Waxman’s Witch Hunt and U.S. Business Intimidation

Last week Henry Waxman, chairman of the House Committee on Energy and Commerce, and Bart Stupak, chair of the Energy and Commerce Committee’s investigative subcommittee, reacted to several corporate financial filings detailing the expected costs of complying with the new health care legislation with outrage. In a manner befitting the policeman who frequents the casino disingenuously declaring, “You mean there’s gambling going on here?” some in Congress appear not to have read the health care bill or the Congressional Budget Office evaluation of the financial effects of the legislation.

Moreover, the reaction also shows an ignorance of the fact that some corporations and states had already been providing health care benefits superior to the new mandatory alternatives, which will make individuals who had those plans less well-off.

Principally, however, the reaction reveals the continuing progression in Washington toward heavy-handedly influencing corporate operations, whether through the Waxman-style investigations designed to intimidate management, directly allocating capital to favored financial services firms, and banning products based only on discretionary “precautionary” concerns rather than scientific principles.

The Obvious Costs of Health Care Legislation

Don’t get me wrong, this is not a treatise about health care legislation. A better way of organizing the health care industry has been needed for some time now (see, for instance, Milton Friedman’s op ed from 1996, recently reproduced in the Wall Street Journal, March 20, 2010).

Rather, stated in economic terms, the problem is that policymakers have sold the plan on a pure “general equilibrium” basis. Economic general equilibrium approaches maintain an implicit assumption that markets immediately jump from one equilibrium to another in response to an outside shock like policy changes, ignoring completely the adjustment costs of the change. Admittedly, such costs are difficult if not impossible to quantify without micro-level data on individual firms that can be aggregated to an economy-wide view. That is why, however, other “partial equilibrium” economists attempt to take into account the microeconomic roots of macroeconomic fluctuations, striving to better understand those adjustment costs.

In the current health care debate, therefore, the problem is a confusion of aggregate effects with individual effects. Costs for some firms will go down, while those of others will rise before we reach the new equilibrium. Indeed, Obama’s approach in the public has been “let’s live with this a while and see what happens,” meaning let’s ride out the unspecified and ill-understood adjustment costs. The problem is that those adjustment costs are going to be large, given the magnitude of the legislation, itself.

All along, though, there was an assumption that tax benefits to firms of offering health care plans to their employees would decline. While the Congressional Budget Office markup of the legislation showed a “net reduction in federal deficits of $118 billion over the 2010–2019 period,” (CBO letter to Harry Reid, March 11, 2010) that was never expected to arise merely from eliminating waste, fraud, and abuse. Rather, the principal effects would be from increased tax revenues, which are higher costs to US businesses. It is therefore a Congressionally-acknowledged mathematical fact that removing tax benefits for American corporations that cover employee healthcare costs will hurt many corporate balance sheets.

Decreased Tax Advantages Hurt the Largest Employers the Most

That the cost effects are reflected primarily at firms with human capital-intensive production functions is no accident. Health plans don’t matter to machines, only humans.

Moreover, as different firms’ employee bases differ, so will health care costs and therefore the ramifications of decreased tax benefits to corporations for providing health care coverage. Firms with young unmarried employees without families will be relatively unscathed, while those providing career employment seeing workers through family development and retirement will bear more of the burden. Similarly, states like Louisiana and Massachusetts, which had long provided health care for their citizens, will be worse off under Obama-care than others that did not.

Most of the immediate concern focuses on the corporate tax exclusion for prescription drug plans, which exempted employers providing generous benefits from adding those to employee compensation, saving employees roughly 28% of the cost of the plan – the tax that would otherwise be paid on the value of the benefit. The Employee Benefit Research Institute estimates the value of this exclusion at about $665 per person next year, netting the Federal Government about $5.4 billion in additional tax revenues when those benefits will be taxed at the corporate tax rate of 35%.

As a result, AT&T – the tenth largest US firm by employee headcount on Forbes’ Global 500 list and the 32nd largest worldwide as well as the target of government incentives to provide health care to legions of its retirees from decades of legacy operations prior to the government’s breakup of the firm – expects to face substantially higher costs of providing prescription drug coverage plans that will be taxed at 35%, up from 0%.

On top of AT&T’s $1 billion, the write-down wave so far includes $150 million for Deere & Co.; $100 million at Caterpillar; $31 million for AK Steel; $90 million for 3M; and up to $20 million for Valero Energy. Verizon has also warned its employees about its new higher health-care costs.

There will be many more in the coming days and weeks. In all, the Wall Street Journal reported that David Zion, an analyst with Credit Suisse, expects S&P 500 companies to take a combined hit of $4.5 billion to first-quarter earnings.

Most consulting firms and independent analysts say the higher costs will induce some companies to drop drug coverage, which could affect about five million retirees and 3,500 businesses. The same Medicare coverage would cost an estimated $1,209 per person, instead of the $665. At least the firms reporting the writedowns are still planning on bearing the cost of the more cost-effective (for the government) plans.

Threatened Congressional Investigations are just the Most Recent Attempt to Intimidate US Businesses to meet the Administration’s Political Goals

All of this was covered in the media prior to and during the bill’s passage. Acting surprised after the fact and launching investigations is therefore destructive to American business.

Securities and Exchange Commission financial accounting rules require that corporations immediately restate their earnings to reflect the present value of their long-term health liabilities, including a higher tax burden. Without alleging any SEC compliance violations, however, Waxman and Stupak have ordered AT&T, Deere & Co., Caterpillar and other firms reporting objectionable results to produce by April 9, 2010: (1) any analyses related to the projected impact of health care reform on the companies; (2) any documents, including e-mail messages, sent to or prepared or reviewed by senior company officials related to the projected impact of health care reform on the companies; and (3) a full explanation of the accounting methods used by the companies since 2003 to estimate the financial impact on the company’s of the 28 percent subsidy for retiree drug coverage and its deductibility or non-deductibility, including the accounting methods used in preparing the cost impact statements released by the companies. Those materials will be the subject of a Congressional Hearing scheduled by Rep. Waxman for April 21, 2010.

But the April 9 deadline for production of disparate confidential material is certainly too short to ensure legal review for compliance, maximizing the conflict in the hearing and placing the firms at risk of full Congressional subpoenas and more threats from Chairman Waxman.

Waxman and Stupak’s efforts are merely an avenue of intimidation, accompanied by no formal charges of any wrongdoing on the part of the companies subjected to this scrutiny. I fear that the culture of intimidation on Capital Hill, fueled by the credit crisis, environmental regulation, and now health care, is growing, and will be deleterious to US business growth and development for many years to come.

Conclusion

As stated earlier, the problem with legislation such as health care is the pain of reallocation, even if the overall benefits are worth the price. Despite Britain’s “Big Bang” sea change in financial regulation occurring in 1986, for instance, the British government was right to monitor markets for decreased activities and perverse incentives that could debase economic performance and set the stage for crisis. Entertaining three “Big Bangs” in the US – in health care, financial services, and environmental policy – during a recession while willfully ignoring the potential for such disruptions sets the stage for potentially massive economic difficulties. Moreover, using those costs as justification for more intervention is counterproductive to the very business investment that is so crucial for economic recovery.


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