What's Bad For Big Swifty Is Bad For The United States...

The benefits of Obama are beginning to pour in, and it appears they're starting to land on Barack Obama, Harry Reid, Nancy Pelosi and Congressional Democrats:

An association representing 300 large corporations urged President Obama and Congress on Monday to repeal a provision of the health care overhaul that prompted AT&T, Caterpillar and other companies to announce substantial charges for the current quarter. 

Representative Henry Waxman criticized the charges by large companies, saying the health reform would save them money.

The association, the American Benefits Council, said the provision — which reduces the tax deductions for companies with drug coverage for their retired employees — would deal a significant blow to corporate profits and would discourage companies from hiring more workers.

AT&T announced last week that it was taking a $1 billion charge because of the provision. Deere & Company announced a $150 million charge, Caterpillar a $100 million charge, and 3M a $90 million charge.

Many companies said they were taking these charges now, before the current quarter ended, to comply with accounting rules. But some corporate critics asserted that the companies’ rapid response to the health legislation was aimed at pressing the administration to repeal the provision.

Unsurprisingly, these corporate critics don't know anything about the Securities Exchange Act. If my memory serves me correctly, that particular law requires companies to publicly disclose, via Form 8-K, any unscheduled material event within two weeks of the company becoming aware of said unscheduled material event.

James A. Klein, the president of the American Benefits Council, called the provision “a serious mistake that is having negative and unintended consequences.”

White House officials defended the provision, saying it was a deliberate effort to eliminate what they said was an unusually generous tax loophole.

Well, let's take a look at the numbers and you can decide.

Big Swifty Manufacturing, Inc. is what you'd call your basic very large corporation. Last year it had a $50 million pre-tax profit, and expects to have the exact same pre-tax profit this year. Back in 2004, Big Swifty decided to add the Medicare Part D Retiree Drug Subsidy (RDS) benefit to its existing benefits package for employees and retirees. The cost of that benefit to the company was $10 million before taxes and the government subsidy for providing said RDS benefit.

As Big Swifty is a C corporation and pulls down $50 million in profit pre-tax, its marginal tax rate is 35%. That means the cost of providing the RDS benefit after corporate tax but before the RDS government subsidy is $6.5 million. The government subsidy paid to Big Swifty is a flat non-taxable 28% of the pre-tax cost of the benefit. In this case that amounts to $2.8 million. Subtract the $2.8 million from the after-tax cost of RDS ($6.5 million), and Big Swifty ends up paying $3.7 million of a $10 million employee benefit. The federal government pays the other $6.3 million ($3.5 million in foregone corporate income tax and $2.8 million in subsidies).

That was 2009. Pre-Obamacare. Now things are different.

Big Swifty, Inc. still pulls down its $50 million in pre-tax profit, still has a marginal tax rate of 35%, and still has pays $10 million pre-tax for the RDS benefit. Since the 28% subsidy is now taxable, the cost to Big Swifty for the RDS benefit is now $4.68 million ($3.7 million plus $980,000 (the $2.8 million subsidy taxed at 35%)). On March 23, 2010 the benefit cost the company $3.7 million to provide. On March 25, 2010, the benefit cost the company $4.68 million.

Now, there are a variety of ways Big Swifty Manufacturing, Inc. can react to this development. They are as follows:

1. They can eat the $980,000 and continue on at status quo. This would probably not sit well with investors, and especially with institutional investors like pension funds.
2. They can kill the benefit altogether and save the company $10 million pre-tax ($4.68 million afiter-tax). The problems here would include the effect on employee (and retiree) morale, and the fact that those employees of Big Swifty who are unionized might have the RDS written into their contract.
3. Big Swifty can demand a co-pay from its retirees and concessions from its unions in exchange for keeping the RDS benefit. This is the most likely of all scenarios.

Given that #3 is the most likely real-world scenario here, it's unsurprising that unions aren't at all thrilled about the subsidy's demise, either:

Many employer plans for retiree drug coverage are part of union contracts. In December, the A.F.L.-C.I.O.’s legislative director, Bill Samuel, joined Mr. Klein in writing to Senator Harry Reid, the majority leader, urging the Senate not to enact this provision.

Gerry Shea, the A.F.L.-C.I.O.’s chief strategist on health care, stopped short of calling for a repeal of the provision. “We’re very concerned about the disruption that could be caused because of this, with people being pushed out of employer plans,” he said. “With all the changes we’re looking at because of the new health legislation, we feel you don’t need this.”

If we go back to our example, let's assume that Big Swifty sits down with its employees, retirees and unions and between the three of them they decide to split the difference: Retirees will pay $326,667 in co-pays, the unionized employees will pay $326,667 in co-pays and wage concessions (after-tax) and Big Swifty will pay $326,666 (pre-tax). Nobody's really happy, but the benefit stays.

So what's the financial scorecard?

• Retirees: $326,667 poorer than pre-Obamacare
• Union members: $326,667 poorer than pre-Obamacare
• Big Swifty: $326,666 less pre-tax profits than pre-Obamacare
• Big Swifty's owner/investors: Depends on how the market for Big Swifty stock reacts to lower profits
• The Federal Government: A reduction of the federal deficit by $0.98 million

Tax loophole closed. The government - and only the government - wins.

And the political scorecard?

Well, you'll have to figure that one out ourself.

Comments

[Allen]

Well, I'm convinced. Linda Douglass, the Whitehouse Communications Director for Healthcare Reform said the benefits to the bottom line for businesses will accrue under "The Plan."

Damnit Dennis get with the program, it's not "The Plan" that's the problem, it's the message. It would seem Ms. Douglass has brought her acute business acumen to bear, via her stint as a journalist, and found, "The Plan is great you stupid business people." I paraphrased that last bit.