ORACLE

The Accountant’s Parable

Doug Samuelsonsamuelsondoug@yahoo.com

The occasion was a first for Joe, an up-and-coming OR/MS analyst who had boldly started his own consulting company a few years ago. Since the company was a corporation, Joe had hired Art, an accountant, to handle its tax returns. Now he had attained enough success to make an appointment, a couple of months before the end of his tax year, to discuss financial strategies.

Art had recommended a couple of tax shelter investments. “You need to reduce your current-year profit,” Art explained, “but of course you want to do it in a way that doesn’t just throw away money, or get you into trouble with the IRS. The basic idea is to convert current-year income into long-term capital gain, so you reduce the tax bite and shift it into later years where you may be in a lower tax bracket.”

“I think I understand,” Joe said, “but it still just seems weird to me that I’m trying to reduce profit. Isn’t maximizing profit what I’m supposed to be doing?”

“You’ve swallowed a myth from your economics classes back in college,” Art laughed. “Businesses do not want to maximize profit. Profit is what gets taxed, and big profits also attract unwelcome political attention, if you get big enough. Especially if you’re publicly traded, you want small, steadily growing profits, to keep the investors and investment advisors happy. What you want to maximize is growth of assets. And that’s a whole different animal, often kept in a separate set of books. Everyone can see the income-and-expenses accounting, but the asset accounting is more important, and usually less available for outside inspection.”

Joe was nonplussed, and fascinated. “So that’s what a lot of high-tech start-up firms were doing during the dot-com bubble, isn’t it? Don’t make much operating profit, but run up the stock price, and then the executives sell their stock and retire?” he asked.

“Not just dot-com start-ups,” Art affirmed, “and not just managements that want to cash out fast. I have a friend who worked for a big, well-known health insurance company back then. One year they were surprised to discover that they were making a bigger profit than they’d expected. They didn’t have time to find an investment that would shelter income without drawing a lot of the wrong kinds of attention. But they found a solution. They threw a huge holiday party. They invited all their employees and their families, all their suppliers, all their agents, the executives of companies they did big volumes of business with – around 40,000 people, as I recall. They rented Madison Square Garden for the occasion. They had nice catered food, and lots of it. They hired Diana Ross to provide the entertainment. Since all this was clearly meant to nurture business relationships, and maybe it actually did generate some business – who knows? – it was all a legitimate business expense. Which means we taxpayers paid for half of it!”

“How’s that?” Joe exclaimed.

“They’re a big corporation, so they’re in the 50 percent marginal tax bracket,” Art said. “Half their profit gets taxed away. So half the cost of this little shindig turns into a reduction in the tax they pay. When enough companies get to do things like that, the rest of us end up getting taxed more to make up the difference. See?

“And here’s another good example,” Art continued. “Remember back in the 1990s, when many economists compared corporations’ quarterly profits to when they installed information technology? These economists saw little or no change in profits, and concluded that investments in IT don’t pay. I think it was one of your OR/MS colleagues who pointed out that if you analyzed oil companies the same way, you’d conclude that they don’t benefit from striking oil!”

“I’m beginning to think we OR/MS analysts should be paying a lot more attention to the difference between income and asset accounting,” Joe frowned. “What other little surprises are you accountants hiding? And here I thought accounting was just this dry field where people plugged numbers into formulas to produce tax returns, without much creative thinking – no offense, Art.”

“No offense taken,” Art grinned. “You know the old saying, ‘what gets measured gets done,’ right?”

Joe nodded.

“Well,” Art went on, “think about the distortions an accounting system can cause in a field like healthcare. Providers get paid for services, so they have an incentive to do more procedures, and more expensive procedures, with too little attention to what’s actually best for the patient. With many managed care plans, someone else gets paid to be a gatekeeper, limiting what gets done – and their incentive is to block access to expensive care, also without much regard for what’s best for the patient. You don’t need Betsy McCaughey’s ‘death panels’ to ration care; we have private insurers doing that now! But if you shift to a system of ‘capitated care,’ where a provider organization gets paid a set amount to keep a defined set of beneficiaries as healthy as possible, the incentives are in the right direction: more preventive care, more looking for the most cost-effective treatments, fewer heroic but unpromising efforts near the end of life. This is one of the things we should like about Obamacare. And even better, they’ve mandated changing the accounting, looking beyond individual provider-patient encounters to whole sets of treatment. This way, we’ll actually start seeing what long-term patterns of care work best with ailments that have a long duration, like cancer and heart disease. I think it’s no accident that the big killers are mostly these long-term ailments – what we don’t measure, we don’t see, and what we don’t see, we don’t improve!” ORMS

Doug Samuelson (samuelsondoug@yahoo.com) is president and chief scientist of InfoLogix, Inc., in Annandale, Va., and a principal decision scientist with Great-Circle Technologies, Inc., in Chantilly, Va.

Author’s note:

By coincidence (yeah, uh-huh), this topic is related to the lead feature article in this issue. And that analysis about the benefits of IT was in the 2000 “Encyclopedia of OR/MS.”