The medical device tax: A primer

Quickly following on the heels of the midterm elections, Senate Majority Leader Mitch McConnell (R-KY) indicated that the medical device tax was a key target for repeal in the 114th Congress. Today, the Senate Finance Health Care Subcommittee will hold a hearing about the effects of the 2.3 percent tax that was included in the Affordable Care Act. Many believe that a repeal is, in fact, possible. Below is a basic primer about the tax and its contentious history.

1. What is the medical device tax?

Included in the Affordable Care Act (ACA) and launched in 2013, the medical device tax imposes a 2.3 percent sales tax on medical device supplies. The tax applies broadly to a range of products, including pacemakers, artificial joints, surgical gloves, and dental instruments. It does not apply to eyeglasses, contact lenses, hearing aids, wheelchairs, or any other device that the public generally buys for individual use. Further, the tax is applied equally to imported and domestically produced devices, and devices produced in the U.S. for export are tax-exempt.

2. Why was it included in the Affordable Care Act?

According to the Joint Committee on Taxation, the tax is estimated to bring in $29 billion over the next decade. The tax was one of many revenue-raising provisions designed to offset the cost of providing coverage to more than 25 million Americans through the ACA, and these newly insured individuals would likewise increase demand for medical device manufacturers’ products and services. Other industries were subject to levies as well, including health plans (an estimated $101 billion), and employers (an estimated $130 billion). It has been noted that then-Senator John Kerry from Massachusetts helped negotiate the tax from 4.6 percent to 2.3 percent.

3. How has the medical device industry responded?

The U.S. is home to more than 7,000 medical device companies with estimated annual sales of $106 to $116 billion per year. The largest concentrations of companies are located in California, Massachusetts, New York and Minnesota. Since 2010, the medical device industry has led a full court press effort to repeal the tax. Companies and trade groups argue that the tax would cost over 40,000 U.S. jobs, and undermine innovation by moving manufacturing offshore – conclusions that are heavily contested by the tax’s supporters.

By some accounts this tax is coming at a particularly challenging time for medical device innovation. A recent analysis by Ernst & Young reported that venture capital investment in medical devices in 2013 fell 17% from the previous year, a downward trend that has been observed for the past seven years. In addition, investment funding is also shifting towards less risky later-stage medical device companies instead of smaller earlier stage ventures. These trends are worrisome since early-stage investment companies can promote innovative and disruptive medical device technologies that introduce new therapeutic benefits or quantum improvements in patient care.

It is unclear what impact the medical device tax will have on investment in early stage innovation. Key factors that have reduced the availability of venture capital for early-stage medical device companies pursuing pre-market approval include U.S. regulatory unpredictability and delays in approval, and an uncertain reimbursement environment. Additionally, efforts outside the U.S to attract medical device investment, such as offering tax havens and other incentives for device developers in Ireland and the Netherlands add to the attractiveness for device companies to move out of the U.S. Moving to a country that has lower tax rates and less stringent corporate governance requirements may save large device companies billions of dollars.

Recognizing that the “country of first choice by medical device developers is a key contributor to early patient access to high-quality, safe and effective devices,” the Center for Devices and Radiological Health’s (CDRH) at the U.S. Food and Drug Administration issued its 2014-2015 Strategic Priorities, which describe their efforts to improve regulatory predictability and device development efficiency in order to “help medical device developers choose the U.S. as the country of first choice for their technologies.” While the FDA’s efforts seem to focus on encouraging medical device innovation in the U.S., the medical device tax seems to be contradictory to this effort.

Some also argue that while expanding insurance coverage will help drug companies sell more products and bring in new patients for providers and hospitals, it will not help sell more devices because the majority of potential beneficiaries are much older and already covered by Medicare.

Hundreds of companies and trade groups have signed on to letters opposing the tax from industry associations, like the Medical Device Manufacturers Association (MDMA) and AdvaMed. Others have launched significant lobbying efforts to support the tax’s repeal, an industry that accounts for $30 million in lobbying expenditures annually since the ACA was passed in 2010. The Center for Responsible Politics has also identified $5.7 million in political contributions on behalf of medical device companies to specific candidates during the 2013-2014 campaign cycle.

4. How are lawmakers responding?

The tax’s repeal has been supported by Democrats and Republicans alike. Many opponents cite the Senate’s fiscal 2014 budget resolution as an indicator of support – drumming up 79 supporters for repeal, including 33 Democrats. However, the resolution “was non-binding and viewed as a free vote to show displeasure with an unpopular aspect of the health law.” The tax’s repeal has garnered outspoken support from Orrin Hatch (R-UT) and Mitch McConnell (R-KY), as well as Elizabeth Warren (D-MA), Al Franken (D-MN), Amy Klobuchar (D-MN) – Democrats with notably high concentrations of medical device companies in their states. The House has approved the repeal of the device tax three separate times in the past two years, including as recently as September 2014. The White House has historically opposed these efforts, but President Obama recently indicated he would entertain the idea.

A report from the nonpartisan Congressional Research Service, released last week, concluded that the tax is unlikely to hurt the profits of device companies, estimating that it will reduce industry output and employment by no more than .2 percent. CRS states, “The effect on the price of health care, however, will most likely be negligible because of the small size of the tax and small share of health care spending attributable to medical devices.” A separate report from Ernst & Young last month finds that domestic revenues for medical technology firms grew 4 percent to $336 billion in 2013, the first year the tax went into effect – about the same rate from 2012, indicating that the industry seems financially stable for now.

Editor’s note: This post was originally featured in RealClear Markets on November 12, 2014. Click here for the original posting.