Stock options, the buyback boondoggle and the crisis of capitalism
As if there weren’t already enough reasons to eliminate the egregious stock option tax loophole, a column by Eric Reguly in this month’s Report on Business magazine highlights yet another.Â This reason helps to explain why we had such a booming stock market up to 2008, but little growth in real investment and productivity.
First of all, the stock option deduction, which allows those recipients of stock options to only pay half the statutory rate of income tax on their gains is:
Expensive, costingÂ Canada’s federal government an average ofÂ almost $1 billion a year in foregone tax revenues annually during the past five year, according to Finance Canada’s tax expenditure accounts.
Unfair, with the benefits going overwhelming to those with the highest incomes, including CEOs, as Hugh Mackenzie has outlined in his annual CEO pay Â report for the CCPA.Â Â For example as I showed a few years ago, this tax loophole saved Robert Gratton, former CEO of Power Corp over $24 million in federal income taxes,Â just on one year’s income.Â Â This is a major reason why some of the highest paid people in our society pay tax at a lower rate than ordinary workers.
Distortionary and destabilizing, creating the misaligned incentives and pay structures that reward short-term risk taking that Bank of Canada governor Mark Carney identified as one of the key reasons for turbulence in the financial markets in a speech he gave two years ago.
Bu there’s an even more devastating reason why the tax loophole for stock options should be eliminated: it hasÂ been very damaging for the economy.
Research by William Lazonick, director of the Centre for Industrial Competitiveness at the University of Massachussets, shows that stock buybacks–using a company’s funds to buyback its own shares–has swallowed up an enormous amount of the income of major US companies.Â Â Canadian companies have also put increasing amounts of their income into stock buybacks and not into more productive investments, as I outlined a few years ago.
TheÂ stock buybacks have resulted in pretty blatant stock price manipulation, boosting stock price value for these companies, and paying off very handsomely for those who hold shares, which includes most CEOs and senior executives, especially since they only pay half the rate of tax on these gains.Â Â It’s been greatÂ for shareholders and other employees who also own shares, at least in the short-term.
The problem is that in the long-term it has bled the economy of real investment in the economy.Â As Reguly writes:
Every dollar spent on buybacks means one less dollar spent elsewhere-on R&D, on training, on equipment, on creating employment, on innovation. Ultimately, competitiveness and economic growth suffer.
The government also needs to enact legislation that drastically reins in top executive pay, which means placing restrictions on stock-based remuneration, especially stock options.
We will soon see in the federal Throne Speech and budget what Canada’s federal government has planned to revitalize Canada’s economy coming out of this recession.Â Â But if it is just more faith in the same old simplistic laissez-faire Advantage CanadaÂ framework without fixing any of these problems, it will have very little success.