AdvaMed (the Advanced Medical Technology Association) released a study on September 7 which concluded that the 2.3% medical device tax scheduled to kick-in in 2013 under the Accountable Care Act (ACA), could cost tens of thousands of jobs, almost double the industry’s total taxes, harm U.S. competiveness and cause a decline in the demand for medical devices.
The study, prepared for AdvaMed and titled, “Employment Effects of the New Excise Tax on the Medical Device Industry, ” was written by Hudson Institute senior fellows Diana and Harold Furchtgott-Roth.
Ms. Furchtgott-Roth was chief economist of the U.S. Department of Labor from 2003 to 2005. Mr. Furchtgott-Roth was commissioner of the Federal Communications Commission from 1997 to 2001, and chief economist of the House Commerce Committee from 1995 to 1997.
Report: Device Demand Will Drop
The authors write that the new excise tax is complex, and will substantially raise the tax burden on the medical device manufacturing industry. In response to the new tax, they argue that prices of medical devices will rise, and consumers and health care providers will pay more for medical devices.
The exact change in prices for medical devices as a result of the excise tax will depend on various economic parameters, but, according to the authors, an estimated half or more of the excise tax will likely be passed along to end users in terms of higher prices.
“Correspondingly, states the report, “the quantity of medical devices demanded will decline in response to the higher prices that include the excise taxes.” They estimate that medical device demand would decline between $0.67 and $6.7 billion annually.
They argue that there is no reason to assume that the demand for medical devices is inelastic. “Consequently, the imposition of the excise tax on medical device manufacturers will likely lead to distortions in demand.”
New Paying Customer?
The study, however, does not address the expected expansion of coverage for the uninsured and likely larger number of patients with money to pay for new devices.
We are not advocating higher taxes for device makers, but we think it’s important to evaluate the impact on the industry correctly.
When the tax was first proposed in September 2009 as part of a way to pay for increasing coverage for the uninsured, we noted there are 35 million to 40 million uninsured people in the U.S. (we saw numbers as high as 47 million, but if you exclude non-citizens the number drops). If the ACA plan to increase coverage is half way successful and 15 million newly insured patients come into the healthcare system, orthopedic companies, we calculate, will sell 8% more implants. That’s $2.4 billion of incremental revenue.
By our estimates, the number of potential new orthopedic patients would rise by 300, 000.
The Industry’s Economic Impact
Setting aside the issue of device demand, the AdvaMed study provides a recent picture of the device industry and its impact on the U.S. economy.
In 2006, medical device manufacturers reported taxable income of $13.7 billion and paid $3.1 billion in corporate taxes. The new tax, according to the AdvaMed study would add $2.67 billion a year in new taxes.
Impact on Innovation and Employment
The study says the tax would be especially harmful to companies that create novel technologies. These companies tend to suffer losses in their early years when focused on research and development for a new product. These start-up companies would have to pay the full tax regardless of whether they had any profit. “This is a tax on innovation, ” said Stephen J. Ubl, president and CEO of AdvaMed.
According to the study, the tax could reduce employment in the industry if there is a decline in demand for medical devices and by encouraging American firms to shift production overseas. States the study:
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.
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 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.
We noted in our September 2009 story that if demand for devices increases, the effective rate of the tax begins to drop because the tax will be collected on revenues for the previous year, while demand is rising in the year the tax is actually paid.
Manufacturing Exodus
Suzhou, China/Wikimedia CommonsFurthermore, the authors conclude:
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.
“This new tax burden could force companies that would otherwise never leave the U.S. to make difficult choices based on stark economic reality, ” added Ubl.
Impact on Earnings and Pricing
The effect of the tax on earnings of U.S. companies is likely to be significant, according to the study. In 2006, medical device manufacturers reported taxable income of $13.7 billion and paid $3.1 billion in corporate taxes. The U.S. already has one of the highest corporate income tax rates in the world. The new 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
The authors argue that the tax would likely increase the after-tax prices to American consumers between .02% and 2.1% with most price increases around 1%.
Wall Street’s Analysis on Orthopedics
What will be the impact of the tax on some specific orthopedic companies?
Mike Matson, Mizuho Securities Senior Analyst/MatsonMike Matson, senior analyst for medical supplies and devices at Mizuho Securities USA, Inc., updated his 2013 estimates for a number of orthopedic companies on September 14.
Matson argues that companies with more domestic medical device sales, lower margins, and/or lower tax rates should see a greater hit to their EPS (earnings per share) from the excise tax.
Larger-cap medical device firms tend to have more international sales and higher margins and should generally see 2013 EPS reduced by 4% to 6% as a result of the tax.
In contrast, says Matson, smaller-cap medical device firms tend to have less international sales and lower margins and should generally see 2013 EPS reduced by 10% or more.
Within the universe of orthopedic companies that Matson follows Wright Medical Group, Inc. should see the largest impact followed by NuVasive, Inc. and Orthofix International. He expects median 2013 EPS growth of 4% for device makers, including the med tech tax (or 10% excluding the tax).
Ortho Market for 2013
Matson expects the orthopedic recon market to grow by 3% in 2013. That beats the cardiac rhythm management and drug-eluting stent markets of 0% and 2% respectively.
He looks for hip and knee sales to each grow by 3%
He includes the impact of the 2.3% medical device excise tax in his 2013 estimates and assume that the device companies will not be able to pass through or offset any of the tax. He believes the tax will hurt Wright Medical Group the most.
Matson says given the high degree of global economic and government policy uncertainty, he admits that his crystal ball is hazy. For now, he assumes that 2013 estimated growth in the major med tech markets will be consistent with 2012 growth.
The excise tax is tax deductible so the bottom line impact, according to Matson, should be softened a bit at companies that are paying taxes.
Risks
As Matson looks at target stock prices for orthopedic companies in 2013, he notes risks related to market share, pricing and procedure volumes.
For Medtronic the risk is primarily a greater-than-expected spine market share loss. NuVasive’s risks include worsening spinal implant pricing or spinal fusion procedure volumes.
For Orthofix he identifies the risk of slower-than-expected spine stimulation growth and worsening spinal implant pricing and procedure volumes.
He is bullish on Stryker given the company’s large cash position, but cites the risks of worse–than-expected orthopedic implant pricing and difficulties integrating recent acquisitions.
In addition to Wright’s exposure to the device tax, Matson says potential worsening orthopedic implant pricing and repercussions of recent compliance issues are risks.
Finally, he says the primary risks to Zimmer Holdings, Inc. include worsening implant pricing and potentially, greater-than-expected market share loss to competitors
We note that Wright announced on September 15 that the company will lay off about 6% of its workforce (80 employees) to reduce costs. The company did not cite the expected device tax as a reason for the restructuring in its press announcement.
Rewarded or Punished?
The 2.3% excise tax will certainly hit medical device manufacturers who are one of America’s bright spots when it comes to growth and exports. If demand rises, their forced contribution in helping cover the uninsured will likely, as Stryker chief Stephen MacMillan and former Senate Majority Leader Bill Frist, M.D. suggested, be rewarded. If demand declines, as the AdvaMed study argues, Congress will have taxed the goose that has been laying golden eggs for America.
