Calling it the I.R.A. is an Insult
By David Nelson, CFA
The Inflation Reduction Act of 2022 has passed the Senate with a tie breaking vote from Vice President Kamala Harris. Democrats have been desperate to put some points on the board and the secret negotiations between Senator Joe Manchin and Majority leader Chuck Schumer pushed the bill closer to the finish line. It now heads to the house and if it passes there to the desk of the President.
The last holdout was Senator Kyrsten Sinema who held up the bill demanding the revised tax code on Carried Interest Income be taken out settling instead for a 1% tax on stock buybacks. I’ll touch on that in a second.
The bill will provide tax incentives to reduce carbon emissions and for the first time allow Medicare to negotiate the price of certain prescription drugs. (I’ll be covering this in a separate article as the the word negotiate hardly seems appropriate the way the legislation is written) To help pay for the above the bill establishes a 15% corporate minimum tax.
First of all, if you want to pass climate and tax legislation and you have the votes, go for it.
But OWN IT! Calling it the Inflation Reduction Act of 2022 is an insult to the intelligence of anyone with a pulse.
The Penn Wharton Budget Model Summary:
Summary: PWBM and CBO find an almost identical impact of the Inflation Reduction Act of 2022 (“IRA”) on the budget, with small differences stemming from the timing of the corporate minimum tax revenue. The impact on inflation is statistically indistinguishable from zero for either estimate.
Even Senator Sanders sees it. The Hill
“According to the [Congressional Budget Office] and other economic organizations that have studied this bill, it will have a minimal impact on inflation,” Sanders declared on the Senate floor to open debate on the 755-page bill…
So, what did Joe and Kyrsten get for coming on board.
From the New York Times August 7th
Mr. Manchin’s recent surprise agreement to back the Biden administration’s historic climate legislation came about in part because the senator was promised something in return: not only support for the pipeline in his home state, but also expedited approval for pipelines and other infrastructure nationwide.
For those you who watch The Money Runner Podcast hosted by yours truly you’ve heard me say this often. In the end, Money Touches Everything, especially in Washington.
Carried Interest, the loophole that never dies
Alright, back to Senator Sinema and the Private Equity Lobby. According to the Financial Times the senator has received more than a half million dollars from the industry this election cycle.
For the uninitiated, Carried Interest is the share of profits a private equity or hedge fund manager would receive. A typical arrangement is 2 & 20. The managers receive a 2% annual fee on the assets under management or AUM and a 20% share of the profits. If the fund made 10% in a given year, 20% of that return or 2% of the total would go directly to the general partner.
It is taxed differently and treated the same as the investments in the fund and subject to capital gains tax almost always lower.
Efforts to kill this giveaway and unfair loophole that benefits the real 1% has been going on for decades. Somehow the Private Equity lobby always gets their way protecting the gift that keeps on giving.
What about the 1% tax on buybacks?
The 1% is just the beginning and you can bet there will be calls to increase it over time. However, the bigger issue is that stock buybacks have their roots in a deeper problem, stock option grants. But that’s another whole can of worms.
IBM Stock Buybacks since 2008 – Do the Math
I’ve been a long outspoken critic against stock buybacks for much of my career. I can probably sum up my thoughts with a look at my response to the Wall Street Journal Editorial Board Op-Ed
David Nelson, CFA response
I’m usually in agreement with the board’s views but your characterization of buybacks is out of touch with reality. Certainly, there are some companies that can’t deploy all of their cash as it is just too large i.e., Apple but for most companies it’s the easiest way for a CEO to hit performance-based pay targets.
A buyback does nothing for revenue and nothing for net income. It just boosts earnings per share because the share count is lower. It is often code that management has run out of ideas on how to better grow the company.
The poster child of this behavior was IBM which wasted $Billions in stock buybacks every year to grow EPS instead of reinvesting in the company. Today it is a shell of its former self. Airlines spent $Billions buying their stock in the years running up to Covid and the American tax payor ended up footing the bill.
Stock buybacks are also used to offset the dilution of stock option grants which dilute existing shareholder value. I’ve been running money for better than 25 years and I’ve been hearing this same old tired excuse for buybacks my entire career. Most of those touting their usefulness are on the inside receiving the benefit. David Nelson, CFA Chief Strategist & Host of the Money Runner Podcast.