• Repealing the medical device tax

    It’s not by chance that we spend much more time on this blog talking about what Obamacare does than on how it raises the money to do it. We’re much more interested in health policy than in tax policy. Well, at least I am. We’re also focused on the outcomes, not necessarily the process. That’s why we can defend the need for an individual mandate, while also acknowledging that other mechanisms might get us the same results. It’s also why we aren’t spending as much energy defending the employer penalty, which has a much less important function.

    Which brings me to the medical device tax.

    Honestly, I just don’t care that much about it. As I’ve long advocated that everyone in the health care industry is going to have to suck it up a bit to make real reform happen, I imagined this was the way that this industry would contribute. Hospitals are shrinking. Doctors are complaining about taking a hit. The pharmaceutical industry gave concessions. The insurance industry is going through a major transformation. Hell, even tanning salons were taxed. The medical device tax is another way that we’re going to raise revenue so that even more people could buy what they make.

    I get why the industry doesn’t like it. But repealing it just makes the deficit worse, no? Again, this isn’t my thing. So I’m outsourcing this to Tim Carney:

    The medical device tax, like the rest of Obamacare, is bad. Congress is correct to repeal it. But the whole scene demonstrates again the way Washington works: Obamacare hurts many people and many industries, but those with access to power often escape the harm.

    Obamacare created a 2.3 percent excise tax on the manufacture and import of medical devices. This tax doesn’t really fall on patients, except in very indirect ways.

    According to Ernst & Young, the federal government — through Medicare, Medicaid, the Veterans Administration, and the Department of Defense—accounts for a majority of U.S. spending on medical devices. This limits device makers’ ability to mark up prices and pass along costs. This means most of the tax will come out of device makers’ profits, while private health-care institutions and consumers may also bear a portion of the cost.

    How bad should we feel for the device makers?

    USA Today reports: “Medtronic, the largest independent U.S. device maker, has gross profit margins of about 75 percent — compared with an average of 46 percent for the Standard & Poor’s 500. … Even after overhead and research and development, Medtronic reported pretax cash flow of 34 percent of its 2012 sales, well above the 24.5 percent average for U.S. corporate leaders.”

    Also, Obamacare’s subsidies and mandates boost demand for medical devices. Market analyst Ducker Worldwide predicts “the newly insured will increase overall primary demand for the industry’s products by 3 percent after 2014.” Further: “The newly insured will demand medical products and services that are more expensive than they can now afford. This will support significant price increases.”

    Although Tim and I disagree on just about everything else related to Obamacare, we can agree that government often seems beholden to corporate interests. He sees a cherry-picked repeal of the medical device tax as a win for lobbyists and rigged government. I don’t think he’s wrong.

    @aaronecarroll

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    • Uh, you’re wrong. Medtronic may be doing quite well, but they are hardly the only medical device maker out there. It’s like saying “McDonald’s is hugely profitable, so we can put a 2.3% gross receipts tax on all restaurants.” Restaurants have one of the highest failure rates among small businesses, and the average profit is between 4 and 6 percent.

      And I’m not sure it’s fair to say that repealing this tax would be ‘cherry picked’ and a ‘win for lobbyists and big government,’ any more than the Democrats repeal of the ‘luxury tax’ on yacht makers was. It was a matter of recognizing that they’d done something extraordinarily stupid that destroyed an industry, and then tried to fix it.

      Imposing a 2.3% gross receipts tax on companies that don’t have profits (which is the case for many small, start-up device makers) is just bad policy. There’s a reason why Elizabeth Warren and Amy Klobuchar, hardly right-wing pro-corporate shills, want to see this tax repealed.

      • Exactly. I’ve made similar arguments before elsehwere:

        “-This is a 2.3 percent tax on gross sales, right? If gross sales are $10, and profits are 10% or $1, then a 2.3 percent tax on gross sales wipes out roughly a quarter of the firm’s profits. For early stage companies with sales but with current operating losses, or negligible profits this could easily mean either paying taxes on losses or imposing losses on break-even revenues.

        It’s also worth noting that profit realization is not evenly distributed over the product cycle – there are often many lean years or outright losses despite healthy or growing gross sales figures while device companies invest in scaling up production, etc – and forcing early stage companies to pay 2.3 percent of gross sales during the early stages of their product cycles could have a much more dramatic effect on the sector than most people would expect – “Hey – the sector is very profitable and it’s only 2.3 percent, so what’s the big deal?”

