Health Care Subsidy Provision Causes Stir

Thu April 15, 2010 - Northeast Edition
Giles Lambertson



America’s drawn-out and contentious debate about health care did not end with the passage of the Patient Protection and Affordable Care Act, which was signed into law March 23. In some respects, the national argument has just begun — and construction equipment manufacturers Caterpillar and Deere & Co. suddenly find themselves at the heart of it.

Just two days after the bill’s signing into law, President Obama was in Iowa when Deere, Iowa’s largest employer, announced that the value of its assets dropped by $150 million as a consequence of one of the law’s provisions. Deere said the change would be recorded as a one-time cost in the second quarter; its stock dropped the next day, losing 29 cents per share to $60.20.

The construction and agriculture equipment manufacturer was not the only company to notify the U.S. Securities and Exchange Commission of its bookkeeping loss — as required by law. Fellow equipment-maker Caterpillar announced a $100 million loss, characterizing the law’s pertinent provision as a “tax increase.”

“Although this tax increase does not take effect until 2011,” the company’s SEC filing stated, “Caterpillar is required to recognize the full accounting impact in its financial statements in the period in which the act is signed.”

Firms besides Deere and Caterpillar that have announced the impact of the law on their bottom lines include, among others, AT&T ($1 billion), Verizon ($970 million), 3M ($80 million), AK Steel ($31 million) and ethanol refinery owner Valero Energy ($20 million).

The estimated total impact on businesses is $4.5 billion, as calculated by Congress. Private sector estimates range as high as $14 billion.

However, some companies report no immediate consequences. Terex Corp. spokesman Michael Bazinet said the company is still looking at the healthcare law “to gauge overall impact. However, with regard to the Medicare issue for retirees that is affecting Cat and Deere, we will not face this impact.”

A spokesman of Volvo Construction Equipment North America said that the company is not apt to know for some time how its “bottom line” will be affected.

“We are currently still analyzing the legislation and our experts are working on evaluating the effects,” said Beatrice Cardon, vice president of corporate communication.

The Provision

The nature of the provision in question is disputed. What Caterpillar terms a “tax increase,” a White House spokesman said just “closes a loophole.” Essentially, both views are correct. The provision changes the tax code to eliminate a deduction, which causes some companies to have lower after-tax profits.

The “loophole” was created knowingly by 2003 legislation that added a prescription drug benefit to Medicare. Because some companies already provided the drug benefit to their employees, Congress worried that those companies would simply drop their plans and let the retirees move onto the Medicare plan, thus upping the cost to taxpayers.

So a deal was struck: A 28 percent subsidy, which Washington gave companies for continuing to offer a drug benefit, would not be counted against the companies at tax time. In other words, a company was allowed to ignore the subsidy in its tax calculations and deduct 100 percent of funds spent on drug coverage. The new law eliminates that privilege, meaning that a company can only deduct 72 percent of its drug benefit expenditures at tax time.

Though the provision doesn’t take effect till 2013, the SEC requires that such projected changes in liabilities and assets be reported as soon as changes are known so investors have a clear picture of a company’s worth going forward. On March 23, affected companies knew their financial statements had changed. The SEC filings followed.

The reason the “loophole” was signed into law in 2003 was to induce companies to keep their retirees in their own programs rather than dump them into Medicare Part D. According to benefits consultant company Towers Watson, some 3,500 U.S. employers are eligible for the drug benefit subsidy, with more than 6 million retirees in company plans.

Towers Watson researchers concluded that the federal subsidy costs taxpayers less than $700 per retiree — about half what it would cost taxpayers were the retiree on the Medicare drug plan. So taxing the incentive provision will reduce the value of the subsidy — the incentive — about a third.

How many companies will drop their drug plan now depends on a variety of considerations, including the new law’s overall cost to them. One study by a former Office of Management and Budget official predicts as many as 2 million retirees will be shifted to Medicare.

“The 2003 legislation encouraged companies to stay in the game and continue to fund their retirees’ prescriptions,” Deere spokesman Ken Golden said when the company announced its $150 million charge against earnings. Neither Deere nor any other company has announced how long it will remain “in the game” now that the rules have been changed.

The Reaction

The company announcements were not well received in Washington by advocates of the healthcare law. In fact, Rep. Henry Waxman ordered chief executive officers of Deere and several other companies to testify before a hearing of his House Committee on Energy and Commerce. They were ordered to bring with them to the April 21 hearing various company documents justifying their actions.

The summons was generally — though not universally — seen as an act of political intimidation. It probably surprised executives at Caterpillar and nine other companies, including Verizon and Boeing, who had forewarned House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid of the immediate consequence. In a December letter, the companies declared that passage of the bill would mean they would need to “immediately account for the present value of this tax increase” by adjusting their earnings statement.

For his part, Congressman Waxman said he only wants to get at the truth. In the letter to James W. Owens, CEO of Caterpillar, Waxman said he wants to ensure that the healthcare law “is implemented effectively and has no unintended consequences.”

Responding to Caterpillar’s “assertions” that the law would cost the company immediately and jeopardize the ability of the company to continue its drug benefit plan for its retirees, Waxman wrote, “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.” He cited some Congressional Budget Office (CBO) analysis to prove his point.

The CBO citation does not impress David L. Kendall, professor of economics and finance at the University of Virginia at Wise. Kendall said he tells students in his classes to find one — one! — CBO forecast of the cost of a program that didn’t prove to be half of what the program eventually cost. He sees the same dynamic at play in the healthcare law.

Kendall calls himself a citizen — rather than a Republican, Democrat or independent — and said, therefore, he isn’t being partisan in characterizing the healthcare bill as “quite possibly the most hideous piece of legislation this country has ever seen.”

The professor offers no opinion on the particular subsidy provision that suddenly has Caterpillar and Deere in hot water with some members of Congress, but expresses total assurance that business and personal taxes inevitably will increase.

“It absolutely is the case, without question, unequivocally, that our taxes will have to go up for this bill to be implemented. That is not difficult at all to understand. Anyone who says otherwise is living in La La land.”

Veteran business and economics editor Megan McArdle of The Atlantic magazine finds a bit mystifying Waxman’s demand for corporate executives to testify.

“What AT&T, Caterpillar, et al did was appropriate,” she wrote in her regular published column. “It’s earnings season, and they offered guidance about, um, their earnings. Obviously, Waxman is incensed because this seems to put the lie to the promise that if you like your current plan, nothing will change.

“But this was never true. Medicare Advantage beneficiaries are basically going to see their generous benefits slashed, retiree drug benefits suddenly cost more and may now be discontinued, and ultimately, more than a few employers will almost certainly find it cheaper to shut down their plans. If Congress didn’t want those things to happen, it should have passed a different law,” McArdle wrote.

The business editor suggested Congress should marshal its facts and defend the law, rather than attack private sector critics.

“At the very least,” she wrote, “I think we can ask that they [members of Congress] refrain from trying to force companies to join them in denying reality by threatening congressional investigation of any company who dares to notify investors that this thing is going to cost them money.”

Kendall suggested that the true impact of the 2,700-page law cannot yet be known because most of it will never survive the start-up process. The immediate write-downs aside, many of the bill’s parts simply are unworkable, he said.

“The bill that has been passed won’t see the light of day. It will be amended before any provision of it is put in place. The provisions have absolutely no chance of being implemented before being put into effect.”

In the meantime, companies in and out of the construction industry are waiting to see what comes from the April 21 hearing before the House committee. How committee members and business executives communicate to one another at the microphones might give everyone an idea of what to expect as the rest of the health care law rolls out for public examination.