Are You Ready for the Medical Device Excise Tax?

Mark Crawford

Most people say it’s really going to hurt—especially for small- to mid-sized medical device manufacturers, possibly even driving them out of business. Companies will likely have to cut jobs and reduce R&D budgets to have enough cash on hand to pay the tax, which goes into effect January 1, 2013.

In February, the Massachusetts Medical Device Industry Council (MassMEDIC) conducted a survey among medical technology companies to see how they are dealing with the Medical Device Excise Tax (MDET). Signed into law in 2010 as part of the Affordable Care Act, the 2.3% excise tax is expected to raise about $20 billion over ten years to help finance health care reform. The tax will be collected on medical device sales, even if a company is losing money.

“We warned two years ago that medical device companies would be forced to deal with this tax by preparing for job cuts and reductions in R&D spending,” says Tom Sommer, president of MassMEDIC. “TheU.S.leads the world in developing and manufacturing medical products. It doesn’t make sense that on one hand the government is promoting exports and manufacturing jobs, while on the other it is implementing policies that will cut jobs in this sector and harm our competitive advantage—the development of innovative medical technologies.”

According to the MassMEDIC survey:

• Only 25 percent of companies have systems in place to comply with the MDET.

• 44 percent of the responding companies plan to pass the cost of the new tax on to end users such as hospitals, clinics, purchasing organizations and doctors.

• 39 percent of respondents stated they would assume the cost of the MDET, implementing internal cost reductions to meet revenue losses, including cutting R&D, laying off workers, or outsourcing to low-cost regions.

Bourne Partners (www.bourne-partners.com), a firm that provides strategic and financial advisory services to the health care industry, warned that “with the excise tax introducing further price pressure on an already fragmented industry struggling to maintain innovation in the face of reimbursement cuts, the device space may see more acquisitions—especially those that introduce benefits of scale and diversity of product offering while achieving cost synergies.”

Further, states Bourne Partners, with the exception of a handful of global players, the medical device sector is largely comprised of start-ups and small businesses—in fact, over 80 percent of medical device companies employ fewer than 50 employees.

It’s not just the small companies that are worried—some of the big guns are already taking action. For example, industry observers believe that Stryker’s workforce reduction by about 1,000 people last year was in preparation for paying the excise tax

Stephen Rapundalo, director of industry association MichBio (www.michbio.org), in a recent Xconomy article on how the Affordable Care Act may be thwarting innovation, states that “the medical device excise tax has very broad implications for innovation and the sustainability of medical device manufacturers in Michigan. The tax doesn’t recognize the difference in business models between pharma and medical devices. Medical devices are more like commodities, purchased by hospitals, for example, and I don’t think it’s fair to levy an excise tax.”

Advocates of health-care reform maintain that the Affordable Health Care act will lead to more medical device sales because tens of millions of Americans will be newly insured and need these devices.

This, however, has not held true inMassachusetts, which passed a universal health care law six years ago. “With nearly 100 percent of the population now covered by health insurance plans,” indicates MassMEDIC, “a KPMG survey asked participants if their companies had experienced an increase in unit sales inMassachusettssince 2006. None of the respondents reported an increase in unit sales in that time period.”

Given the uncertainty associated with the new excise tax, there may be opportunities to restructure operations, especially related to supply chain management, to better navigate the new tax laws.

“In a November 2011 Ernst & Young  presentation entitled ‘Making Sense of the New Excise Tax on Medical Devices,’ authors Christopher Ohmes and Michael Udell point out that while the tax might merely be added to the invoice price of taxable medical devices and passed along to customers in a manner similar to, for example, the manufacturers excise tax on tires, this scenario is unlikely because Medicare and Medicaid, the Veterans Administration, and the Department of Defense pay for the majority of the medical device sales and uses in the United States,” concludes Bourne Partners. “In this scenario, it is likely private payers that will bear the brunt of any price increases introduced to offset the MDET. Manufacturers may try to push the tax back onto their suppliers or try to reduce their operating costs in response to this new tax.”