Health Reform WK-EDGE A taxing medical device situation excised, temporarily
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Wednesday, February 3, 2016

A taxing medical device situation excised, temporarily

By Anthony H. Nguyen, J.D.

“Suspended for two years”—Those are the words the medical device industry has been waiting to hear since the 2.3 percent medical device excise tax was established by the Patient Protection and Affordable Care Act (ACA) (P.L. 111-148) (as amended by provisions in the Health Care and Education Reconciliation Act (HCERA) (P.L. 111-152)). The industry was able to breathe a sigh of relief, albeit temporarily, when President Obama signed a $1.8 billion taxation and spending bill that extended tax credits for various industries and adjusted spending allocations for favored issues of both political parties (see Changes to ACA requirements, COOL, cybersecurity, and more in Appropriations Act, December 23, 2015).

This Strategic Perspective will examine what, if any, impact the suspension of the medical device excise tax will have on the industry.

Why was the excise tax unwelcomed from the start?

The medical device excise tax began on January 1, 2013, and imposed a 2.3 percent tax on the sale of certain medical devices, including pacemakers, ventilators and artificial hips when sold by manufacturers, producers, and importers. The excise tax revenues are used to fund and offset some of the costs associated with the implementation of the ACA.

The excise tax is not imposed on medical devices “generally purchased by the general public at retail for individual use” such as prescription eyeglasses, hearing aids, or contact lenses. Medical devices that are manufactured in the U.S. and are exported abroad are also not subject to the excise tax under the ACA. The excise tax can be deducted from a company’s income tax as part of the ordinary cost of business and, in turn, if a firm is profitable, the effective rate of the excise tax will fall to 1.4 percent.

Immediately from its onset, the medical device excise tax was largely unpopular among industry and lawmakers on Capitol Hill (see Money talks in fight against medical device tax, November 12, 2014). Discussions regarding a repeal of the tax have been ongoing for quite some time (see Medical device excise tax leads to substantial loss of jobs, February 26, 2014, and Hatch files amendments to UI bill repealing medical device tax, employer mandate, April 9, 2014). The excise tax received significant criticism for the alleged burden it would place on new entrants to and small players in the medical device market space although some smaller companies reported no change in bottom line costs for the excise tax’s first year (see Half of small to mid-size companies make no changes in first year of excise tax, February 19, 2014).

Both Republicans and Democrats wanted to repeal the tax since its inception, but the inability to find an offset to pay for the loss funds was cited as the main stumbling block for repeal. Senator Harry Reid (D-Nev) even refused to bring the tax up for a binding vote in the Senate, incurring the consternation of GOP senators (see Revolt against Reid stalls tax extenders bill in Senate, May 21, 2014, and Senate GOP calls for two-year delay of medical device and ACA taxes, May 21, 2014).

CRS says no negative effect. The industry and congressional debate on the drawbacks of the excise tax were in stark contrast to a Congressional Research Service (CRS) report on the potential billions added to government coffers (see Excise tax expected to raise $29 billion, have small negative effect on industry, January 8, 2014). For instance, the CRS data suggested that output and employment in the medical device industry would be reduced by no more than two-tenths of one percent. Additionally, the effect on prices would be low due to the size of the tax rate and the small share of health care spending in the medical device field.

The CRS later asserted that consumers would likely be the group to bear the brunt of indirectly paying for the excise tax (see Industry shouldn’t worry about excise tax, consumers take brunt of financial impact, November 12, 2014). The actual impact of the excise tax on a medical device company could be mitigated in a variety of ways, including: (1) the excise tax can be deducted from a company’s income tax (making its true impact closer to 1.4 percent); (2) a research and development (R&D) tax credit of nearly 2 percent which can also be deducted from corporate income taxes; (3) larger medical device manufacturers raising prices while reducing costs and discretionary spending; and (4) lower corporate tax rates on foreign operations which will also allow larger medical device manufacturers to offset the effects of the excise tax.

Are industry concerns supported by evidence?

Because it is incredibly difficult to convince lawmakers to consider repealing a tax, particularly after the money has been collected, the medical device industry spent millions in behind-the-scenes lobbying on Capitol Hill and campaign contributions to politicians on both sides of the aisle.

Manufacturers like Medtronic, located in Minnesota, spent millions of dollars hiring lobbyists such as those from the Advanced Medical Technology Association (AdvaMed) to advocate for a repeal of the excise tax. In 2014, AdvaMed spent over $2.36 million lobbying in 2014 and nearly $2 million in the first three quarters of 2015. According to the Center for Responsive Politics (CRP), device makers paid more than $30 million in lobbying.

