Medical Device Tax

The medical device tax is a 2.3% tax on medical devices, everything from bed pans to surgical tools.  It was signed into law as part of the Affordable Care Act, also known as Obamacare.  As I understand, the logic behind it was if more people are getting more care, more medical devices are being sold and therefore medical devices can pay some of the way.  This logic doesn't follow for drugs, whose companies have better lobbyists.

What is a company to do?  Assuming you are a public company and a certain margin is expected you can either pass the costs on to your customers or cut back on generally marketing and/or R&D (you could also cut quality, but I wouldn't recommend that).  I suspect if you're in the low margin bed pan business, you pass the costs on, you don't have a bunch of bed pan R&D to cut.  If you are the stent or some other product with higher margin, I suspect you also pass the costs on to your customers.  You have some brand leverage and a product you can differentiate yourself from the competitors so switching is more difficult.

Alternatively in either case you could just suck it up, maybe decrease your dividend and hope your investors are kind, but I'm telling you right now, CEOs are looking for ways to pass costs on to their customers.  That is their job, to look out for the company.  Passing the costs on to the customers defeats the whole purpose of the tax, lets look at the cutting R&D option as well.

The Incidental Economist has a post title the job killing medical device tax parts 1 and part 2.  He quotes a recent paper by Bryan Schmutz and Rex Santerre on the device tax and R&D, in part:

simulations show that the recently enacted excise tax on medical devices, taken alone, will reduce R&D spending by approximately $4 billion and thereby lead to a minimum loss of $20 billion worth of human life years over the first 10 years of its enactment.

So decreased R&D spending on medical devices reduces health care quality, which again defeats the purpose of the tax.

The incidental economist has seven points about the tax, none of which I entirely disagree with, however a one I think deserves comment.

One can be confident that the medical device industry will benefit tremendously from the large increase in the number of insured individuals to begin in 2014.

On this point, it depends on the device, some devices are presumably being used to treat the entire population that needs treated now.  These devices would typically be used in emergency cases.  For example, if you're having a heart attack, if you show up at the hospital, you'll get the treatment you need.  If there are people out there not getting treated, it is not because of insurance, more likely its due to access to medical care (i.e. they live in a place that can't deliver the needed treatment), or patient education (i.e. they think they'll be fine if they just wait it out).  More insured people won't increase device use here.  The devices most likely to be used more are the low margin ones, which are generally manufactured overseas.

In fact, a company could end up in a situation where the low margin products increase, the higher margin products don't increase, and you have a tax to deal with where you must cut R&D on high margin products, and/or pass the tax on to customers, neither of which was the purpose of the tax.

One of the comments brings up a good point about start ups:

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.

There are a decent number of companies with a few products and don't currently make a profit as they expand, they don't lose much either, but they are constantly on the edge.  It would be somewhat interesting to see how a company like Thoratec would have grown with this tax in place.  This makes it seem to me that a start up economics may change and a start up may try to sell itself or its products to a larger company sooner, as the transition from small to medium sized company is now harder.  This would result in the 10 or so large diversified companies that dominate the market continuing to do so.

All of this remains to be seen, and I'm trying to keep an open mind about it, but it doesn't make much sense to me right now.