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The healthcare reform law exposes an extraordinary tax subsidy

March 31, 2010 |  6:22 pm

Perhaps the very first effect of the new healthcare reform law was to cause a number of major corporations to restate their earnings -- dramatically so. AT&T announced a $1-billion charge. Deere & Co. and Caterpillar said they would take charges of $150 million and $100 million, respectively. And Boeing cut $150 million from its first-quarter earnings. That's because the so-called Patient Protection and Affordable Care Act eliminated a 4-year-old tax break for employers that provided prescription drug benefits to retirees. The tax break doesn't go away until 2013, but some companies felt compelled by securities law to report the hit to their earnings right away.

Some critics of the bill have pointed to the numbers as evidence of yet more of the bill's hidden costs to industry and the economy. But it's worth keeping them in perspective. Analysts at Credit Suisse predicted that the restatements would have minimal impact on company valuations, despite the fact that they would add up to a whopping $4.5 billion in lower earnings industrywide. Marie Leone of CFO magazine explains why:

Indeed, the "eye-popping" numbers being reported are not a good indication of the costs being incurred in the first quarter, notes [Credit Suisse] study co-author Christopher Cornett. That's because a quirk in the accounting rules requires companies to recognize the present value today of future cash costs going out as far as the drug benefits are offered. "So that's a big number," says Cornett. (Accounting rules mandate such current-period true-ups when tax-code changes require accounting adjustments to items that are already on the balance sheet, he explains. In most cases, an ongoing future cost would be recognized every quarter, year after year.)

UC Berkeley Economist Brad DeLong also points out that the tax break being eliminated was an extraordinary one to begin with. When Congress was working on a bill to add a prescription drug benefit to Medicare, some lawmakers worried that the new benefit would lead employers to eliminate the drug benefits that they had been providing retirees. So they agreed to reimburse employers for 28% of the cost of any plan that was at least as generous as the new Medicare benefit. That bit of corporate welfare was unusual in and of itself. But lawmakers also made the subsidies tax free, allowing employers to deduct the full cost of the benefit they provided -- even the part financed by the taxpayers

By DeLong's calculation, that approach resulted in the government covering 63% of the price of retiree drug benefits at companies in the top tax bracket. The change will leave the government covering about 53%. As subsidies go, that's still pretty generous.

Nevertheless, you might argue that the reduction in the tax subsidy might lead fewer companies to provide these benefits, and it's better to have the government paying 63% of the bill than 100%. But that overlooks an important reality of the market. Companies don't agree to provide drug benefits to retirees out of the goodness of their hearts. They do it because employees (or more typically, their unions) demand them and are willing to accept lower wages, pensions or other forms of compensation as a trade-off. It's hard to see how such a small reduction in their employer's subsidy would affect their willingness to make that trade.

-- Jon Healey

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