Medical Device Tax Hits Most of Health Care Industry

Industry leaders speculate about the financial impact of the wide-ranging tax.

  • O&P Business News, Fall 2010

The medical device tax embedded in the Patient Protection and Affordable Care Act (PPACA) that was signed into law in March imposes a 2.3% excise tax on the sale and import of Class I, II and III medical devices, beginning in 2013. The vast majority of O&P products, as well as durable medical equipment, are considered Class I devices. Medical device manufacturers and O&P industry leaders will be tracking the development and implementation of this tax closely through the legislative or regulatory processess before its 2013 implementation, according to the National Association for the Advancement of Orthotics and Prosthetics (NAAOP).

 
  © 2010 iStockphoto.com/geopaul

Last minute changes

Originally, the medical device tax was limited to Class II and III medical devices. These devices include implanted devices, such as hip replacements, stents and pacemakers. Congress instituted a 2.9% tax on the sale and import of those medical devices, raising $40 billion in 10 years. But industry pressure later convinced Congress to reduce the impact of the tax to $20 billion over ten years.

“Once we saw the first draft of the legislation, our members and stakeholders in the medical device community reached out to elected officials to tell them the impact that it would have on one of the only industries that reduces the costs of health care and that still creates good jobs in this economy,” Mark Leahey, president and chief executive officer of Medical Device Manufacturers Association (MDMA) said. “While we appreciated the $20 billion reduction and the efforts of congress who advocated for this, more work remains.”

According to NAAOP, the original Senate bill was repealed and replaced with a different tax of smaller magnitude during the reconciliation process, known as the Health Care and Education Reconciliation Act (HCERA). The HCERA compromise slashed the tax from 2.9% to 2.3%, in order to reduce the impact on medical device manufacturers, but in order to continue to raise $20 billion in revenue, the tax was expanded to include Class I medical devices. Although the tax rate was cut, it now touches nearly all medical devices.

“I think the original intent was to tax the large companies that manufacture MRI machines, imaging equipment and other medical devices used in hospitals and health offices across the country,” Peter Thomas, JD general counsel for the NAAOP, explained. “But when they extended the tax to Class I, they really opened the door. When they included Class I, they covered most devices.”

Long odds

Legislators left a small window for medical device manufacturers and the O&P industry. According to the HCERA, exclusions from the tax include: “eyeglasses, contact lenses, hearing aids and any other medical device determined by the [Department of Health and Human Services] Secretary to be of a type that is generally purchased by the general public at retail for individual use.”

  David Nexon
  David Nexon

“Every part of that last definition is important,” Thomas explained. “Clearly, all of O&P is for individual use, arguably it is at retail, depending on the definition of retail. The other issue is whether O&P services and devices are ‘generally available to the public.’ O&P tends to be available to a subset of the general public that requires use of these devices. We will be closely monitoring and trying to impact how that definition ultimately impacts O&P.”

Brian Gustin, CP, president of Forensic Prosthetics and Orthotics, explained that because of the billions of dollars the health care bill intends to cut, the O&P industry will no longer be excluded from similar tax provisions.

“Unfortunately, I do not think there will be any legislative process to exempt O&P because the government will not play favorites and leave certain industries out,” Gustin said. “Quite frankly, O&P is too small of a market for a legislator to fall on a sword for.”

  Brian Gustin
  Brian Gustin

Providers pay heavy price

Although the health care debate that raged for more than a year has simmered, questions regarding the 2,700 page bill remain. New and raised taxes usually spell trouble for the consumer. The manufacturer sells a product to a company at a higher price and the company charges the public more. The consumer loses in the end.

Regarding the medical device tax, due to fee schedules, the end user’s price is already set and can not be raised. Therefore, who will be impacted from this tax?

“Who this tax should really make nervous are the individual providers who are going to be purchasing those devices,” Gustin said. “Ultimately, the tax gets passed down to the consumer, but in this case, the provider is the consumer, not necessarily the patient.”