        My prediction is that the magnitude of the effects at the margin – ranging from whether or not companies can raise sufficient capital to bring a given new device to to market to where they decided to make the said devices will be far more significant than one might guess just by looking at the number 2.3 percent.”

        • But the same can be said of hospitals. A sizable minority have margins 1-2%.

          Medicare approx 40% of revenue.

          After ACA performance penalties, very likely, they lose 1% of Medicare, absolute.

          Thats 0.4% off a razor thin margin.

          Mayo and Partners will sleep at night. The small shops take the hit.

          The grass always greener.

          Brad

      • I’m curious to hear your thoughts on the increase of demand the ACA will grant device makers. Are we more concerned about margins or gross profitability?

        http://www.elsevierbi.com/~/media/Supporting%20Documents/The%20Gray%20Sheet/39/15/WellsFargo_benefits_Of_NewInsured_vs_DeviceTax_Impact_Report.pdf

        I thought this report by Wells Fargo was interesting given their claim that the ACA would lead to a cumulative increase in volume by 3.6% from 2012-2022 and thus offset the 2.3% tax.

        • I hope you don’t do your own taxes.

          $100 in revenue @ 10% profit margin. Feds/state currently take 20% in income taxes, so $2 in taxes and $8 in profits after taxes w/o GRT.

          $100 ==> $103.60, per the Wells Fargo study. Same fed/state income tax take, 20% of $10.36, so $2.07 in taxes and $8.29 in profit.

          Now subtract 2.3% of gross revenue for the medical device tax. $8.29 – $2.30 = $5.99.

          So the profit from that 3.6% boost in overall revenue pretty much gets wiped out, and then some – about 1/4 of all profits in this case. Now do this exercise for a company with a 5% profit margin. Or a 50% profit margin if you want. The numbers turn out the same – a hit to profits, which is not recouped by any increase in volume.

          • You know, you’d be a much more effective debater if you didn’t act like a 12 year old child and drop the elitist sarcasm and snark. It’s tiresome.

            I’m well aware of how taxes and margins work. I could do that math just fine, thanks for changing the subject.

            You simply disagree with the Wells Fargo method. Got it – won’t bother asking you questions again.

            • You asked my thoughts, I explained them – sorry if that’s considered changing the subject, elitist, snarky, or 12-year old behavior.

              If you could do the math, you would have realized that an increase in volume doesn’t translate into sufficient profits to ‘offset’ the GRT, at least not unless profits are running well north of 50% across the industry. The Wells Fargo paper barely mentions it in passing, it’s not at all included in the actual analysis as near as I can tell. Not something I’d place a lot of stock in.

            • Sean, you are so frustrating because you don’t focus on the details and you jump to conclusions to support your own preconceptions.

              The Wells Fargo study notes their assumptions on gross margin:

              “We estimate the median cumulative volume benefit in the
              U.S. from the increase in coverage due to the ACA between 2012 and 2022 will be 3.6%. Based on average gross margin of 60-70%, we believe that the benefit from increased healthcare coverage should be largely sufficient to outweigh the cost of the 2.3% excise tax in most major device categories (see Figure 11). We should reiterate that the incremental benefit appears to be greater for most of the orthopedic categories vs. the cardiovascular categories. It’s also important to note that our analysis focuses on the U.S. only, which accounts for about 55% of worldwide sales among our 15 covered companies. Therefore, the impact of the ACA on worldwide sales would be almost half of the impact in the U.S. ”

              You seem more focused to attack my own knowledge and ability to analyze data, when I’m more interested in a response to the validity of that statement. Perhaps I should have been more clear initially. I honestly do not know if a GM of 60-70% is even remotely reasonable and the report isn’t clear on how it derived this number.

              Note that we are only talking about a few major players in the device industry.

              You clearly don’t know enough to answer the above, so I’m sorry I asked.

      • Sean,

        Amy Klobuchar not “a pro-corporate shill?? Hardly. Her top 10 biggest contributors in 2013 include Medtronic at #7, along with US Bancorp, Target, Xcel Energy, Comcast, 3M and Microsoft. Those remaining on her top 10 list are law firms likely lobbying for these same corporations. It’s pretty obvious where Klobuchar interests lie, and it’s not people’s health.

        • So, some of the largest employers of Minnesota residents have lots of their employees donating to Klobuchar. This is a surprise, or proof of perfidy? Totally off-topic, but it reminds me of the ‘reform’ group several years back that wailed that because of campaign contributions, the head of Anheuser-Busch could get a meeting with Senator Clair McCaskill while the ‘little guy’ couldn’t. Of course. Because without campaign contributions, there’s no reason to think a Senator from Missouri would ever, you know, meet with the largest private-sector employer in the state…

    • The criticisms of the medical device tax are greatly overblown, as the column you cite explains, and as I’ve written (for example, http://www.cbpp.org/cms/?fa=view&id=3684 and .

