Medtech industry braces for excise tax impact

Effective January 1, 2013, the 2.3% excise tax on medical devices could prompt consolidation in a $308 billion global industry consisting mainly of small startups with lean product portfolios and fewer than 50 employees.¹ Some could owe more in taxes than they generate in profits, making them less attractive to investors but enticing to larger companies that are better positioned to absorb the tax and looking to expand their portfolio.

Federal coffers stand to gain $29.1 billion over the next 10 years from this tax, which was included in the Affordable Care Act (ACA).² Much of the industry has labeled the tax a job and innovation killer—predicting nearly 39,000 US job losses.³ Some companies say it’s just another cost pressure in an evolving market, but others have already blamed it for shelved domestic expansion plans and layoffs. One company is cutting its workforce by 10% and plans to move some operations overseas.⁴ Medtronic, a large medical device manufacturer, estimates that the tax will increase its annual tax liability by $125 million to $175 million, or 1%−2% of US sales.⁵

Medtech companies are unlikely to pass on the tax to customers for several reasons. A group of hospital associations opposes pass-through of the tax and has urged the IRS to prevent them from doing so; and industry analysts predict that companies dealing in commodities, such as coronary stents or tongue depressors, are unable to pass it on because of pricing pressure and competition. Unless companies offer a novel product without direct competition, they will have to bear the cost.

As manufacturers look to shift costs, they must also innovate. Nearly 70% of consumers surveyed by PwC’s Health Research Institute say that pharmaceutical and biomedical research is an important contributor to economic health.⁶ While some companies expect to absorb the tax and reduce expenses elsewhere, others are recalibrating operations, resources, and investments to spur strategic growth in other areas to offset it. Because the tax applies only to US sales, medical device makers with robust sales abroad should fare better.

Implications

• Manufacturers that have been waiting and hoping for repeal have run out of time. They should have a basic system for calculating tax liability, or they risk overpaying or underpaying the IRS.
• The supply chain may become volatile as manufacturers, contractors, distributors, and other third parties maneuver to avoid responsibility for the tax. Medtech companies should assess the potential for supply chain disruptions before changing pricing policies.
• Medtech companies should consider working with providers on comparative effectiveness studies of products before they are distributed. Doing so may help reduce write-offs on consignment products, demonstrate value to purchasers, and streamline the portfolio.
• Industry consolidation could give medtech companies greater pricing power in negotiations with insurers, providers, and suppliers.