it seems.

Posted at 6:30 am

Essentially, the Minister of Finance will tax one of the favorite channels of companies in the stock market to redistribute their excess profits, such as share buybacks.

The tax will amount to 2% of the sums distributed to shareholders in this way, specifies the economic balance of last Thursday, whose details will be specified in the next budget. The federal government hopes to recover 2,100 million in the next 5 years.

Before continuing, a parenthesis, a matter of thoroughly understanding the concept of share repurchase.

A company that has a surplus of profits must decide what to do with that money and, moreover, choose the vehicle with the best profitability.

Does the company have a project in the pipeline that promises a great return? Do you have a debt to pay whose interest rate is relatively high, given the risks? Do you have an acquisition in sight that would be attractively priced, given the synergies of a possible merger?

Once these options are on the table, managers must ask themselves whether it would not be more profitable for their shareholders to return these excess profits to them, in the form of dividends or share buybacks.

A share buyback, in particular, has the effect of reducing the volume of shares outstanding and thus increasing earnings per share. This higher multiple generally drives up the stock price.

Critics of share buybacks say they unfairly enrich shareholders and increase inequality. Stock buybacks would also be detrimental because they would encourage executives to think short-term, as their option-based compensation, among other things, would rise faster on stock buybacks.

End of parentheses.

Freeland’s tax doesn’t come out of nowhere. On the one hand, it mimics the one recently implemented in the United States by the Democratic administration (which, however, is limited to 1%). The government hopes the tax will incentivize companies to “reinvest their profits in their workers and their businesses.”

On the other hand, the tax arises in a context where share buybacks have multiplied lately.

In the last year, large Canadian companies (S&P 60) spent 67,000 million dollars to buy back their shares, an amount equivalent to the sums distributed in the form of dividends, according to a statement from the balloon and mail.

Five years ago, this sum was not only less (26 billion), but it was also half the amount of the dividend payment.

The oil sector is in the crosshairs. Many have spent billions of their profits, which came from rising oil prices and the war, to buy back shares. 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 that their business is threatened by the carbon neutrality objective of 2050. Shouldn’t they keep the money to invest more in the decarbonization of their activities or in green energy projects?

The debate may seem simple, but precisely, some believe instead that a 2% tax will curb productive investment in the economy and not the other way around.

“If the goal is to address corporate underinvestment, the tax is going the wrong way,” Raphaël Duguay, an assistant professor of accounting at Yale University, told me.

Why then? Because the shareholders to whom the benefits are paid are usually large funds or pension funds, which reinvest the money in more profitable sectors than the projects paralyzed by the companies that distribute the benefits.

In an article in a Columbia Business School journal, consultants Greg Milano and Michael Chew argue that each year approximately $250 billion of profits distributed to shareholders of American companies are properly reinvested in smaller, non-corporate companies. of the S&P 500.

“In other words, acquisitions and dividends from more mature companies are recycled back to companies that have been the source of the most job creation in recent years. Why would we want to stop this virtuous cycle? “, they write.

The chief economist of the National Bank, Stéfane Marion, does not believe that the tax will increase investment either, 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 bond with stock options than it was before the 2007 crisis,” he says.

Harvard University researchers Jesse Fried and Charles Wang go further. According to them, a pile of dormant cash in a company inflates its value, which increases the salary 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, left as well as right: it will only take effect in January 2024, giving companies time to multiply share buybacks in 2023 and avoid the tax before the fateful date.

It is not so clear, ultimately, that the Freeland tax increases investment. The new 30% cleantech tax credit, also inspired by Uncle Sam, is likely to have more of an effect. To follow.

#Freeland #tax #people #talk

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