Health Reform Watch: AT&T takes $1 billion charge from health reform, files Chapter 11

The folks on the Wall Street Journal are starting to get hysterical over the $1 billion charge that AT&T took due to changes in health reform. What happened, exactly?

First, some accounting. AT&T took a $1 billion charge against earnings. This is not the same as the company writing the government a check for $1 billion. And the headline about AT&T going bankrupt is a joke.

The company, being heavily unionized, has many retirees for which it provides health benefits. In this case, it pays them some benefits for Medicare Part D, which is the prescription drug benefit. Previously, those payments were deductible, meaning that the company could deduct the value of those retiree benefits from its earnings when figuring its tax liability - just like a company can deduct the cost of its employee salaries from its earnings. Earnings, in the accounting sense, are what a company earns after its cost of doing business (like infrastructure, administration, etc), but before depreciation, amortization and taxes.

During the enactment of Part D, many companies threatened to drop drug coverage for their retirees, since they could then get the drug benefits through the public program. Congress then decided to give them a 28% subsidy to continue delivering the benefits - a significant subsidy. Corporations deduct salaries, retiree benefits and other costs like infrastructure from their revenue to figure their taxable earnings, and under the previous regimen, they were allowed to deduct the entire value of their contributions to drug benefits including the cost of the subsidy. Under health reform, companies are now not allowed to deduct the government subsidy from their earnings, which is what should have happened all along.

Ironically, this information comes from a WSJ article by David Reilly, Ellen Schultz and Ron Winslow.

At the time Congress granted the subsidy and allowed companies to deduct the subsidy from their taxes (and again, they should not have allowed companies to double-dip by also deducting the subsidy from their taxes), AT&T reduced its future tax liability by $1.6 billion. The charge they have taken for $1 billion affects their current earnings, but it is a non-cash charge. They will have to pay about $1 billion in extra taxes over a period of many years - basically, over the lives of their retirees. Due to accounting rules, they had to charge off the entire amount now.

A different WSJ article says that the impact to Caterpillar's bottom line, will be more like $7 million per year - in comparison, they took a $100 million charge, their retirees will receive $240 million in government subsidies from 2010-2019, and their profits last year were $895 million.

The companies probably correct in their accounting, but people should not be misled - AT&T is NOT out $1 billion in cash right this second because of health reform. Nobody is going to go bankrupt over this accounting change. In contrast, if we fail to control costs, the entire country is going to go bankrupt.