US medical device tax: should it be gone for good?

Chloe Kent 30 May 2019 (Last Updated May 30th, 2019 17:29)

The basic theory of taxation says; the more you tax something, the less of that activity occurs. That logic is now behind a move to squash unpopular medical device taxes in the US for good. But is the tax as bad as it’s made out to be?

US medical device tax: should it be gone for good?
The US medical device tax has been labelled punitive to start-ups and a risk to patients – but is this just a case of manufacturers pinching pennies? Credit: Shutterstock

In the US, sales of medical devices are supposed to be subject to a 2.3% tax under the Patient Protection and Affordable Care Act (ACA). This clause was signed into law under the Obama administration in 2013. However, this tax is now reaching the end of its fourth year on Democrat-implemented hiatus, and the med tech industry is putting increasing pressure on Congress to scrap it for good.

Prior to the hiatus, the US Internal Revenue Service (IRS), collected between $1bn-$2bn a year in tax from the sector between 2013 and 2015. In July 2018, the House of Representatives passed a bill to eliminate the tax by a 283-132 vote, but the Senate has yet to act on the legislation.

In March 2019, Republican senator Pat Toomey and Democrat senator Amy Klobuchar introduced a bipartisan piece of legislation to repeal the medical device tax across the country.

The charge applies to most types of medical device, with pacemakers, artificial joints, surgical gloves and dental instruments among those affected. Devices generally purchased by members of the public for personal use, such as wheelchairs and hearing aids, are explicitly exempt from the tax.

The tax was initially implemented to help offset the costs of the ACA’s extension of healthcare coverage to previously uninsured patients. Proponents of the tax maintained that the medical device industry’s commercial interests actually stood to benefit from the implementation of the tax, as more individuals would enrol in healthcare insurance in a post-ACA America. They might be paying a little more upfront, but in the grand scheme of things this money would extend access to their product.

When questioned about the tax in a 2012 interview, President Obama stated: “The healthcare bill is going to provide those healthcare companies 30 million new customers…When you have 30 million more people coming in, you’re going to make money, you can do a little more to help facilitate and make sure people are getting the healthcare they need.”

Why is the medical device tax so controversial?

Those opposed to the tax argue that this theory is not realised in practice and leads to higher prices, less medical research and fewer job opportunities – hitting patients the hardest.

The medical device tax is an excise tax, paid when purchases are made on a certain good. These are typically applied to specific behaviours which the state wishes to discourage, such as fuel consumption, tobacco and alcohol.

The application of such a tax to devices such as arterial stents, artificial limbs and insulin pumps seems counterintuitive to many commentators, when the development of medical devices is something the state ought to be encouraging.

“It is the basic theory of taxation – the more you tax something, the less of that activity occurs,” Pacific Research Institute (PRI) senior fellow in business and economics Wayne Wingarden says. “In this case, if the tax on medical devices were implemented, the cost for patients would increase, and the revenues received by medical device manufacturers would decline. As a result, patient affordability would decline, and potential access issues could increase.”

Writing in Forbes magazine, Winegarden used the example of a state-of-the-art 3 Tesla MRI machine. This MRI machine can cost as much as $3m, and with a 2.3% medical device tax on top of this there is an additional $69,000 imposed on all purchases of the machine.

There is a possibility, Winegarden explains, that the manufacturer will simply pass these costs along to the hospital that purchases the machine, which could make the MRI entirely unaffordable for some hospitals. This would make the tax indirectly responsible for reducing patient access to quality care, far from the intended purpose of an excise tax.

The alternative to the hospital footing the bill would be that the manufacturer pays the tax out of pocket without increasing their prices, which will have a negative impact on their earnings and could discourage future research and development (R&D).

Does taxing revenue punish startups?

Furthermore, the medical device tax applies to overall revenue rather than just profit. It has been argued that this is a punitive measure for start-up innovators, who can’t afford to lose another 2.3% of their income on top of their business expenses and remain financially stable.

According to trade group the US Medical Device Manufacturers Association (MDMA), the majority of innovation in med tech comes from small manufacturers working to develop new tools and therapies. The PRI estimated that the medical device tax cuts R&D in the sector by around $2bn a year, which was described by 2020 presidential candidate Senator Elizabeth Warren as “disproportionately impact[ing] the small companies with the narrowest financial margins and the broadest innovative potential”.

Lobbyists for the removal of the tax claim that alongside restricting investment and innovation, the medical device tax will lead to thousands of job losses. Speaking to US political magazine The Hill, Texas Senator Kevin Brady estimated that 20,000 jobs had been lost as a result of the medical device tax.

In 2017, med tech industry association AdvaMed announced that the industry shrunk by around 29,000 jobs (401,472 in 2012 compared to 372,628 in 2015) while the tax was in effect. While the organisation did not attribute the job losses solely to the introduction of the tax, it suggested that the significance of the simultaneous job losses was still too significant to ignore.

However, Americans for Tax Fairness (ATF), a non-profit campaign lobbying for comprehensive, progressive tax reform, has questioned the legitimacy of these claims.

A report from the Congressional Research Service in 2015 stated that the tax is unlikely to have a significant impact on the profits of medical device companies, estimating that it reduced industry output and employment by no more than 0.2%. The report, published before the aforementioned corporate tax cuts, actually states that job loss resulting from the tax “is more likely to be in the range of negligible, or zero”.

Doubts persist over the scale of the claims

ATF also estimates that in reality the tax rate of 2.3% translates to an effective rate of 1.8%.

This is because corporations can deduct the tax as a cost of business from their federal taxes, giving large, profitable corporations a tax break of around $20bn over the course of a decade and providing financial relief to smaller med tech developers. This is alongside the corporation tax breaks the Trump administration has overseen, which cut the overall corporate tax rate from 35% to 21% and cut the tax rate on accumulated offshore profits from 35% to a maximum of 15%.

“We all need to contribute to the healthcare needs of people who can’t afford it, especially big corporations who continue to get tax breaks and aren’t paying their fair share,” ATF executive director Frank Clemente said in July last year.

On the surface, the tax may appear to be less than ideal for the med tech industry – no for-profit organisation is going to revel in handing over vast sums of money to the government. However, a real-term rate tax of 1.8% isn’t a huge cross to bear for US health giants like Johnson & Johnson and Thermo Fisher Scientific, who raked in respective revenues of $27bn and $24.36bn in 2018 and are currently the second and third biggest medical device companies by market share in the world.

Perhaps some sort of compromise is to be made, to negate the risk of pricing out less well-funded hospitals or penalising small med tech start-up. The tax could, for instance, be applied only to companies who hit a certain revenue point, with regulation in place that prevents those applicable from simply charging their buyers an extra 2.3% on a product. Time will only tell what the outcome of Toomey and Klobuchar’s bill is, but after a four-year hiatus the tax doesn’t seem to have much of a future.

“The tax is not currently in effect, but scrapping it removes uncertainty in the market. This improves the incentives for medical device manufacturers, and eliminates a potential cost,” says Winegarden. “Greater certainty improves the market, helping ensure patients have access to affordable medical devices.”