Affordable Care Act: Medical Device Tax a Problem for Innovation

One of the most controversial provisions from the Patient Protection and Affordable Care Act (ACA) is a provision that will impose a 2.3% excise tax on the medical device industry, which is set to take effect in 2013.  The tax applies to all sales occurring on or after January 1, 2013, even though coverage for the newly insured begins in January 2014; and the tax is based on top line sales, not profit.  

Since the ACA was passed, numerous attempts have been proposed to repeal the tax but have been unsuccessful.  Meanwhile, numerous reports have shown that the device tax would have a significantly adverse impact on the medical device industry.  Nevertheless, industry has not received guidance on how the tax will be implemented or collected.  The primary justification for the tax appears to be the expectation for an increase in volume of newly insured patients for medical device companies. 

Over the past few decades, the Medical Device industry (or Med Tech) has positively affected the quality of US health care in a cost effective manner.  In addition, the industry provides substantial contributions to the economy through innovation, quality jobs, higher earnings, and sales.  Consequently, a recent report and white paper from Roth Capital explains the significant impact the device tax will have on the industry, healthcare providers, and patients.  Specifically, the report outlines the impact the medical device industry has on the US economy and the US health care system and identifies the negative effect the Medical Device tax will have on an industry. 

Impact of the Medical Device Industry 

The US Med Tech industry ships $136 billion in products, pays $25 billion in salaries, and employs well over 400,000 individuals.  Investment in quality health care has provided positive economic returns and improved patient outcomes:  

• Death rates are down 16%,
• Life expectancy has increased by over 3 years (+4%), and
• Disability is down 25%.  

Medical Technology is cost effective: Prices grew slower than Consumer Price Index (CPI) and remained consistently only 6% of national health expenditures.  For example,

Smaller companies account for innovation and jobs: 80% of Medical Device companies have fewer than 50 employees and 98% have fewer  than 500.  In addition, more jobs, earnings, and sales: Each medical technology job generates an additional 1.5 jobs in a given state, as well as 90% more earnings and sales.  

Why is Med Tech already suffering?  

Unpredictability in the regulatory environment is already hurting the industry: 53% of companies cite this as biggest challenge in running their business today.  In addition, uncertainty of reimbursement has reduced investment in the category.  Moreover, existing businesses impact by hospitals pushing back on pricing and volume.  

Venture Capital (VC) investment is already on the decline, particularly for early stage companies. This is a good indicator for the health of an industry.  Med Tech appears to be plagued mostly by regulatory uncertainty.  Furthermore, Med Tech Initial Public Offerings (IPOs) have been virtually non-existent in the past four years, which serves as another indicator of a change in the industry’s health.  Additionally, early stage, “Series A” funding is projected to shrink again in 2012, which tends to be a leading indicator of innovation in any industry, as it typically targets those new, and often more innovative ideas, that provide bigger opportunities for economic development and job growth. 

How ACA Should Affect the Med Tech Industry  

The white paper maintains that the rationale for applying the device tax is flawed for several reasons.  First, newly insured patients are likely to be much younger, and therefore not need medical devices.  After choosing five large medical device categories—(1) Heart Valves (70); (2) Implantable Cardiac Defibrillators (60’s); (3) Cardiac Stents (62); (4) Knee implants (64); and (5) hip replacements (75.1)—the average age of patients was well into the 60s for many devices and even 70s or others. Consequently, the report found that 80% of uninsured patients who will be getting insurance under the ACA are under 45 years old and 88% are under 55, well below the average device user.  Only 2% of the uninsured are over 65 years old. 

Second, hospital purchasing appears to be getting worse.  Medical device customers (i.e., hospitals) are attempting to reduce utilization and pricing in the future.  Roth conducted a survey of 13 companies representing just over $14.5 billion in industry revenue, which found that 77% expected purchasing behavior to worsen, and notably none anticipated a better environment.  

Finally, universal health care in Massachusetts provides an example of what might happen nationwide.  The reports finding showed that in Massachusetts, 8 out of 9 companies experienced negative comparative growth rates in Massachusetts as compared to the rest of the US following the implementation of universal health care in that state.  Using the six case studies, the report found that trends in Massachusetts, contrary to an expectation for higher medical device utilization rates, actually lagged the rest of the US in the years following the legislation of universal health care.   

In comparison to five other states in close proximity to Massachusetts, the result was the same: Growth in Massachusetts lagged that of the states in geographic proximity. The percentage of revenue out of Massachusetts between the 2002-04 through 2009-12 timeframe declined, suggesting no windfall was experienced in these businesses. 

Negative Impact of Device Tax on the Industry’s Financial Health  

Roth’s analysis showed that smaller companies, typically the industry’s innovators and job creators, take a disproportionate hit to profits as a result of the Medical Device tax. Greater than 70% expect a somewhat to very negative impact.  Of the 18 small-cap companies used in this analysis, they calculated an approximate average earnings decline of 34% on an aggregate basis.  

All 14 large-cap companies had less than a 10% decline in earnings, a stark contrast from the small cap group where only one of 22 companies had an earnings decline under 10%.  Greater than 70% expect a somewhat to very negative impact from the Medical Device tax.  The report also found an escalating hit to R&D budgets of smaller companies. 

The Device Tax Hurts Jobs & Innovation  

Roth also surveyed companies on their latest plans to manage through the implementation of the Medical Device tax next year.  The report determined that (1) over 80% would either cut jobs or forego new hires and (2) more than 75% would either cut or forego new R&D projects as a result of the tax.  The report also found that 85% of companies would be expanding overseas.   

Brendan Benner, vice-president of public affairs for the Medical Device Manufacturers Association (MDMA) noted that 80% of medical device companies have less than 50 employees.”  He noted how “these are companies that are literally just ramping up, they might have one, two, maybe three technologies or devices they are trying to get these into the marketplace, so they may have revenue, [but] they are not even close to profitability yet.”  This, of course, makes paying a device tax very problematic.   

He noted that there will be companies who will be paying a tax to the IRS without earning one penny in profits.  Although the IRS has not put out its final regulation, a 2.3 percent excise tax on $1 million in revenue, would be a $23,000 bill just for the excise tax—that’s on top of any other corporate income tax it would owe on any profits.    

Conclusions  

Ultimately, the Roth report noted that the device tax will only hurt patient care, and exacerbate current trends of reduced utilization and reimbursement of devices.  Until the Presidential election is over, we likely will not see a final rule from the IRS.  If Obama is re-elected, the device industry may be out of luck, unless Republicans can maintain control of the House and gain a majority in the Senate