Life Science Compliance Update

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September 27, 2011

Affordable Care Act Medical Device Fee’s Cause of 11% Jobs Loss

Medical Device Manufacturing 
The medical device manufacturing industry contributes to the economy of every state.  In 2009, the medical device industry provided well-paying jobs to more than 409,000 employees, who earned more than $33 billion dollars in labor compensation at more than 12,000 establishments around America.  Labor costs per employee of more than $81,000 are well above average compensation for the American economy. 

These jobs are an important component of these states’ economies, and form a segment of the growing advanced manufacturing sector. 

The device industry’s revenues exceed $116 billion annually of which nearly $88 billion was value added (contributions by labor and capital within the industry), and it is one of the healthier segments of American manufacturing, other segments of which have been declining.  For example, the industry spent more than $3.7 billion on new plant and equipment in 2009. 

Medical devices are distributed through wholesale distribution networks, which likely add an additional 34% or $39 billion to the value of medical devices. The total wholesale value of medical devices was approximately $155 billion in 2009. 

Roughly one third of medical devices manufactured in the United States are exported, an unusually high proportion for an American industry. Major markets include Japan, the Netherlands, Canada, Germany, and Mexico. 

During the first 11 months of 2010, the United States imported more than $30 billion worth of devices. Major sources of supply include Mexico, Ireland, China, Germany, and Japan. 

Despite the enormous success and value the medical device industry provides for the American economy, patients, and the life sciences and technology industry, a 2.3% excise tax on the medical device industry contained in the Affordable Care Act, which will take effect in 2013, poses a significant number of problems to the device industry. 

The 2.3% excise tax will be applied to “taxable medical devices” based on statutory definitions of medical devices as well as complex rules yet to be written by the Secretary of the Treasury. The tax will be applied to manufactured devices, but will exclude devices generally purchased by consumers at retail for individual use, and other products at the discretion of the Secretary of the Treasury.  The new federal excise tax will be applied to all sales of a product before other forms of state and local sales taxes are applied. 

According to a recent study conducted by AdvaMed, the tax could reduce employment in the industry by cutting back on the demand for medical devices and by encouraging American firms to shift production overseas.  For example: 

  • Under reasonable assumptions, the tax could result in job losses in excess of 43,000 and employment compensation losses in excess of $3.5 billion.
  • The tax will also especially harm states with large employment in the medical device industry including California, Florida, Illinois, Indiana, Massachusetts,  Minnesota, New Jersey, New York, Ohio, Pennsylvania, Texas, and Wisconsin.
  • The new 2.3% excise tax will roughly double the device industry’s total tax bill and raise the average effective corporate income tax rate to one the highest effective tax rates faced by any industry in the world.
  • Moreover, the new tax will be paid both by firms that have net income and those that do not. The tax will be especially harmful to companies that innovate and tend to suffer losses in the first years or when investing in research and development for a new product but would still be required to pay the tax.
  • Under the tax, U.S. manufacturers will be more likely to close plants in the United States and replace them with plants in foreign countries.
  • Foreign manufacturers will improve their competitiveness relative to American firms, and U.S. leadership in this industry could be threatened.
  • The Joint Tax Committee estimates that the tax will raise $20 billion in revenues over the period 2013-2019, a cost to device companies and the American consumer. The economic impact of the tax on wages and output will be significantly higher. 

According to an article on MassDevice.com, lead author and Manhattan Institute senior fellow Diana Furchtgott-Roth, argued that the government should make the US a more "job-friendly environment" instead of imposing taxes that could push companies outside its borders.  

The Effect of The New Excise Tax 

The new excise tax is complex, and it will substantially raise the tax burden on the medical device manufacturing industry.  In response to the new tax, the AdvaMed report recognized that, “prices of medical devices will rise, and consumers and health care providers will pay more for medical devices.” 

While the exact change in prices for medical devices as a result of the excise tax will depend on various economic parameters, an estimated half or more of the excise tax will likely be passed along to end users in terms of higher prices.  Correspondingly, the quantity of medical devices demanded will decline in response to the higher prices that include the excise taxes. 

