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March 30, 2010
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Congress seeks more information on health care charges

AT&T announced last week that it would charge $1 billion against its
earnings as a result of the recently passed health care bill. Other
companies also announcing charges include Caterpillar ($100 M), John
Deere ($150 M), and MMM ($85-90 M). Analyst David Zion of Credit
Suisse estimated that S&P 500 companies will rack up a combined $4.5 B
charge.

In response, Congressman Henry Waxman (D-CA), Chairman of the House of
Representatives Committee on Energy and Commerce, and Bart Stupak
(D-MI), Chairman of the Subcommittee on Oversight and Investigation,
sent letters to the chief executive officers of AT&T, Caterpillar,
Deere & Co, and Verizon. Here is an excerpt from the letter for AT&T:

After the President signed the health care reform bill into law,
your company announced that provisions in the law could adversely
affect your ability to provide health insurance....

The new law is designed to expand coverage and bring down costs,
so your assertions are a matter of concern. They also appear to
conflict with independent analyses. The Congressional Budget
Office has reported that companies that insure more than 50
employees would see a decrease of up to 3% in average premium
costs per person by 2016. The Business Roundtable, an association
of chief executive officers from leading U.S. companies, asserted
in November 2009 that health care reform could reduce predicted
health insurance cost trends for businesses by more than $3,000
per employee over the next ten years.

That much seems entirely reasonable. The drafters of the legislation
had expectations that were apparently inconsistent with the companies'
announcements, so they'd like to obtain more information. But further
details of the letter troubled some observers:

We request your personal testimony at this hearing. To assist the
Committee with its preparation for the hearing, we request that
you provide the following documents from January 1, 2009, through
the present: (1) any analyses related to the projected impact of
health care reform on AT&T; and any documents, including e-mail
messages, sent to or prepared or reviewed by senior company
officials related to the projected impact of health care reform on
AT&T. We also request an explanation of the accounting methods
used by AT&T since 2003 to estimate the financial impact on your
company of the 28% subsidy for the retiree drug coverage and its
deductibility or nondeductibility, including the accounting
methods used in preparing the cost impact statement released by
AT&T this week.

Representative Michael Burgess (R-TX) expressed concern that this
"looks an awful lot like an attempt to intimidate and silence
opponents of the Democrats' flawed health care reform".

You don't need to pour through email to understand why the companies
were forced to take immediate charges against their profits. The Wall
Street Journal explains:

The charges are related to a 2003 law providing a
prescription-drug benefit under Medicare. At the time it was
adopted, some companies were threatening to drop drug coverage for
their retirees, since this would now be available through
Medicare. Congress voted them a 28% tax-free subsidy for
continuing to provide coverage to retirees eligible for Medicare.

The subsidies caused the cost of companies' obligations for
retiree benefits to decline. AT&T, for example, saw its obligation
drop by $1.6 billion at the time.

The cost of providing retiree prescription-drug coverage was
already tax-deductible before the 2003 law. After that law was
signed, companies remained able to deduct the cost of providing
the benefit, including the portion paid for by the subsidy.

The current health-care overhaul doesn't eliminate the subsidy,
nor make it taxable. What it changes is that companies will no
longer be able to deduct the portion of the drug benefit paid for
by the subsidy.

Since companies had created an asset based on the expectation they
would be getting these deductions over the lives of their current
and future retirees, they say they need to take a charge
reflecting the fall in the asset's value.

Accounting rules say the charges, which affect what are called
"deferred tax assets," must be taken in the quarter in which a
tax-law change is enacted. The first quarter ends Wednesday.
Companies wouldn't have to announce the charges before they
actually report their first-quarter earnings over the next several
weeks. However, if they viewed the charges as material, they might
feel they needed to inform shareholders immediately.

My position is that eliminating the tax-deductibility of the subsidy,
as the recent legislation did, was perfectly reasonable, and that the
companies' responses to the legislation were perfectly reasonable. But
the Congressional "request" for a personal appearance of the CEOs and
the right to peruse all the company email on the topic are not
reasonable.

