Left to their Own Devices

May 31st, 2012

Inspired by Effort to repeal tax on medical devices advances (N.C. Aizenman, Washington Post 5/31/12 page A2).

 

“This is a highly competitive industry with fairly thin margins. This is a tax that can’t simply be absorbed without consequence.” — Wanda Moebius, spokeswoman for the Advanced Medical Technology Association (what reason would she have to lie?)

 

“And who has given him so much that he needs to pay it back?” — Romans 11:35

 

Given SCOTUS review, you’d think healthcare opponents would relax,

But no: the medical device industry is trying to repeal its 2.3% tax.

 

It’s a pretty selfish and greedy thing to do,

Since every other industry is chipping in too.

 

But because they’ve got lots of lobbying support, their position is strong,

Even though the facts and economic theory says they’re wrong.

 

Oh, how quickly we resort to habitual vices

When we’re left to our own devices.

***

There are a number of compelling justifications for the medical devices tax, some of which are referred to in the article, and some of which I’ve come up myself based on further research and application of basic economic theory, neither of which the anti-taxers appear not to have done:

1) As the article points out, the medical tax helps finance an expansion of healthcare demand that will greatly benefit device manufacturers. Other parts of the healthcare sector understood that logic and are bearing some of the cost in order to share in the net benefit they will receive. Why should the medical device sector now be allowed to freeload?

2) The tax is not large: only 2.3% on gross sales over $5 million, meaning that a company with $10 million in revenues would pay an effective tax of only 1.15% on those sales. But since theU.S.market is only part of a large and growing international market, even that low figure overstates the tax’s impact. If that same company exports half of its product (something that we should encourage all our manufacturers to do, and which cutting edge manufacturers should be able to accomplish), then the effective rate drops to only 0.575%, or about half a penny for each dollar of sales. That doesn’t seem like a very high price to pay, especially when one considers that in return, the industry is getting: (a) 30+ million new customers, and (b) continuation of a private-sector based healthcare system that allows it to make much higher profits than would be the case under a single-payer or socialized medicine system.

3) Rather than a corporate profit tax, which corporations are very skilled at avoiding (viz. GE’s $0 tax bill), this is effectively a value-added tax. Simple, straightforward, and uncomplicated, and un-evadable, which I’m sure is part of why the industry doesn’t like it.

4) Companies will not bear the full portion of these costs, but will pass a portion of them on to purchasers in the form of higher device prices. Naturally, they’d like to pass the full tax along to consumers, but generally they’re not able to do so due to competition. The price elasticity of demand determines how much of the tax medical device sellers will be able to pass on: the higher the demand, the higher the share passed on. For sake of arguments, let’s say that in this case it will be 50-50, which means that device prices will increase less than 1% (because of the $5 million exemption, as described above: as described in the final example, the increase would only be half of 0.575%, or only 0.2875%), and seller costs will increase less than 1% (again, in the above example, 0.2875%). That’s about a quarter penny per dollar in cost increases or increased prices respectively. Compared to overall medical sector cost increases which the U.S. economy has been experiencing every year, this potential impact is so negligible as to be non-existent.

 

Now, as to some of the criticisms of the tax:

1) It is “sending jobs overseas.” That would be true if the tax were only on U.S.manufacturers, but it also covers imported equipment, thus ensuring that local manufacturers are not disadvantaged. The Post article doesn’t discuss whether the tax is applied to medical device exports, but it is not. This is a plus, because the tax would in fact (slightly) disadvantageU.S. medical device exporters.

2) The tax is not a “job-killer,” as asserted by Stryker Corp., a Michigan-based hip and knee replacement manufacturer which claims that the tax is forcing it to cut its labor force by 5% (1000 jobs). First of all, it’s much more likely that Stryker is planning to cut those jobs for the same reason that most manufacturers do: to increase short-term profits. But if you’re going to cut the jobs anyway, why not cynically blame it on a tax you oppose? In reality, most manufacturers already cut employment costs to the bone, in defense of which they routinely explain that fealty to shareholders requires them to do so. So it’s unlikely that Stryker can cut labor costs more than it’s already done without damaging its operations and sacrificing its ability to meet demand. If Stryker is therefore forced to absorb a portion (that half penny or less per dollar of sales) of the tax, it’s more likely that they’ll be forced to absorb it in the part of their budget that they aren’t already constantly trying to minimize: executive salaries, bonuses, and profits. And guess what: THAT is exactly why company shareholders and upper management really oppose to the tax, not because it will supposedly force them to cut jobs.

3) Industry apologists also claim that the tax will force them to cut R&D. Again, why? If R&D investments are profitable, why would the small portion of the tax that device manufacturers bear fall disproportionately on R&D? R&D is a tech company’s life-blood. Why would it cut off its nose to spite its face?

4) Industry reps say the tax will squelch start-ups, which drive much of the industry’s innovation. This is obviously and patently false, since the tax exempts the first $5 million in sales, probably for that very reason. But what about a company with $7.5 million in sales? Since only the last $2.5 million is subject to the tax, their effective tax rate will be only 0.77%. Not only that, their profit margins should increase because of the (slight) upward pressure on prices which the tax will create, meaning that the tax should actually end up helping medical start-ups.

In any case, the tax does not affect start-ups at all during the key early years is which they are developing and commercializing their products, and have no or low sales. Indeed, any given start-up will sell $5,000,000.50 worth of equipment before it pays even a penny in tax, at which point they’ll pay…exactly one penny in tax. Somehow, I don’t think that will break them.

5) In a more dynamic sense, the tax is extremely unlikely to result in either higher prices, pressure on companies to cut jobs, R&D, or even executive compensation and corporate profits. That’s because the addition of 30 million new customers to the system will itself result in upward pressure on prices, plus increased valuation for medical technology companies’ intellectual property values, both of which result in lower cost of goods for each unit of production. Since that additional demand is going to make prices go up anyway, all the tax does is capture some of that price increase (almost certainly not all, given how much prices have been increasing historically) so that those funds can then be recycled back into the system. So it’s absurd to say that the tax will cost companies x% relative to CURRENT profits, or a y% reduction in CURRENT employment levels, because all of those levels are going to be pushed up by the demand which millions of new customers will create.

Given how much of a major financial boon that new demand is to the medical devices industry, it’s therefore petty, selfish, and factually incorrect for the industry to complain about what will probably be less than a half-penny on the dollar in tax. Profits (and probably also employment) will still go up as a result of all those new customers, just not quite as much as without that tiny tax, which itself supports the increased demand.

So the industry’s complaints about the medical device tax is like saying: “I demand that I get all 100 cookies you baked today, and I won’t share even one of those cookies with you even though you have been working all day without anything to eat.” My advice to the industry and its lobbyists: share the cookies; cease and desist in their lobbying efforts. If they don’t, then Congress should not accede to those unreasonable demands.

Yes, one expects for-profit businesses to be at least a little bit greedy and resist even reasonable cost-sharing for the common good. But government officials representing the public interest don’t have to give in to that greed.

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