Time to End the Medical Device Tax

March 29th, 2013 by Leave a Comment

By Tim Lusby

The most ill-conceived federal sales tax law took effect this year, created by the Executive and Legislative branches and their staff attorneys who obviously have never made a payroll or managed a business. 

Section 1405(a) of the Health Care and Education Reconciliation Act, which amended the Patient Protection and Affordable Care Act, requires any “manufacturer, producer, or importer” of taxable medical devices to pay a tax equal to 2.3 percent of the sale price of the device.

This is a nonpartisan issue. The United States Senate approved an amendment recently to end the tax by a margin of 79 to 20. Unfortunately, the amendment was attached to the nonbinding Senate budget resolution that will never pass in the House of Representatives.

This law, which specifically targets the medical device industry, is the first national sales tax ever imposed on a U.S. medical industry. President Obama’s defense was that the medical device industry will now have access to 30 million new customers due to the health care law that takes effect in 2014, but the tax started this year. It is expected to raise $29 billion in government revenues through 2022 at an expected annual implementation cost of $660 million.

The medical device industry employs 409,000 people in 12,000 plants across the nation. Many operate at a loss for several years as they pioneer the next generation of life-improving devices. Eighty percent of device companies have fewer than 50 employees, according to the Medical Device Manufacturers Association.

The tax, which must be paid regardless of the corporate net income, is already forcing small businesses to cut workers and is shrinking or eliminating research and development budgets for large and small medical devices. If a business has net income of 15 percent on gross sales; a 2.3 percent tax decreases this net income margin to 12.7 percent. The marginal effect of the tax is 15.33 percent and is obviously more punitive if the company does not have any net income.

The typical Days Sales Outstanding (DSO) for a medical device company is approximately 65 days. This means that a business collects approximately 82 percent of its cash in a given year assuming that there is no allowance for bad debt. In terms of cash flow, this tax rate would effectively be 2.8 percent.

To many, the solution seems simple: The medical device industry can either pass through the tax as an add-on to the hospital’s invoices or mark up prices by 2.3 percent. But the powerful Group Purchasing Organizations (GPO) are encouraging their hospital partners not to contract with device manufacturers that bill their hospitals for this tax and many GPOs have informed device vendors that they will not pay for the tax as it was not the intent of Congress for the hospitals to be burdened with the tax.

Marking up prices to cover the tax is not an option, either: Most devices have captive pricing at every hospital, meaning that hospitals have established prices that every competitor must meet to become an approved device manufacturer.

Compounding matters, this tax must be computed and paid on the 15th and last day of the month. The industry is burdened with closing its accounting system two times per month and will be subject to penalties if it not accurate. This administrative burden will undoubtedly add to the overall costs of this ill-conceived tax.

Efforts to increase revenue should not penalize industry, let alone one specific industry. Creating a revenue stream could be as simple as offering a corporate “tax amnesty” in 2013 to allow U.S. corporations to bring back their foreign subsidiaries’ retained earnings. An estimated $2.5 trillion in retained earnings are in U.S. corporations’ foreign subsidiaries would be taxed at a corporate rate of 35 percent if brought back into the United States through their parent corporations. Taxing those earning at a 5 or 10 percent rate if they are brought back home would create hundreds of billions in tax dollar revenue.

Best of all, the revenue could come in 2013 instead of eking a hoped-for $29 billion in tax revenue over nine years via the medical device tax law. Can you imagine what $2.5 trillion could do for the United States economy? The U.S. corporations would invest these funds in their U.S. operations rather than creating infrastructure and employment overseas.  Such leadership and creative action would help solve this nation’s economic crisis; politicians must act boldly to convince Americans they possess these skillsets.

Tim Lusby is COO of Amendia, a medical device company headquartered in Atlanta. The Georgia Public Policy Foundation is an independent think tank that proposes practical, market-oriented approaches to public policy to improve the lives of Georgians. Nothing written here is to be construed as necessarily reflecting the views of the Georgia Public Policy Foundation or as an attempt to aid or hinder the passage of any bill before the U.S. Congress or the Georgia Legislature.

© Georgia Public Policy Foundation (March 29, 2013). Permission to reprint in whole or in part is hereby granted, provided the author and his affiliations are cited.

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