Posted by James Hamilton at March 30, 2010 04:04 PM

digg this  reddit

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Comments
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Excellent post. Companies wouldn't lie about such a thing - it is hard
to imagine they would deliberately make their books look worse than
necessary. I'm sure the Congressmen were glad to count the reduction
in costs when the legislation was scored, what did they expect?
The WSJ could have stated the issue more simply - companies received a
subsidy that was excluded from taxable income to maintain drug
coverage for retirees. The new health reform makes the subsidy
taxable. Might some companies now respond by dropping the drug
coverage, as they threatened originally? Was this response included in
the scoring for the legislation? Or is it another example of hiding
the true long-run costs?

Posted by: don at March 30, 2010 05:20 PM

great post -- thanks JDH.

Posted by: Sjp at March 30, 2010 05:49 PM

Actually, in my experience companies lie about stuff like this all the
time - see Lehman and Repo 105 not to mention the even more egregious
$450+ million overvaluation of their Archstone Properties real estate
holdings . . . . sadly, though, the companies cited aren't lying about
the deferred tax asset charges, which are entirely legitimate and
required by GAAP.

Posted by: Anarchus at March 30, 2010 06:26 PM

Menzie assures us that the CBO numbers were good. No doubt the CBO in
its analysis factored in the tax and other effects on corporations, so
I'm a bit surprized that Waxman and Stupak are surprized. Now why
could that be, if the CBO ran its numbers properly?

Posted by: Steven Kopits at March 30, 2010 07:49 PM

QED.

Posted by: Phil Rothman at March 30, 2010 07:59 PM

The Congressmen have a legitimate point but not one that GAAP
recognizes. Retiree medical and prescription drug projections, net of
tax-subsidies justified or not, are subject to present value
calculations and the gains/losses on the deferred tax assets are
recognized immediately into income. More general company promises to
maintain medical benefits structures for active employees are not
subject to such present value determinations and the changes in the
related assets are not recognized in income by GAAP. The GAAP
rationale is that one cost, that for post-retiree medical, is paid out
of an accumulation from current wages and the other cost, the cost for
active employees, is exclusively paid from/paid in lieu of their
current wages. So the Congressmen's expected active employee costs
reductions will be recognized in the income of the corporations as
they occur in the future.

Posted by: d4winds at March 31, 2010 01:39 AM

You are entitled to your opinion, of course, professor. I tend not to
take the pronouncements of major corporations at face value, myself. I
expect the e-mail trail to show that this request was not as
unreasonable as you seem to think, unless you believe in a corporate
right to privacy?

Posted by: benamery21 at March 31, 2010 03:38 AM

Don is wrong. The subsidy is not taxable under the new legislation.
However, it must be subtracted from the drug benefit expenditures that
generate the subsidy. Thus, the tax benefit of the subsidy is
eliminated. For example, if a company spends $100 on drug benefits, it
was allowed to deduct that amount for tax purposes under the previous
law. Now the 28% subsidy must be deducted from the $100, resulting in
a tax deduction of $72 instead of $100. Hence, the company loses 28%
of the $100 times the marginal tax rate, or .28 x .35 = .098 of the
expenditure. The subsidy itself remains tax free.

Posted by: gene at March 31, 2010 05:41 AM

Companies do all kinds of things to make their books look better or
worse than they are, depending on which gives them the most short-term
benefit. I think it's well-worth Congress seeing the accounting that
led to the latest claims. Thanks to Gene for explaining things more
clearly than the WSJ. Seems to me the WSJ was also trying to paint the
picture worse than it is--just a correction to the 2003 law to avoid
something like a double deduction.

Posted by: dvdhwl at March 31, 2010 09:10 AM

Many states have anti-SLAPP laws in place, to protect people from
being harassed by businesses, and that's a good thing.

But maybe we also need anti-SSAPS (strategic subpoena against public
speaking) laws to protect people from being yanked before Congress for
saying things that Congress doesn't like.

