The Real Impact of the Medical Device Tax

Medical Device companies didn’t “play ball” with Leftists when Obamacare was being rammed through Congress and for that reason, they were punished with a 2.3% device tax on any product they sell in the US. 

This Forbes article makes the point that the Medical Device Industry was cautious in playing politics (as opposed to the pharmaceutical industry) and it hurt them.

The research-based drug makers were revealed early on to have been key players in passing the despised legislation. As late as last week, Republican legislators were digging out e-mails detailing the deal-making between them and the White House. It’s not surprising that those legislators are not investing seriously in executing the industry’s post-Obamacare agenda. (The Prescription Drug User Fee Act, PDUFA, which is sailing through Congress with overwhelming bipartisan support, has nothing to do with Obamacare, but renews a twenty-year old law).”

“The medical-device industry, on the other hand, acted more carefully during the debate over Obamacare. It did the best it could to protect its members’ interests, but avoided the temptation to jump on the bandwagon and commit to promoting the terribly one-sided, partisan, uncompromising bill.”

“With the benefit of 20/20 hindsight, I suspect it’s an approach that leaders in other health-care sectors wish that they had taken.”

Many articles have been written how this Medical Device tax will not only kill jobs, innovation but also patients.  From the Pacific Research Institute (emphasis mine):

Because incentives to invest in the research and development of new medical technologies are driven by perceived returns, the excise tax on durable medical equipment and medical supplies can be predicted to reduce such investment. The finding here is that such investment would be reduced by about 10 percent annually, or about $2 billion during 2013 through 2020. By analogy with the estimates available in the literature for pharmaceutical investment, this investment loss would cause, conservatively, a loss of about 1 million expected life-years each year, the economic cost of which would be about $100 billion per year, a figure substantially greater than the entire U.S. market for medical devices and equipment. The sheer magnitude of this adverse economic effect suggests strongly that the excise tax on medical equipment and supplies should be repealed.”

This is tragic enough to drive our government to repeal, at a minimum, this section of Obamacare but I’d like to show you how this new device tax would impact the Profit and Loss statements of medical device companies and show that the impact is much larger than a simple 2.3% reduction in net profits.

Remember that the 2.3% tax applies to SALES and not profits so the reductions in sales is part of the top line of a P and L statement so we must then deduct for Cost of Goods Sold (COGS), R&D, Selling, General and Administrative (SG&A) and other special charges (such as purchasing other companies) to arrive at a final Net Profit.  I will start this simulation with a fictitious company that has just over $5 billion in sales and the following P and L statement (items marked in yellow are assumptions and the other numbers are calculated from those assumptions).

This fictitious company takes in a net profit of $500 million in one year (based on my assumptions for COGS, SG&A, R&D, etc.) and I’m assuming that 50% of their sales occur in the US.  $500 million is a lot of money but let’s take a look at what that company would choose to do with that profit.  It might buy new growth businesses, pay out dividends to stock holders, pay profit sharing to its employees, increase research and development or save that money for future economic calamities.  Remember that Apple has over $100 billion cash on hand and one of the metrics used to evaluate a company’s health is cash on hand so $500 million yearly profits in a highly risky and regulated market such as medical devices is not uncommon. 

Now let’s see what happens when the Medical Device Tax kicks in and we assume all other variables remain equal.

Although the Medical Device tax is 2.3%, this reduces this company’s Net Profit by 7.6% ($38 million)!  Will Wall Street investors keep their money in this company under this scenario or will they leave the company and cause the company’s market capitalization to drop like a rock?  It’s anyone’s guess but my money is on the latter versus the former and I expect investors to leave Medical Device companies in mass after earnings are severely reduced from this Medical Device tax.

One way this company could offset the Medical Device tax effects on its bottom line is to increase sales but how much will they have to increase sales to offset this 2.3% tax?

This company would have to increase their sales by over 7% in one year to offset the Medical Device tax and anyone in business knows that this kind of sales increase is difficult, if not impossible, under the current economic climate which has been made worse by Obamanomics.

Increasing sales is difficult so most companies will, most likely, choose to reduce their manufacturing costs (COGS) so let’s see how much this company would have to cut to offset the Medical Device tax.

The company would have to cut over 7% of its manufacturing costs and this would also be difficult in the current economic climate which has already forced manufactures to do more with less.  Some companies might move manufacturing offshore to reduce costs but this would adversely affect US jobs numbers and is a fact that many Leftists don’t seem to realize.

Since manufacturing has already been cut to the bone, maybe a company would choose to sacrifice long term gains by cutting Research and Development costs to offset the Medical Device tax.

Research and Development would have to be cut by over 12% to recoup the Medical Device tax and companies that are in this industry rely on R&D to provide products that are the future growth drivers of so cutting this vital department would not only increase unemployment in the US but jeopardize the long term viability of this company.

This simulation was done on the assumption that a company only has 50% of its sales in the US but let’s take a look at what would happen if a company had 100% of its sales in the US (meaning that a higher percentage of its sales would be affected by the new Medical Device tax).

In this scenario, a company would see its Net Profits drop by over 15% or, to offset the impact of this tax, the company would have to increase its sales by over 15% or reduce its COGS or R&D expenses by 11% and 20% respectively.  How long will Wall Street continue to invest in a company that delivers 15% Net Profit reductions year over year or cuts to their long term viability (R&D) by 20%?  A company who has a majority of its sales in the US would be devastated by the Medical Device tax and it would not be a surprise to see many companies go out of business as a result of this punitive tax. 

No matter how you look at it, the Medical Device tax from Obamacare is a killer for business, jobs and innovation.  Repeal it now!

ADDENDUM – The full spreadsheet calculations can be found here -> p and l study.

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11 Responses to The Real Impact of the Medical Device Tax

  1. Henry K. says:

    Its not hard to understand how this medical device tax will affect people of our country. There has to be a common middle ground where we can still tax but allow the development and design of various healthcare needs.

  2. Alison says:

    Thank you for writing about this topic. Quite frankly, I am baffled why this tax is even up for debate. The U.S. economy needs help, not another hit.
    “How long will Wall Street continue to invest in a company that delivers 15% Net Profit reductions year over year or cuts to their long term viability (R&D) by 20%?” -This brings up an even better point… aside from established companies, how will the tax impact the likelihood of medical device startups (like the company I work for) to receive funding in order to develop innovative medical devices?

  3. tannngl says:

    Cosmocon,

    I see a simple slide from the best health care in the entire world to something much less. Quality of care which includes medical devices is on its way down down down.

    You know, eventually, the panel that decides on standards for which groups of people recieve which treatments/procedures, will drastically cut those treatments/procedures. That’s another decrease in your medical devices.

    I know of physicians who are leaving their profession due to their payment. They have never recieved 100% of what it costs them to give care when the payors are medicare or medicaid. They made up the differences from private health care and some self pays. Now the amt of patients on govt health care plans will ultimately end up being everyone. Who will do that job then?

    This law must either go or be gutted so it fails.

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  5. Daniel Prewitt says:

    You’ve left out 2 simple pieces of math. One – there will be 30 million more customers and therefore an increase pie for their products and the 2.3% will simply be passed on as is any cost increase.

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