Minnesota is second only to California in the number of people — some 35,000 — working in medical technology at more than 700 companies, so it’s not surprising so much was paid to lobbyists regarding the excise tax. According to AdvaMed, the House passed a repeal of the excise tax at least five times since the enactment of the ACA (see Excise tax repeal bill introduced, again, January 14, 2015). The bills have included two standalone measures, a reconciliation vote, a jobs package and a continuing resolution.

Medtronic had projected that the medical device excise tax would cost the company $210 million during fiscal year 2016. Because companies could deduct the tax when filing other taxes, the overall impact was closer to 1.5 percent of sales. Opponents of the excise tax argued that because it was a tax on sales, the effect of the tax was often on small (often unprofitable) companies. With the suspension of the tax, these smaller companies have expressed hope that the money earmarked for the taxes could be funneled back into R&D and infrastructure to develop medical devices.

Will industry change policy with excise tax suspension?

As discussed earlier in this Strategic Perspective, government reports did not conclude the 2.3 percent excise tax would lead to massive job losses. Instead, the CRS said the tax was unlikely to affect profits because the added costs would largely be passed on to consumers through higher prices. Additionally, the GAO found overall net profits among 30 large-sized companies, including Medtronic, grew 43 percent from 2005 to 2014 (see Has the ACA medical device tax been bad for business?, August 5, 2015). Although profits generally increased between 2005 and 2014, there were three periods during which they fell, the last of which ended in 2011. Profits have risen since then for the industry as a whole.

The top 30 large firms were the most profitable. In fact, they had $90 billion of the $95 billion in sales in 2005 and $129 billion of the $136 billion of sales in 2014, averaging 4 percent growth per year. However, the GAO found that of the 37 small medical device companies, which combined for about 1 percent of total medical devices sales, their sales declined about 12 percent between 2005 and 2014.

There is some thought though that small device companies may now have a more inviting environment for product development with the temporary suspension of the excise tax. Under the excise tax, the funds that small and mid-sized companies would normally put towards product innovation and improvements were potentially allocated towards paying the excise tax, which potentially inhibited market development. This was especially felt by companies with just one or two products and less than 50 employees. As the excise tax was levied on sales and was paid out whether a device earned a profit or not, concerns were raised that the tax would squeeze out R&D funds, because an estimated 7 percent of revenue generally is devoted by device companies to this area.

Yet, industry concerns over the overall impact on medical device companies may have been overstated as the larger, better capitalized companies seemed to operate at similar levels prior to the excise tax. There was concern at the time that U.S. companies might look to use distribution channels overseas, where regulatory processes are less rigorous, to market products thereby preventing U.S. patients from accessing the latest technologies. Whether this would have come to fruition is up for debate, as the excise tax was suspended relatively quickly after it was initially levied. With the suspension coming relatively quickly after the excise tax was levied, it is difficult to conclude that such measures would have been undertaken. Emergo, a group that annually surveys hundreds of U.S. device company executives, found that while 14 percent of respondents cut jobs because of costs associated with the device tax, another 29 percent raised prices to compensate, but surprisingly, 57 percent of companies did nothing.

Thus it seems large device companies, in general, did not change their allocations greatly because of the excise tax. Instead, the ultimate effect was that the larger, more established device firms (particularly those that are publicly traded) had an even stronger hold on the market, as evidenced by government reports of rising sales and profits, thereby reducing the competition. In turn, if fewer innovations made it to market because of fewer competitors, it was patients who stood the most to be impacted.

Regardless, the suspension of the medical device excise tax without an apparent offset may be considered anticlimactic. The device excise tax was originally expected to generate approximately $30 billion in net revenues to support the ACA, under the assumption that greater access to healthcare coverage would create a larger market for medical devices. However, in the first year of the tax, it raised only 60 percent of the expected amount. Thus, the excise tax may not have provided a substantial source of revenue to offset funding of the ACA.

Conclusion

The efforts to end the excise tax by the medical device industry finally paid off, albeit only until December 31, 2017. Whether both large and small companies will realize gains, as advocated during the run up to the suspension, is left to be determined. Although the larger device companies professed harmful impacts from the excise tax, such claims were not supported by government research. Smaller device companies stand to realize benefits, even in a generally difficult market. Regardless, the medical device industry is hopeful that the temporary suspension will turn into a permanent repeal, as the less appealing alternative is endless extensions of the suspension, as is often done by Congress.

MainStory: StrategicPerspectives MedicalDeviceTaxNews MedicalDeviceNews

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