Posted by: Dan Weber at March 31, 2010 09:14 AM

I'd like to dwell a bit more on the CBO error here. Clearly,
government analysts did not reach out to the private sector to assess
the impact of proposed policy, otherwise they would have quickly
encountered these accounting issues.

As a functional matter, this failure is easily addressed. Go to the
company website, find the CFO's name, call his assistant, and say,
"Hello, my name is name, and I'm with the Congressional Budget
Office. We're analyzing the economic implications of the proposed
healthcare law, and as part of our efforts, we are contacting a few
leading corporations to better understand their perspective. Would it
be possible to arrange a call with the CFO or the respective subject
matter expert?"

Now, I would guess you'd get a friendly call within 24 hours from the
CFO, who would be more than interested to give you his take on the
issue, since his analysts have been running scenarios for him for the
last couple of months. For him, this is a great lobbying opportunity
at the technical level, and he'll approach it with two goals. First,
he'll want to insure you actually understand the implications of what
you're doing (which clearly, the CBO did not, in this case). Second,
he'll want to lobby for favorable treatment, which he'll do by
offering suggestions or perspectives or just engaging in a
problem-solving dialogue. In any event, you'll get both stories, and
that's fine--it's entirely normal. It's up to the analyst to sort fact
from desire, and I would hope any (experienced) analyst capable of
getting a job at the CBO would be able to do so.

Does the CBO reach out like that? (I don't know...maybe I should call
and ask.) They didn't appear to in this case. But it's easy to do. I
have probably made a hundred cold calls in the last year looking for
information, and only twice have people refused to speak with me (and
I remember their names). And I'm not the CBO.

'Analyst' should not mean 'isolated'. Analyst-to-analyst personal
relationships enable backdoor communications in a way that formal
channels often do not. These help institutions avoid foolish blunders,
as with these surprize write-downs.

Is the culture at CBO open? I have no idea, but if it's not, it
wouldn't hurt to take greater steps toward openness.

Posted by: Steven Kopits at March 31, 2010 09:50 AM

gene - go back and reread your comment. Then tell me, what is the
substantive difference between reducing the deductible expenses by the
amount of the subsidy and taxing the subsidy?

Posted by: don at March 31, 2010 10:45 AM

Well, the JCT (who provide the official scoring for Congressional
legislation) estimated that the elimination of deductions for expenses
allocable to the Medicare Part D subsidy would raise $400 million in
FY 2013, $600 million in each of FY's 2014-2016, $700 million in each
of FY's 2017-2018, and $800 million in FY 2019. The total revenue over
the period FY's 2010-2019 is $4.5 billion. So, what years are covered
by the charges against earnings announced by the companies? Should
Congress be surprised by the company announcements (and disappointed
in the JCT), or should the JCT be lauded for accuracy? The JCT is a
pretty sharp group, so I wouldn't be surprised to learn that this
brouhaha arose because certain Congressmen simply weren't paying
attention.

Posted by: don at March 31, 2010 11:14 AM

"...Accounting rules say the charges, which affect what are called
"deferred tax assets," must be taken in the quarter in which a tax-law
change is enacted. The first quarter ends Wednesday. Companies
wouldn't have to announce the charges before they actually report
their first-quarter earnings over the next several weeks...."

So will every company have to take a charge like this in Q1, even if
they don't announce it until they announce Q1 earnings?"

Posted by: jman at March 31, 2010 11:40 AM

Not "every company", but many Fortune 500 companies have these health
care/drug plan related deferred tax assets which will have some degree
of impairment.

To confuse things further, there's the issue of materiality - the
larger the dollar amount involved relative to the size of the company,
the more reason there is to "pre-announce" the accounting charges
before current quarter earnings are officially released after the end
period of the current quarter. At the tiny end of the spectrum, some
companies may have a minor degree of impairment but either not release
the specific information, or they may choose to include it as a
footnote to the 10-Q when those statements eventually are filed with
the SEC.

