Uwe Reinhardt, a Princeton economics professor:
A coalition of 300 large American corporations is lobbying Congress to rescind a tax provision in the recently passed health reform bill. This provision forces companies to book sizable write-offs in the current quarter.
In its lead editorial of March 27-28, The Wall Street Journal decried the provision as “The ObamaCare Writedowns,” writing that
ObamaCare passed Congress in its final form on Thursday night, and the returns are already rolling in. Yesterday AT&T announced that it will be forced to make a $1 billion writedown due solely to the health bill, in what has become a wave of corporate losses. This wholesale destruction of wealth and capital came with more than ample warning.
What might have prompted the Obama administration and its allies in Congress to embark on this alleged “wholesale destruction of wealth?” Is it, in fact, a wholesale destruction of wealth?
To understand this issue, it may be well to illustrate it with a familiar analogy: a household expenditure that is deductible from taxable income under current law. For example, consider interest payments on mortgage loans made by homeowners who itemize their tax deductions.
Suppose that last year a homeowner made all his monthly payments on the second year of a 20-year, fixed-rate mortgage loan, which had an A.P.R. (“Annual Percentage Rate”) of 5 percent per year.
Using a standard amortization table for such a mortgage, we find that a homeowner with this mortgage could deduct $14,338 in mortgage-interest payments for 2009 from his taxes.
Now suppose that for some reason, the government had decided to grant homeowners a 30 percent subsidy on that interest expenditure. Consequently, this homeowner gets a check for $4,301 from the government.
What amount should that homeowner then be allowed to deduct from taxable income for 2009 – the gross interest payment of $14,338, or the net interest payment $10,037?
If the former, the homeowner in effect could tax-deduct an expenditure that was actually made for him by the government. Would that be reasonable? Many people would say no.
The answer to this question bears directly on the current brouhaha over the “ObamaCare Writedowns.”
In previous decades, many American companies offered their workers retiree-health plans that promised to cover sundry medical expenses not covered by Medicare, prescription drugs prominently among them. Economists are convinced that, at the time they were made, these promises were substitutes for the cash take-home pay of workers.
Under a Financial Accounting Standards Board statement (FASB ASC 715), business firms since 1993 have had to estimate, at the end of any fiscal year, the total projected cost of all future retiree health benefits promised to employees already on board or already retired at that time. Companies must then add that total to the liabilities on their balance sheets.
To maintain the famous accounting identity
NET WORTH = ASSETS – LIABILITIES
firms also recorded a corresponding reduction in the firm’s reported net worth. That reduction in the firm’s book net worth, however, is not a destruction of wealth. It merely makes visible the net worth that management has already given away to workers in the form of promised future retiree health care ...
Enter now the Medicare Modernization Act of 2003, which since 2006 has provided Medicare beneficiaries with substantial federal subsidies for prescription drugs.
To encourage corporations to continue the provision of prescription drugs to retirees under their retiree health plans, rather than dumping the outlay into the lap of the new Part D Medicare program, the law granted corporations a federal subsidy equal to 28 percent of their outlays on prescription drugs for retirees.
The sum of the projected subsidies in the year the law was passed then became a reduction in the firm’s liability for retiree health care, with a corresponding increase in the firm’s net worth. Once again, this book entry was not an increase in real wealth because the subsidies were mirrored in higher current or future taxes falling on other taxpaying entities.
Now, a question confronting the drafters of the Medicare Modernization Act was analogous to the one raised above for our hypothetical homeowner.
Suppose a firm in, say, 2009 spent $1 billion on prescription drugs for retirees and received from the government a $280 million subsidy toward that outlay.
Should the firm be allowed to deduct from its taxable income only its net outlay of $720 million on prescription drugs for retirees (Option A), or should it be allowed to deduct the full $1 billion (Option B)?
The Bush administration and the lawmakers in 2003 chose Option B ($1 billion in our illustration), in effect allowing corporations to deduct from their taxable income an expenditure actually made by the general taxpayer.
Evidently the Obama administration and its allies in Congress disagree with that decision, for included in the recently passed health-reform bill is a provision allowing business firms to deduct only their net outlay on prescription drugs for retirees (Option A above — $720 million in our illustration).
Under the rules of accounting (FASB ASC 740), this change in the law now forces companies to calculate the sum of the difference between (a) the larger projected tax savings under the Medicare Modernization Act and (b) the smaller tax savings under the current legislation. That sum then is deducted from the asset account “deferred tax assets,” with a corresponding reduction in book net worth.
It is this accounting entry — the required deduction from book net worth — that The Wall Street Journal and like-minded critics of the current health reform bill appear to regard as a “wholesale destruction of wealth.”