The Corner

We Call That Ignorance

The New York Times today editorializes in defense of the provision that is causing all the Obamacare write-downs (“We Call That Double-Dipping“):

The affected companies have already profited from an inequitable provision in the 2003 Medicare prescription drug law. At the time, many employers were already providing drug coverage for their retirees. And to keep them from dropping that coverage, the new law provided doubly sweet subsidies to corporations.

For every $100 the company spends on retiree drug benefits, Medicare sends it a subsidy payment of $28. On top of that, the companies got a rare double tax break. The $28 subsidy is tax-free, and the company was allowed to deduct the entire $100 as a business expense.

I tried to explain the error in this way of thinking about the deduction in a piece I wrote last week; now I see that Megan McArdle has explained it more thoroughly:

Say you have a company that in 2002 was providing drug benefits to its retirees at a hypothetical cost of $2500* per retiree.  Each $2500 you pay reduces the taxes you owe by about a third of that amount, so the actual cost of the subsidy to the corporation is about $1700.

In 2003, the Congress passes a Medicare prescription drug benefit.  Worried that corporations would drop their benefits and stick the government with the tab, they offer a subsidy for firms that continue their retiree drug benefits.  That subsidy, 28% of the total benefit cost (up to a cap), costs the taxpayer on average much less than providing the drug benefits, so it’s a good deal for the taxpayer.

So now the cost to the company for these benefits is $1700-700 or about $1000.  The cost to the taxpayer is $2500-1000, or about $1500–still slightly less than Medicare pays for the average Part D beneficiary, but for much more generous benefits.  One can argue about the economic distortion, but it’s not your traditional “corporate giveaway”.  If it’s a giveaway to anyone, it’s to corporate retirees.

However, had the Congress structured it the way that is now mandated by the new reform, the company would minimize its tax bill by about $600 instead of $800.  The cost of the drug benefits to the company would be $1200; the cost to the taxpayer, about $1300.

So this really is an instance of giving the subsidy, and taxing part of it back, because the company was already getting the standard tax subsidy for its retirement benefit.  On the one hand, you’re giving them a new subsidy; on the other hand, you’re taking away part of the old subsidy.

Congress structured the subsidy this way deliberately, writes American Benefits Council president James Stein in today’s WSJ:

… some historical context is helpful. In 2003 Congress considered enacting either a larger, taxable subsidy or a smaller, nontaxable one. From both the perspective of the federal government and the companies receiving the subsidy, the real economic impact would have been identical either way. For reasons that entirely served the federal government’s peculiar accounting methods, Democratic and Republican lawmakers agreed to the smaller non-taxable subsidy.

We don’t know yet whether companies will actually drop their retiree drug coverage and leave Medicare Part D to pick up the slack — I speculated last week that Henry Waxman’s intent in holding hearings on this issue is to bully companies into keeping their plans and swallowing the bigger tax bill. But we do know that Congress meant the subsidy and the deduction to work together to keep companies from dropping their coverage, and that the total subsidy, including the deduction, was probably calculated based on estimates of how big it needed to be to preserve private plans. Simply put, the government offered companies a payment in exchange for sharing the cost of covering seniors. Now that the government has reduced the payment, it is rational to assume that many companies will ask, “What’s the point?” As Klein writes:

The real story here—and the one that is getting little attention—is that the new law will likely result in a change of drug coverage for 1.5 million to two million retirees as they are moved from their employer-sponsored plans, according to a study we commissioned by former Office of Management and Budget official Don Moran. Reasonable people can differ as to whether shifting retirees to the Medicare drug program is good or bad policy. But two things are certain. First, it will cost the federal government more money. Second, employers will be excoriated when it happens.

They’re being excoriated in advance. The Times concludes its editorial as cluelessly as it began it, writing that companies should keep sharing the cost of covering seniors because: “That’s the least they should do in return for the generous tax benefits they have been receiving.”

Generous? The government is paying them to keep paying for something the government already pays for — “like buying your workers ice cream on Free Cone Day,” as Tim Carney puts it. The Times argues that these companies have been getting a great deal because they’ve been partially reimbursed for all the free ice cream they’ve been buying; the Times further argues that they should be grateful that the partial reimbursement has been so generous; and the Times concludes that they should gladly accept a reduction in the reimbursement. I think it’s more likely that employers will decide to “single-dip,” meaning they will keep all of the money rather than spend it on free ice cream.

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