Analysis: Medical device tax revenues could top $2B next year

MassDevice.com coverage of the medical device tax

by Brad Perriello, Brian Johnson and Arezu Sarvestani

The medical device tax set to start next year has become a lightning rod for criticism, with the med-tech industry claiming it will be catastrophic for the industry and its critics claiming those concerns are overblown.

AdvaMed, the national lobby for the medical device industry, commissioned a pair of reports it says show that the tax will kill between 39,000 and 43,000 med-tech jobs and cost the industry between $670 million and nearly $7 billion. Countering those claims, Bloomberg Government issued a report of its own saying the real cost won’t be anything like that.

But a MassDevice.com analysis of last year’s U.S. sales for nearly 50 of the largest medical device makers reveals two potential aspects of the tax that neither side addresses:

First, the tax could have a wildly disproportionate effect on med-tech companies, depending on their margins.

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Further, our analysis revealed that the tax, as currently constructed, is likely to generate far more revenue than the $2 billion a year it’s designed to deliver.

Sen. Scott Brown (R-Mass.) told MassDevice.com he isn’t surprised about our findings, saying that the politicians who wrote the law "knew what they’re doing" when they created the tax.

Sen. Scott Brown

Sen. Brown

"We can’t get any accurate numbers and the numbers that are coming out now are all over the place. It’s very frustrating that it’s so tough to get a straight answer," Brown told us.

Asked if it’s fair to call his position "repeal or bust," Brown dismissed the idea of altering the scope of the med-tech tax.

"It doesn’t help to modify it by going to a lower rate," he said. "No, the bottom line is the [tax] is just there to pay for a health care bill I didn’t support in the first place."

An uneven playing field

While the tax prescribes a flat 2.3% levy from all U.S. sales of medical devices, the effects would be wildly disproportional in practice.

For several companies that posted losses last year, the tax would have pushed them further into the red, and for a few companies it would have meant a swing from profitability to losses.

For more than 75% of the other companies on our list, the tax means lower profits by between 5% and nearly 50%. Take Integra LifeSciences (NSDQ:IART), which posted U.S. medical device sales of about $593 million last year, according to Integra’s annual report. A 2.3% whack would have taken $14 million off the top line – exactly half of Integra’s 2011 profits.

At the other end of the spectrum, there’s Sirona Dental Systems (NSDQ:SIRO) and the $256 million it logged in domestic medical device sales last year. Its tax tab, had the measure been in effect, would have been $6 million, or about 5% of its $122 million in profits.

Click here for a larger interactive version of this graph

For 6 of the med-tech companies on our list, the tax would have meant more red ink, ranging from 9% (Philips (NYSE:PHG)) to 934% (Orthofix (NSDQ:OFIX)). For 3 others, the tax would have pushed them from black to red. ConMed’s (NSDQ:CNMD) $1 million in profits would have turned to an $8 million loss; SonoSite’s (NSDQ: SONO) $1 million bottom line would have swung to a $3 million loss; and Symmetry Medical’s (NYSE:SMA) $3 million profit would have instead been a $3 million loss.

Bloomberg Government takes on AdvaMed’s report

Industry lobby AdvaMed issued its own analysis of the medical device tax last September, focusing on overall impacts to the industry. According to the study’s authors, the impending levy represents "the last straw on the camel’s back" for medical device companies trying to thrive in the struggling American economy, all but forcing companies to ship manufacturing overseas.

AdvaMed’s ominous projections got a lot of attention, especially from members of Congress already favorable to the industry, but it also caught the eye of Bloomberg Government analyst Christopher Flavelle, who deemed the entire report "not credible."

AdvaMed’s analysis concluded that the industry directly employs more than 400,000 in the U.S., and that "under reasonable assumptions, the tax could result in job losses in excess of 43,000 and employment compensation losses in excess of $3.5 billion."

The figure came from an economic analysis commissioned by AdvaMed and conducted independently by Diana Furchtgott-Roth, senior fellow at the Manhattan Institute, and Harold Furchtgott-Roth, former chief economist of the House Commerce Committee.

"We are not in a strong economic position," Diana Furchtgott-Roth told media during a September conference call when the report was released. "This is not the right time to impose a new tax."

The threat of 43,000 U.S. jobs lost became a rallying cry among industry supporters protesting the tax, including med-tech advocate Rep. Erik Paulsen (R-Minn.) who cited the figure in a letter, with 74 co-signers, sent to House leaders last month.

Medical device executives and related lobbies also used the estimate liberally, especially as companies such as Zimmer (NYSE:ZMH) and Stryker (NYSE:SYK) began announcing layoffs in efforts to cut costs ahead of the tax. But Bloomberg’s Flavelle cast a wary eye on the industry report, chiding it for exaggerating the impacts of the levy without enough solid evidence.

"AdvaMed’s "reasonable assumptions" conflict with economic research, overstate companies’ incentives to move jobs offshore, and ignore the positive effect of new demand created by the law," Flavelle wrote.

Flavelle’s arguments stemmed from a Bloomberg Government analysis that he also penned entitled "Medical Device Industry Overstates Tax Impact," in which he breaks down the assumptions underlying the AdvaMed report’s projections.

He argues that the study’s authors rely too heavily on hypotheticals that blow the tax’s potential impact out of proportion, especially in regard to the loss in revenue and shift to overseas manufacturing.

The AdvaMed report’s most salient projections include heavy layoffs, closure of U.S. plants in favor of overseas manufacturing, price increases on life-saving medical devices and reduced research & development budgets.

Flavelle concedes that the industry may take some hits, but believes losses in revenue attributable to increased prices may be partially or entirely recouped by the 23 million Americans newly insured under health care reform. He finds the threat of a flight overseas untenable, as "the tax by itself creates no specific financial incentive to move production," and he paints the 43,000 jobs lost estimate as little more than a wild guess.

"This industry, as with any industry, has a responsibility to its shareholders to maximize profits and minimize costs at all times, before the tax and after the tax," Flavelle told MassDevice. "The question isn’t whether there are incentives to cut costs – there are always incentives to cut costs. The question is, what new incentives are created by this tax to move jobs overseas?"

"If it’s more cost-effective for Company X to create devices in some other country, you’ve got to assume from the outside that they would do that in the absence of the tax," he added.

AdvaMed generally dismissed the point as an editorial representing one person’s take on the issue.

"Opinions are like noses," public affairs chief Gary Karr told MassDevice. "Everybody’s got one."

The industry lobby stood beside its study, maintaining that it’s the spirit of its conclusions that matter, not the numbers themselves.

"It’s almost kind of beside the point whether 42,000 is the right figure or 39,000 is the right figure or 10,000 is the right figure or even 8,000," Karr said. "It’s still a lot, that’s our point, not the specific number that it’s likely to be. We are certainly in danger of significant job loss because of the device tax."

"At the end of the day it’s really incontrovertible that the medical device tax is a danger to jobs in the medical device industry – it’s just a question of how much," Karr said. "I think for the people who have already been told that they’re going to be laid off by companies who have already announced that, I think 1 job lost because of the medical device tax is 1 too many."

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