      One more point: The medical device tax, like all taxes, is designed to raise revenue. If we repealed the device tax, we would have to make up the money by raising some other tax or cutting spending. And if it were possible to come up with some acceptable offset, I’d rather use it to pay for something more critical, such as an SGR fix or scaling back the effects of sequestration on discretionary health programs, or to reduce the deficit.

      • “Top device manufacturers are highly profitable and can easily absorb the tax. A new report by Consumers Union examines the financial statements of 18 leading device companies and finds that they are all well situated to absorb the tax without a significant effect on their bottom line. Investors apparently agree. Since the tax took effect in January 2013, the stock prices of the top device manufacturers have generally outperformed the market averages. For example, Medtronic is up 29 percent, Johnson and Johnson 24 percent, Boston Scientific 104 percent, and St. Jude Medical 46 percent — compared to a 19 percent increase in the S&P 500 stock index.”

        -The medical device sector is composed of quite a bit more than “top device manufacturers,” and this argument totally ignores the effect on small, early stage companies who may not even have operating profits, let alone the capacity to “easily absorb the tax.”
        Making it harder for small, innovative companies to obtain initial funding or secure enough financing to bring a product to market will only serve the interests of the larger players.

        Have you considered the effects of this tax on small and early stage companies, and if so, are you prepared to claim that the effects on them will also be negligible?

        • How much of the market is comprised of these small device manufacturers?

          Where has most of the innovation come from? Small or large manufacturers?

          Your theory on how this hurts small start ups is probably correct, but if small start ups have a negligible impact on the market as a whole – why should we care? The goal here is to improve health outcomes and lower longterm growth in expenditures on healthcare.

          How much overlap is there if the above is your goal, rather than nurturing small business?

        • But if the top companies pay most of the tax–by one estimate 86 percent–as the Consumer Reports article points out, and top companies won’t be adversely impacted, why should the large companies be let off the hook?

        • If you read the report you would see that it only speaks only to the ability of large manufacturers to pay the tax and holds open the possibility that smaller companies may be different. If large manufactures can absorb the tax, they should pay it as they account for most of the tax revenue anyway. Other stakeholders benefiting from expanded covered customers have to pay, the large manufacturers should have to pay. The tax could be adjusted to meet the concerns of smaller companies while having the large, highly profitable companies continue to pay the bulk of the tax.

    • Think this through. “Oh, the tax will be paid out of the profits, not out of what they charge their customers.”

      OK. Assume that’s true, So the tax reduces the profitability of the medical device industry.

      Is capital unlimited, or limited? Is investment capital available to all industries evenly or do investors rationally seek out area of high return?

      A reduction in the profitability of an industry is likely to (A) reduce (B) increase investment in that industry.

      A reduction in investment in the medical device industry is likely to (A) reduce or (B) increase innovation and new discoveries from that industry.

      A reduction in innovation and a slowdown in the deployment of new inventions is likely to (A) reduce or (B) increase the number of people who die because there’s no widget that can fix what’s wrong with them.

    • I’m sympathetic to the cause of supporting small businesses in any industry, and so I’m wary of the device tax for all the reasons Sean lays out above. And I think Robert presents a compelling logic chain demonstrating that reduced profitability may indeed slow growth and innovation in this industry (by reducing the incentive for small players to get/stay involved).

      However, I cannot accept the implicit assumption that underlies the industry/Sean/Robert’s view: that all innovation is inherently good (from an individual patient and societal perspective). Rather, I would posit that at least *some* innovation can in fact be neutral (i.e. a new, “innovative” product is merely more expensive and no more effective/useful that its predecessor) or even bad (i.e. new product is both more expensive and less effective that its predecessor, but nonetheless is profitable because of aggressive marketing to patients who demand it on the grounds that its new and they don’t know any better otherwise).

      IF we had a robust system for making and disseminating such determinations based on clinical evidence, THEN I might conclude that we should not stymie *true* medical device innovation by (increased) taxing of firms that provide it. However (PCORI aside), such a system does not exist and so sorting out good from bad innovation takes many years of accumulated patient outcomes and research. One possible way to reduce the incentive for firms to produce “bad” innovation is by lowering the profitability of such innovations–hence the device tax.