Posted by: Anarchus at March 31, 2010 12:19 PM

For the sake of completeness, here is a bullet point list outlining
milestones along our journey to Health Care Nirvana in the USofA.

David Walker, former U.S. Comptroller General and head of the
Government Accountability Office, recently stated that the cost side
of the plan is very real, but the cost savings side of the plan
requires much wishing and praying.

So I think over the next 8 years we will see many mismatches in the
timing of costs and savings, and will probably need another CSPAN
channel dedicated soley to Congessional Health Care Hearings.

One day after the plan passed Krugman did a victory dance declaring an
important political victory for Democrats, and now we can start work
on fixing the plan! I assume that means more needs to be done in
Congress? So whilst wondering if I should get out my red pom-poms or
blue pom-poms, I noticed the $27K/year family "Cadillac Plans" aren't
taxed until 2018!?, and tossed all my pom-poms in the garbage. They
are taxing ZIRP interest and disappering dividends starting 2013, so
now we are "rich people" if we have a savings account, money market
fund, or bank CD. I'm still wondering if you can legally fine
"illegals" for not having insurance, or legally give them subsidies,
or if "santuary cities" and the free emergency room will still
function as it does now.

2010

•Subsidies begin for small businesses to provide coverage to
employees.
•Insurance companies barred from denying coverage to children with
pre-existing illness. Adults are NOT covered for pre-ex on individual
plans until 2014.
•Children permitted to stay on their parents' insurance policies until
their 26th birthday.

2011

•Set up long-term care program under which people pay premiums into
system for at least five years and become eligible for support
payments if they need assistance in daily living.
•Taxes and fees
•Drug makers face annual fee of $2.5 billion (rises in subsequent
years). No prohibition for direct pass through of costs to consumers.

2013
Taxes and fees

•New Medicare taxes on individuals earning more than $200,000 a year
and couples filing jointly earning more than $250,000 a year.
•Tax on wages rises to 2.35% from 1.45%.
•New 3.8% tax on unearned income such as dividends and interest.
•Excise tax of 2.9% imposed on sale of medical devices.
•Cost control
•Medicare pilot program begins to test bundled payments for care, in a
bid to pay for quality rather than quantity of services.

-- 2014 --

•Create exchanges where people without employer coverage, as well as
small businesses, can shop for health coverage. Insurance companies
barred from denying coverage to anyone with pre-existing illness.
•Requirement ("Individual Mandate") begins for most people to have
health insurance. Subsidies begin for lower and middle-income people.
People at 133% of federal poverty level pay maximum of 3% of income
for coverage. People at 400% of poverty level pay up to 9.5% of
income. (Poverty level currently is about $22,000 for a family of
four.)
•Medicaid, the federal-state program for the poor, expands to all
Americans with income up to 133% of federal poverty level.
•Subsidies for small businesses to provide coverage increase.
Businesses with 10 or fewer employees and average annual wages of less
than $25,000 receive tax credit of up to 50% of employer's
contribution. Tax credits phase out for larger businesses.
•Taxes and fees
•Employers with more than 50 employees that don't provide affordable
coverage must pay a fine if employees receive tax credits to buy
insurance. Fine is up to $3,000 per employee, excluding first 30
employees.
•Insurance industry must pay annual fee of $8 billion (rises in
subsequent years).
•Cost control
•Independent Medicare board must begin to submit recommendations to
curb Medicare spending, if costs are rising faster than inflation.

2016
Taxes and fees

•Penalty for those who don't carry coverage rises to 2.5% of taxable
income or $695, whichever is greater.

2017

•Businesses with more than 100 employees can buy coverage on insurance
exchanges, if state permits it.

2018
Taxes and fees

•Excise tax of 40% imposed on health plans valued at more than $10,200
for individual coverage and $27,500 for family coverage.

Posted by: Cedric Regula at March 31, 2010 12:24 PM

GAAP is GAAP, no need to argue over it. Let the corporate accountants
and the auditors sort it out.

The larger issue is that the democrat party and the progressive party
are using intimidation to silence critics. The same approach they use
against the Tea Party, conservative talk radio, fox news channel, and
others.