AdvaMed recognized that, “the tax would be especially harmful to companies that innovate, and hence tend to suffer losses in the first years or when investing in research and development for a new product.  Such a company might have large market share, but no profits, in the initial years after research takes place.  Companies that innovate frequently have losses, but they would be required to pay the tax anyway.  Thus, the market share tax could be an unintentional tax on innovation.” 

The tax would likely increase the after-tax prices to American consumers between .02% and 2.1% with most price increases around 1%.  Medical device demand would decline between $0.67 and $6.7 billion annually.  Industry employment should decline between 2,300 and 23,000.  Employment compensation would likely decline between $190 million and $1.9 billion annually. 

In fact, some manufacturing of medical devices may shift offshore as a result of the new excise tax to minimize losses.  Studies have found that many (non-device) manufacturing operations have relocated from the United States abroad in recent years with substantial losses in American manufacturing employment.  Many manufacturing industries have had substantial reductions of operations with employment losses well in excess of 10% over the past few years.  Many medical device manufacturers already have plants overseas, so shifting at least some production would not be difficult. 

Jobs can effectively move overseas in two ways.  U.S. manufacturers can close plants in the United States and replace them with plants in foreign countries, or locate future job growth abroad rather than in the United States.  Alternatively, foreign manufacturers can improve their competitiveness relative to U.S. firms with the result that foreign domiciled companies increasingly dominate manufacturing for the American market.  Both are likely to occur under the new excise tax according to the report. 

The effect of the tax on earnings of U.S. companies is likely to be significant.  In

2006, medical device manufacturers reported taxable income of $13.7 billion and paid= $3.1 billion in corporate taxes.  The United States already has one of the highest corporate income tax rates in the world.  The new 2.3% excise tax will roughly double their total tax bill and raise the average effective corporate income tax rate to one of the highest effective tax rates faced by any industry in the world.  Moreover, the new tax will be paid both by firms that have net income and those that do not. 

Ninety-five percent of American device firms have sales of less than $100 million, and these firms manufacture exclusively or primarily for the domestic market.  Even larger American firms with substantial international sales typically sell a much higher proportion of their products in the U.S. market than do their foreign-based competitors. 

Accordingly, American-domiciled firms will be at a significant disadvantage compared to foreign competitors.  Smaller companies selling exclusively in the domestic market will be hardest hit in their ability to maintain profitability, attract capital or invest in innovative products compared to foreign rivals. 

Even large international firms will be placed at a disadvantage relative to their foreign competitors.  Large companies will move jobs abroad or place a higher share of their new employment abroad as the relative profitability of sales in foreign markets increases.  Start-up companies will increasingly locate abroad rather than in the United States. 

For example, if 15% of production were to migrate offshore as a result of the excise tax,

U.S. industry employment would decline between 63,000 and 85,000 while employment compensation would decline between $5 billion and $7 billion.  Doubling the shift of production offshore to 30 would have approximately double the effect.  The harmful economic effects of the excise tax will likely be felt in every state.   

Industry employment declines in every state and totals more than 45,000 nationwide. Fourteen states would be expected to lose 1,000 workers or more.  Employment compensation declines by more than $3.7 billion.  These states include: California, Florida, Illinois, Indiana, Massachusetts, Minnesota, New Jersey, New York, Ohio, Pennsylvania, Tennessee, Texas, Utah, and Wisconsin. 

At the time of passage of the new law, the Joint Committee on Taxation estimated tax revenue at between $2.7 billion and $3.4 billion annually between 2014 and 2019. The excise tax was estimated at the time of enactment to raise $20 billion over the period 2013-2019. 

These estimated revenues are likely less than lost labor income and capital income from displacement as the result of the tax.  The excise tax may also cause dislocations outside the medical device manufacturing industry.  The Lewin Group, using a multiplier analysis, finds substantial effects on employment in the broader economy from the medical devices industry. 

In discussing the report, Stephen Ubl, president and CEO of AdvaMed noted that, "It's important for [Congress and Americans] to understand the device tax is counter-productive to economic growth and the shared aim of putting more Americans to work."  Ubl called the 2.3 excise, a "tax on innovation," because start-up companies are required to pay the full tax regardless of their net-revenue margin. 

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Thank you for this interesting post. It would seem highly unfair if medical devices that were imported into the United States were not subject to the same excise tax.

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