  Peter Thomas
  Peter Thomas

According to Gustin and Thomas, it is unlikely that medical device manufacturers will simply absorb the tax. They wholeheartedly expect manufacturers to pass that tax downstream to the provider by raising their prices. Health care providers and O&P practitioners may be the ones forced to absorb the tax.

The legislative route is a risky move for the O&P industry. According to Thomas, the O&P community could band together with various other groups and argue that they should be exempt or that any company with less than a certain amount of revenue should be excluded. If they succeed and are exempt, Thomas explained, the O&P industry could open itself up to alternative tax provisions.

“The question becomes if we are exempt from this tax, might there be a risk of then being taxed as a regular retail sale, which has never applied to O&P?” Thomas asked.

How providers can prepare

According to Gustin, providers should reduce their costs in order to offset the potential rise in price for medical devices. Providers should look at their processes closely during everyday operations and ask themselves a simple question — why do we do this?

“Does this process add value to the company?” Gustin asked. “If it does not, my advice is to change it or eliminate it because it is going to be tougher and tougher to remain viable when all of health care is being asked to cut billions of dollars every year for 10 years.”

Gustin dismissed the notion that the health care bill will provide more customers for the O&P and thus offset any loss from raised taxes.

“O&P insiders seem to believe the fallacy of volume,” Gustin explained. “The fact of the matter is if you are selling something at a loss, selling more of it does not make up for that loss, you actually get a bigger loss.”

Concerns for manufacturers

David Nexon, senior vice president of Advanced Medical Technology Association (AdvaMed), said there is concern within the industry about the impact of the medical device tax.

“We will be looking at ways we can mitigate the impact of the tax,” Nexon explained. “We will be working with the treasury department and we will be keeping an eye on what is happening legislatively. Any prudent sense tells you to start planning now, even though this tax will not be applied until 2013.”

However, a legislative appeal would require Congress to offset the cost of the provision, thereby raising $20 billion in revenue in some other way.

“This tax could mean layoffs, reduction in pay, pay freezes, or reductions in cost structure, which would likely include the research and development department,” Nexon said.

The tax may force medical device companies to cut their budgets in the short term in order to remain viable, according to Leahey.

“Every poll and study that we have seen shows that companies will cut back research and development, eliminate jobs and in extreme situations, go out of business,” Leahey said. “Unfortunately, the tax is on gross sales, regardless of whether or not your company is profitable. As a result, this tax could prove to be a fatal blow to small and mid-sized companies that are just beginning to grow.”

Nexon agrees with Leahey’s assessment.

“If you are a new medical device company with less than 100 employees, you are just ramping up with little to no profits anyway,” Nexon explained. “Trying to come up with additional 2.3% of revenue is a significant burden.”

Proponents of the tax argue that the bill would create approximately 30 million potential customers, therefore offsetting any potential budget concerns. However, for many medical device manufacturers, this is not the case.

“Most of our company’s products are used in the acute care setting, which all Americans, whether insured or not, have access to,” Leahey said. “We do not anticipate any increase in sales once this bill is implemented.”

The bottom line is that a tax on medical devices is not going to go away. Even if this particular medical device tax is repealed, it will be replaced with a new provision.

“This thing is not over by any means, but at some point, something has to give,” Thomas said. “They have to fund the expansion of health care coverage somehow, unless Congress and the President essentially reverse course on health care reform.” — by Anthony Calabro

Perspective

The medical device tax is yet another bullet for the O&P community. The provider, not the patient, will be asked to take the hit on this one. If you add this to a long list of other hits, one begins to ask the question, “How much more can I take?”

When this happens, usually the provider, patient and industry begin to crumble due to lack of quality in service. You get what you pay for and if you are not getting paid, the service will ultimately reflect that.

However, I still have hope that in the end our value to health care will prevail. But in order for this to happen, we must educate our legislators and work together as a team to address these various challenges. If suppliers, providers and authorizing parties do not work together, this just might be the last bullet.

—Rick Fleetwood
Chief executive officer, Snell Prosthetic and Orthotic Lab

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