As a supporter of the democrat or progressive party, you may not like
what the opposition has to say, but in America we are allowed to speak
without fear that the government will try to silence us. At least it
used to be that way.

It has gotten to the point where I feel uncomfortable having
discussions in a public setting, like a restaurant, where my 'dissent'
might be heard by an overzealous Obama supporter.

Posted by: tj at March 31, 2010 01:03 PM

Just found another analysis by Kiplinger. Their version states the
interest and dividend tax only applies to real rich people. Whew. I
can postpone my move to Mexico under this reading of the bill.

$200,000/year income.
200,000/.01= $20 million in principal at 1% interest. Dodged another
bullet!

+++++++++++++++++++++++++++++++
Changes to Medicare and to the individual insurance market will affect
retirees. Here are key details that you need to know.

On Tuesday, President Obama signed a law that finalizes his landmark
health care overhaul. Here are key provisions that could affect you.

Medicare. The Part D prescription-drug doughnut hole will be gradually
reduced by 2020. Seniors who reach the doughnut hole in 2010 will
receive a $250 rebate. Starting in 2011, drug companies will be
required to provide a 50% discount on brand-name drugs bought in the
coverage gap. The federal subsidy for Part D premiums will be reduced
for higher-income beneficiaries. Cost sharing for preventive-care
services is eliminated.

A new advisory board would submit recommendations to Congress to
reduce the rate of growth in Medicare spending. The board is not
allowed to submit proposals that would ration care or change benefits.

More Medicare beneficiaries could be snared by the Part B premium
surcharge for high-income seniors. The law freezes the income
thresholds for income-related Part B premiums from 2011 to 2019.

Medicare Advantage plans. Studies have found that Advantage plans cost
the government 14% more on average than traditional Medicare. To get
costs more in line with traditional Medicare, the new law freezes
federal payments to private Medicare Advantage plans at 2010 levels.
These plans will be required to spend at least 85% of their revenues
on patient care. Plans that prove they provide high-quality efficient
care will get rebates from the government.

New taxes. The law would raise the Medicare payroll tax by an
additional 0.9% (to 2.35%, from the current 1.45%) on earned income
above $200,000 for individuals and $250,000 for joint filers. It would
also impose a Medicare tax of 3.8% on investment income, such as
dividends and interest, for individuals with adjusted gross income
above $200,000 and joint filers with AGI above $250,000. These taxes
will go into effect in 2013. Distributions from pensions, IRAs,
401(k)s and other qualified retirement plans will be exempt.
Self-employed people will have to pay the additional tax.

Medical tax deductions. Beginning in the 2013 tax year, the threshold
for the itemized medical deduction rises to 10% of AGI, from the
current 7.5%. Individuals age 65 and older, and their spouses, would
be exempt for the tax years 2013 through 2016.

Early retirees and self-employed. For most workers who receive
employer-sponsored coverage, the new law is not likely to have much
impact. But the law provides a number of protections for those who
need to buy insurance in the individual market. Six months after
enactment, health insurers cannot place lifetime limits on the value
of coverage or revoke existing coverage. Starting in 2014, insurers
must accept all applicants, including anyone with preexisting medical
conditions.

Until then, individuals with preexisting conditions who have been
uninsured for more than six months will be eligible to enroll in a
national high-risk pool and receive subsidized premiums. Cost sharing
will be capped at $5,950 for individuals and $11,900 for families.
This could be especially helpful to early retirees in Arizona and
Nevada, which do not have state high-risk pools. It could also help
Floridians, because Florida's is not open to new enrollees.

Exchanges and coverage subsidies. Nearly everyone would be required to
buy coverage, or pay a penalty. Early retirees, the self-employed and
others without insurance would be able to purchase coverage through
state-based exchanges. Tax credits would be available to individuals
and families with income between 133% and 400% of the poverty level
(that's $19,378 to $58,280 for a couple).

Private insurance companies could sell policies through the exchanges.
Buyers would choose among four benefit categories.

