The two percent tax on share buybacks announced last week in the federal financial update highlights the lack of understanding by many politicians and bureaucrats of fundamental economics and the mindset of investors..For those in government, there is no financial cost of capital — their currency is votes. Financial and tax decisions are therefore made in part by calculating the political cost or gain of extracting additional capital from taxpayers. This government likes to increasingly direct our lives with money taken from us by taxation. Buybacks are only the most recent example, following carbon taxes, child and dental care and since 1917, the income tax itself..When considering a company from an investment perspective, capital allocation decisions are a critical factor. One of the most significant roles of a board of directors is to determine how much capital to raise and when, how capital should be allocated across projects and opportunities and the determination of investment allocation policies including paying dividends to shareholders. Or when a company's share price is less than its intrinsic value, repurchasing shares from investors at the current market value..The math is simple — the current share price is compared to the present value of the expected future cash flow of the enterprise. In Canada today, energy sector valuations are so low that share-buybacks are likely to provide high returns to remaining shareholders.. Chrystia Freeland“I know the challenge today is real,” said Finance Minister Chrystia Freeland. .Although the tax is applied widely, the current robust buyback activity in the energy sector suggests that Ottawa is again targeting one sector. Hardly a surprise..Chrystia Freeland, the finance minister who announced the tax effective January 1, 2024, is an intelligent accomplished former journalist. But the announcement displays her unfortunate lack of understanding of long term strategic thinking essential to a country’s prosperity. Also not surprising..If the minister's objective is to influence companies to allocate more capital to grow the business, then there is an easier and more effective solution — the federal government should reconsider its full-frontal attack on the oil and gas sector. One of the primary reasons the industry is sharing more cash flow with shareholders is the long term risk of investing in a country that has pledged to ultimately kill the industry. Reward reticent, risk-averse investors now..Capital is a coward. Studies have revealed that investors place at least twice the emotional value on a loss, versus the value of a gain. One way for a CEO to shorten tenure is to misallocate capital, suffer lower returns of the business, and watch the share price decline..At a higher conceptual level, how is it the role of government to stick its nose into boardrooms to direct corporate capital allocation anyway? Like it once was with our health care system, today Canadians can boast about our world leading corporate governance practices. The current problem in Canada is more about the business and investment climate, not the governance of the corporate sector..Canada has become a jurisdiction which repels capital. According to StatisticsCanada, Canadian annual direct investment inflows and outflows were about equal. Although inflows have increased, they are now exceeded by Canadians moving capital abroad by almost $500 billion annually. This is a sign of reduced confidence in our country; the wide negative gap came only after 2015 when the current government was elected. This is especially true in the energy sector as one major player after another has sold, moving the capital to more favourable jurisdictions. Are you surprised?.Our ambitious finance minister considers herself a global player, indeed pursuing her successful career in the Ukraine, London, and New York prior returning to Canada. It is disappointing and disconcerting that she does not appreciate Canada’s diminished international standing from a time when capital was safe, and profitability was celebrated..Addressing a nonexistent problem by further taxation confirms a mindset that is more damaging than the substance of the policy, or the additional revenue. Our federal government can constructively address our declining economic prospects by making our country more, not less, hospitable to capital..Now that would be a surprise!
