INSIGHT: New federal tax is shrinking medical equipment market

05 December 2013 17:12  [Source: ICIS news]

By Joe Kamalick

US healthcare law could shrink medical gear marketWASHINGTON (ICIS)--A new federal tax on manufacturers of medical devices and equipment may drive some US-based companies out of business and force others to move offshore, reducing a key downstream market for domestic chemical and resins producers.

Despite numerous appeals from medical device manufacturers and considerable bipartisan support in the House and Senate, there appears little prospect that Congress will act to eliminate the 2.3% medical device excise tax that took effect on the first of this year.

Part of President Barack Obama’s signature health care law - the Patient Protection and Affordable Healthcare Act (ACA), also known as ObamaCare - the special tax on medical device manufacturers is part of a raft of new taxes designed to support the multibillion dollar ACA.

The ACA also imposes increased taxes on health insurance providers, pharmaceutical producers and an excise tax on generous employer-provided health insurance plans.

The White House and Democrats in Congress who championed and passed the ACA in 2010 argue that the additional taxes are fair and warranted because device makers, insurance companies and drug makers will have a lot more paying customers thanks to the new law and their business volumes and profits will increase proportionately.

In theory, the ACA is to provide health insurance coverage for some 30m Americans who do not now have such policies.  By bringing those consumers into the paid medical services industry, the White House argues, the law provides millions of additional customers for medical equipment manufacturers and healthcare providers.

But a coalition of nearly 1,000 medical device manufacturers, related trade associations, healthcare providers and venture capital firms argues that White House assumptions about the medical devices market are wrong, and the impact of the excise tax could be devastating to the industry.

In a September letter to House and Senate leaders of both parties, the group said that the excise tax - estimated to cost manufacturers $30bn (€22.2bn) - will not be offset by increased demand for medical devices.

“There is no evidence suggesting a device industry ‘windfall’ from healthcare reform,” the group wrote.

“Unlike other industries that may benefit from expanded coverage, the majority of device-intensive medical procedures are performed on patients that are older and already have private insurance or Medicare coverage,” the group said.

Medicare is the federal healthcare programme for the US elderly and typically kicks in at age 65.

In addition, the producers argue, “Where states have dramatically extended health coverage, such as in Massachusetts where they added 400,000 new covered lives, there is no evidence of a device windfall”.

The ACA mandates that all US citizens purchase health insurance, and the plan is aimed particularly at getting young people in the 18-35 age group to sign up for coverage.

Because that age group typically requires little or no health care - on average they seek medical attention only six times during that 17-year period - their health insurance premiums are supposed to support the much higher healthcare services demand among the elderly.

Medical device manufacturers also argue that the ACA excise tax is particularly onerous because the 2.3% tax is levied on sales, not income, so that it takes a much bigger bite of their cash flow than a tax on profits.

The excise tax, now in force for almost a full year, “is already having an adverse impact on R&D investment and job creation, jeopardising the US global leadership position in medical device innovation”, the industry letter to Congress said.

“If this tax is not repealed, it will continue to force affected companies to cut manufacturing operations, R&D and employment levels to recoup the lost earnings due to the tax,” the producers warned.

The impact will be most severe, they contend, on smaller companies and innovators whose new product developments are not immediately profitable.

Kenneth Schuckers, tax director at the Atlanta, Georgia, accounting and financial consulting firm of Bennett Thrasher, said the excise tax on smaller or new medical device manufacturers is already having devastating effect.

He cited as an example a start-up manufacturer with one commercialised product, annual sales of about $1m and net profits of $100,000.

Under ACA, “the company is now paying a 2.3% excise tax on the $1m in sales, or $23,000”, he said.

“This $23,000 equals 23% of the company’s profits,” he said, adding:  “The company also owes $22,250 in federal income taxes on its profits of $100,000, making the total amount paid to the federal government $45,250 or 45.25% of its profits.”

Facing additional state taxes, the owners of a start-up of this sort might have to borrow money to pay all the taxes, making their venture all the more precarious, Schuckers argued.

Writing in the magazine Today’s Medical Developments, Schuckers said that “business owners are now sharpening their pencils to look at the real return on investment of manufacturing in the US versus manufacturing abroad”.

In addition, he said, investors such as venture capital funds and private equity groups now will be more reluctant to put money into medical devices projects.

“These types of negative pressures on a business cause investment firms to think twice before investing in this industry segment,” he said.  “Ultimately, this disproportionate amount of tax is discouraging start-ups and the innovations that they can contribute to the US economy.”

In order to survive, he added, start-ups and even well-established small manufacturers are shifting production to foreign shores and sending high-paying jobs abroad with that shift.

The medical devices industry at first had hopes of seeing the excise tax repealed.

There is strong bipartisan support for repeal among Republicans and Democrats in both the House and Senate. The House twice passed repeal bills, and the Senate passed what amounted to a non-binding “sense of the Senate” measure.

Despite that support, repeal does not look at all likely.

MedPage Today, a news service for physicians, quoted Senate Majority Leader Harry Reid (Democrat-Nevada) as saying that he would reject any effort to repeal the medical device tax.

MedPage Today noted that if Democrats in Congress were to allow repeal of the medical devices excise tax, other healthcare industry players - insurance carriers, hospitals, drug makers, etc. - would press hard for similar waivers, and the ACA would be broadly undermined.

As a result, it is likely that medical device and equipment manufacturers will not get repeal of the ACA excise tax.  Instead, they may see reductions in their ranks as producers shut down, fewer new start-ups are launched, and more production shifts to foreign shores.

In all, that could mean a diminishing domestic market for chemicals and resins manufacturers who serve the industry.

The medical device manufacturing sector could become the sick man of the US healthcare industry.

Is there a doctor in the house?

($1 = €0.74)

Paul Hodges studies key influences shaping the chemical industry in Chemicals and the Economy

By: Joe Kamalick
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