Retiree health plans. If you are 55 or older and receive retiree
health benefits from your employer, you could benefit from a
government reinsurance program. The program will reimburse employers
or insurers for 80% of retiree claims between $15,000 and $90,000.
Payments from the reinsurance program will be used to lower the costs
for enrollees in the employer plan. The program will end on January 1,
2014. It will not reimburse costs for retirees who are eligible for
Medicare.

Long-term care. In 2011, workers can enroll in a national insurance
program to cover non-medical services in case of disability. After a
five-year vesting period, the Community Living Assistance Services and
Supports program will provide individuals who become disabled with a
benefit of about $50 a day. The program will be financed with
voluntary payroll deductions.

Posted by: Cedric Regula at March 31, 2010 02:21 PM

d4winds: "Retiree medical and prescription drug projections, net of
tax-subsidies justified or not, are subject to present value
calculations and the gains/losses on the deferred tax assets are
recognized immediately into income."

I should have read your comment before posting. So it looks like
Congress may be guilty of no more than ignorance of accounting rules.
I can't complain, as my earlier comment displayed the same ignorance.
But it looks like the JCT had it about right.

Posted by: don at March 31, 2010 02:38 PM

Gene, your comment was very helpful. Thanks. This sounds like it is
mostly a tax accounting phenomena. I'd like to know the cash versus
non-cash impact. My hunch is most or all of Caterpillar's $1 billion
write-off is a non-cash asset that cleanses the non-cash profit they
accumulated on their tax books. If so, my bottom line is - so what,
its not cash? Then it seems like they have a much smaller cash impact
going forward. That would be interesting for Congress to hear about.
Am I on the right track, or all wet?

JDH, given the quick, broadcasted announcement from Caterpillar, I bet
their Chairman is eager to provide data and commentary to Congress. He
was looking for a soap box and now he has a bigger one. Why don't you
stick to economic commentary where you have some expertise?

Posted by: Mike Laird at April 1, 2010 02:35 PM

Mike-

Read the post - lower deductions, more taxes. I understand that taxes
must be paid in cash.

Waxman- I am shocked, shocked to hear that this bill that most of us
have not read has ill effects! Evil Republican businessmen!

Posted by: Rich Berger at April 1, 2010 06:23 PM

It is interesting that the Communications Workers of America union web
site lays this out pretty clearly, though they keep changing the
wording. It appears they are trying to find a way to blame the ATT for
following the law and taking the write-down.

Posted by: RicardoZ at April 4, 2010 08:03 AM

I don't know about the law itself, but based on the WSJ article,
gene's reading seems correct.
For every $100 spent, a company gets a $28 subsidy from the
government. That $28 could be treated in one of three ways:
1) its income to the company for which taxes must be paid.
2) it is not income, but a company is not allowed to take a $28
deduction against other income.
3) it is not income, and a company is permitted to take a $28
deduction against other income.
#3 is the status quo pre-HRC. In otherwords, a company could spend $72
of their own money, and $28 of the governments, but take a deduction
for the whole $100. so they got to deduct, against other income, a $28
"contribution" they did not make because the government made it for
them.
Post HRC, #2 is the situation. The company can take a $72 deduction
for the $72 they contribute, but they cannot deduct, against other
income, the $28 contribution the government made. However, they still
do not have to pay taxes on the $28 becuase it is not income.

By way of illustration:
OLD PLAN: a company earns $1K, spends $72 on heathcare, government
contributes $28, company gets to deduct $100 K so taxable income is
$900.

NEW PLAN, company earns $1K, spends $72 on health care, government
contributes $28, deduction: $72, so taxable income is $1K - 72= 928.
If, as don says, subsidy was taxed, taxable income would be $1K + $28
(subsidy counted as taxable income) - $72 (contribution) = $956.
If the WSJ is correct, Megan McCardle also got this wrong.
In my simple illustration, $28 is the "substantive difference".

Posted by: jwg at April 6, 2010 12:30 PM

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