Time for a reality check on the medical device tax

By: 
August 06, 2015

If you have been following the debate swirling around the medical device excise tax, as I have, you might have been startled by some recent headlines trumpeting that large medical device manufacturers have continued to see their profits increase, despite the 2.3% tax on the sale of certain medical devices. This is quite a contrast with what many in the medical device industry have pilloried as a job killer and stake in the heart of medical innovation. So, what gives?

 

Hywards
Image courtesy Hywards/freedigitalphotos.net.

The recent headlines came on the heels of a report published by the Government Accountability Office (GAO), which analyzed information on the net sales and profits of 102 medical device companies before and after implementation of the Affordable Care Act (ACA), aka Obamacare, based on their filings with the Securities and Exchange Commission (SEC). The study was requested by Senate Minority Leader Harry Reid (D-Nev), who is a supporter of the device tax.

The GAO found that net sales increased overall for the companies it examined from about $95 billion in 2005 to about $136 billion in 2014, which is in the neighborhood of a 43% increase over that period and an annual increase of about 4%. Net profits also increased overall from about $11.4 billion in 2005 to about $16.5 billion in 2014. Not too shabby.

However, the GAO notes that it does not infer a causal relationship between provisions of the ACA and changes in companies' sales or profits since other factors, such as mergers and acquisitions and new product introductions, may have played a role. It also noted that a solid majority of the companies reported uncertainty about the full impact of the ACA in their financial disclosure statements to the SEC, while some noted that the tax, reimbursement changes and coverage expansions likely had an impact on their earnings. I would add that companies plan business strategies well in advance, and they may have already enacted measures—layoffs, plant closures and other cost-cutting moves—to offset the perceived impact of the device tax.

Industry trade association AdvaMed, which has been an effective mouthpiece for industry in opposing the device tax, raised a few issues it had with the GAO report in a statement it released on July 30. Notably, according to a survey that it conducted, "more than half of medical device manufacturers have reduced their R&D budgets as a result of the tax, hampering innovation and slowing medical advancements."

The association also has published compelling anecdotal evidence on how the tax has negatively affected industry. B. Braun, for example, said that, because of the device tax, the company did not hand out raises to its workers for the first time in its history. "And we did it twice," said Senior VP and CFO Bruce Heugel. "We are not proud of it. We cut clinical trials. We cut research and development. We cut capital investment and product line expansion."

Steve Ferguson, Chairman of the Cook Group, said that the tax led his company to put on hold plans to open five new medical device manufacturing plants in the United States. Instead, it is using "the capital intended for these projects to pay the excise tax," said Ferguson.

In its critique of the GAO study, AdvaMed noted that the office examined only companies that filed SEC statements, which represent a small part of a highly diverse industry. It also called attention to the fact that the statistics represented global earnings. As AdvaMed notes in a paper on the medical device tax, "what is important for jobs and U.S. patients is what is happening here at home." And then there is the question of context.

AdvaMed CEO and President Stephen J. Ubl cites a report from Ernst & Young published in 2013, the first year of the tax, which found that public medtech companies saw revenues, employment and R&D spending increase. "However, setting is important," adds Ubl.

"The economy is still slowly emerging from the worst economic downturn since the Great Depression, and the medtech industry was impacted like all others," notes the report. A closer examination of the facts, as articulated by Ernst & Young, shows that:

  • Growth in net after-tax income was zero.
  • Growth in gross revenues was just 30% of the pre-recession average and 40% less than the average during the recession (2008-2011).
  • Growth in R&D spend was just 40% of the pre-recession average and less than the average during the recession.

More worrisome in some respects is the drop in venture capital investment in medtech companies, states Ubl, which has declined 43% between 2007 and 2013, and a whopping 73% in early stage companies, "the seed corn for future medical progress."

"The bottom line is that the medical device tax is simply indefensible from a policy standpoint—it's bad for patients and bad for a critical U.S. industry," writes Ubl.

Fair enough. The business case for a repeal or revision of the device tax is sound. The U.S. medical device industry has been an engine of growth and job creation, and, by and large, it has created those jobs in the United States. The debate gets a whole lot messier in the political sphere, though.

As I wrote in an earlier blog post, it's clear that many opponents of the device tax in Congress are, in fact, using this as an opportunity to degrade and destroy Obamacare. The problem is, with few exceptions, opponents of the ACA have yet to offer a realistic alternative.

Turning back the clock to a time when insurance companies could refuse coverage based on a pre-existing condition and huge numbers of people went without insurance because they could not afford it would be nuts. Everyone knew back then that the system was unsustainable, and the passage of time has not healed that wound.

The market-based and state-based alternatives that Republicans occasionally float are dusty, old ideas that lack imagination.

And if by some unexpected turn of events the Senate were to muster enough votes to repeal the device tax, the question then would become how to offset the lost revenue, which helps to fund the ACA. Forbes contributor Len Burman has an idea: Let's tax cigarettes, instead. Burman argues that "the Joint Committee on Taxation estimates that raising the cigarette excise tax by 50 cents from $1.01 to $1.51 would bring in about $37 billion over the 10-year budget window, more than offsetting the $29 billion in revenues lost if the medical device tax is eliminated."

I don't know—I think we may have been to that well a few too many times and reached the point of diminishing returns. Remember, in addition to the federal tax on cigarettes, there are state taxes, some of which surpass $3 per pack. Making cigarettes prohibitively expensive may be a positive in terms of preventive health, but it would not achieve its goal of offsetting the device tax as fewer tax dollars stream in.

But at least Burman is offering a constructive alternative and not using opposition to the device tax as a means of dismantling the ACA. Political class (and I write this on the day of the first 2015 Republican presidential candidates debate): Please take note.

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