The Senate passed the Inflation Reduction Act of 2022 through the budget reconciliation process. The bill allocates over $300 billion to incentivize clean energy production and fight climate change, extends Affordable Care Act subsidies created at the height of the pandemic, and grants Medicare limited powers to negotiate prescription drug prices. But the bill’s changes to the tax code are the most significant because they are the crux of how the Inflation Reduction Act would reduce the federal deficit, and thus may help curb inflation.
The Inflation Reduction Act’s tax changes consist of a 15 percent corporate minimum tax and a 1 percent excise tax on stock buybacks. The bill originally contained a provision that tightened the carried interest loophole, which uniquely benefits private equity and hedge fund managers, but Senator Kyrsten Sinema (D-AZ) had any mention of carried interest removed from the bill as the condition for her support.
The 15 Percent Book Minimum Tax
The 15 percent corporate minimum is a “book tax” on the publicly reported financial statements of corporations whose annual profits exceed $1 billion. Corporations are presently required to pay a 21 percent federal income tax, subject to tax credits and deductions which have allowed fifty-five of the largest, highly profitable US corporations to pay $0 in federal income taxes the past few years. Tax credits and deductions create discrepancies in how corporations report earnings to the IRS versus how they report those same earnings to shareholders. If corporations’ tax burden ends up lower than 15 percent after those credits or deductions are calculated, and only in that circumstance, they would face the 15 percent “book minimum” in lieu of the 21 percent rate.
The Joint Committee on Taxation estimated, before Democrats hammed out compromises on the provision, that the 15 percent minimum would raise $313 billion over ten years. This estimate may have become too optimistic after the Senate passed an amendment exempting companies financed by private equity from the book tax.
At least $40 billion in savings will be lost by another amendment from Sinema, which exempts “accelerated depreciation” from the corporate minimum. Companies will maintain the ability to claim larger write-offs for depreciation on an earlier schedule than if those deductions were spread out across the normal lifespan of an asset. Accelerated depreciation has accounted for just over 50 percent of the “total income tax breaks” granted to twenty large corporations, from Google and Amazon to JPMorgan Chase and United Airlines. However, the 15 percent book tax still positively influences how corporations calculate their liability, especially if they claim depreciation benefits early and pay closer to 15 percent in subsequent years.
Despite compromises, the 15 percent book minimum tax ensures that the corporate income tax has a more solid floor that makes it nearly impossible for large corporations to have a tax bill of $0, or possibly a negative bill. Critics argue that the book minimum tax would incentivize corporations to under-report their income to shareholders. In fact, taxing the books is more likely to improve financial reporting by giving investors an accurate account of a corporation’s real after-tax income. Under-reporting income on financial statements is less likely than over-reporting, the more prevalent issue where corporations defraud investors by overstating their growth. A book tax would discourage the latter kind of manipulation because corporations would not over-state their earnings to shareholders if they want to avoid paying a greater proportion of taxes (15 percent of a larger whole).
Excise Tax on Buybacks
The Inflation Reduction Act levies a 1 percent excise tax on share buybacks, which is predicted to raise $74 billion in revenue over ten years. When corporations purchase back their own stock, they raise share prices and indirectly enrich shareholders in lieu of paying dividends. Buybacks enable some shareholders to reduce their tax liability by ensuring they are taxed at the capital gains rate and allows all shareholders to defer taxes by not realizing any capital income.
Buybacks increased significantly after the Trump tax cuts reduced the corporate income tax from 35 to 21 percent. The largest corporations mostly decided to buy back their stock with the tax savings they could have invested in new products, or spent on hiring and increased wages. The new excise tax will impose a modest fee on buybacks, which certainly would not drive the practice out of existence; one financial analyst refers to the tax as “a 1 percent salami slice taken off the top” of buybacks. But if the tax even slightly discourages buybacks, that would ultimately be a win for workers and the real economy.
Opponents of a buyback tax argue that it would penalize “mom-and-pop investors as much as institutional investors.” Yet share buybacks themselves harm investors in the long run by prioritizing artificial, short-term gains in stock price over the reinvestment of profits in workers and innovation. This is why Senator Elizabeth Warren (D-MA) called buybacks a “sugar high.”
Companies listed on the S&P 500 put 51 percent of their earnings towards buybacks between 2004 and 2013, according to UMass economist William Lazonick. Lazonick argues that buybacks amount to manipulation of the stock market because the practice puts “value extraction” above “value creation,” and concludes that only the latter can benefit the whole economy. The 1 percent excise tax will not systematically shift corporations’ incentives towards value creation over buybacks, but it is progressive for recognizing that corporations should compensate the public for the externalities coming from buybacks.
The Inflation Reduction Act was a compromise from the outset, taking the place of the more ambitious Build Back Better Act. Recent negotiations meant that the Inflation Reduction Act was further whittled down in ways that blocked meaningful proposals, such as tightening (and someday ending) the carried interest loophole. But the 15 percent book minimum tax and 1 percent excise tax on buybacks will raise billions in revenue by creating a fairer tax burden for corporations.