      This of course ignores the political reasons for the tax, namely that all industries need to contribute something to the effort to expand coverage/access.

      Thanks,
      SB

    • @SB

      The problem is that no such system for objectively sorting out “true” innovation from false innovation. While you can certainly devise a methodology for determining the clinical of various medical devices, whether or not they are actually generating outcomes that justify their expense is inherently subjective. Is a new hip replacement that marginally increases mobility, lasts longer, and minimizes post-operative pain and suffering “worth” bringing to market? In order to answer that question, you have to attempt to assign a monetary value to increased mobility, pain and suffering, etc. Good luck doing that in the aggregate. Ditto for implantable pacemakers, replacement heart valves, etc, etc, etc. Any such evaluations depend on simplifying, aggregate assumptions that fall apart when you look at the particular situations of given indivudals.

      Even if you could conceivably design such a system on paper, the reality that emerged with all of the incentives, constraints, and distortions that operate on political systems would render the actual system that emerged from such a process much different than the ideal prototype.

      I think you can make an argument for reference pricing – e.g. the government will pay for the lowest cost drug/device and if you want something better you pay the extra cost out of your own pocket, but that’s as far as one can go. I shudder to think where we be if we applied the standard that you are proposing to any other area of innovation, and tasked bureaucrats with the responsibility of determine whether or not the semi-conductor was sufficiently innovative to justify the additional marginal cost over and above the vacuum tube, etc, etc..

      • Thanks for the reply, JayB.

        I generally agree with your concerns–it would be a herculean (and perhaps sysiphean) undertaking to establish the government (and therefore political) controls on industry innovation that I was implicitly arguing for in my defense of the device tax. In a more humane world, medical decisions would be primarily between the patient and their physician (sometimes under the watchful eye of a third-part payor). Unfortunately that is not the case in the present system, where we often have employers, multiple layers of government, multiple payors, etc. all (in)directly involved in patient care decisions.

        The other patient care decision factor, which I understand to be unique to American medicine, is Direct to Patient advertising (and if you’ve ever watched Nic-at-night or similar old person-oriented television, you know what I’m talking about). I suspect this anomaly could make “bad” or “neutral” innovation more profitable for device manufacturers in USA than in other countries where such advertising is banned, and that this play some part in our inflated costs/spending.

        Assuming there is such a thing as “bad” innovation, and that it can be quite profitable for it’s producers, it makes sense for Medicare (being such good stewards of our tax-payer $$ :-)) to seek ways to stymie the spread of such innovation. Since we agree that bureaucratic approaches are likely to fail, and the political will to outlaw direct to patient advertising is missing, then perhaps we can also agree that increasing the barriers to market entry (via higher taxes) seems like a potential way to curb the profitability of “bad” innovation, namely by ensuring that the only players in the market are those invested for the long haul (meaning steadily producing “good” innovations that are also profitable).

        I should probably add that I’m certain this line of thought was not in the minds of policy-makers during the ACA debate, and that I like the reference pricing idea you mentioned better than the taxation approach. Still , increased taxation could be one indirect way of improving outcomes and saving money, at least in the long run, not to mention making the funding of Obamacare possible (assuming you take the ACA as a positive; I mostly do).

        Thanks,
        SB

    • Late to this discussion.

      Not sure we will see the added tax come out of corporate profits.

      It was noted that: “According to Ernst & Young, the federal government — through Medicare, Medicaid, the Veterans Administration, and the Department of Defense—accounts for a majority of U.S. spending on medical devices. This limits device makers’ ability to mark up prices and pass along costs. This means most of the tax will come out of device makers’ profits, while private health-care institutions and consumers may also bear a portion of the cost.”

      OK. Yes, the majority of spend comes from those sectors – where the government sets the prices. But, nothing precludes the medical device manufacturers from attempting to top up the prices charged to those who do not have the protections of the government setting prices – to leave profits unchanged.

      Wouldn’t be the first time we have seen such activity to maintain revenue streams.

      • Hi BenefitJack,

        I’m inclined to agree. My industry (hospitals) has deployed the same strategy, for many years, to decent effect. Unfortunately for us, it seems that gravy train is starting to slow down as insurers are more and more willing to simply exclude us from their provider networks rather than pay the rates.

        Thanks,
        SB

    • A medical device tax would only make sense if it were a pigovian tax meant to reduce use of medical devices due to some externality.

      In the short run the devise manufacturers will pay most of the tax but in the long run patients who use medical devices will pay most of the tax.

      So taxing medical devices is just a way to tax the people covertly. It is CORRUPTION plain and simple!