As part of the Affordable Care Act, a 2.3 percent tax on medical devices and products was passed. The tax was levied on devices such as pacemakers, advanced imaging technologies (Cat Scan, MRI and ultrasound equipment), artificial joints, surgical gloves, and dental instruments. Devices that the public generally buys for individual use, such as eyeglasses, hearing aids, and wheelchairs, were explicitly exempted from the tax.
The medical device tax was never an economically sound policy. In recognition of this tax’s many flaws, both the Senate and House of Representatives have separately passed repeal legislation. While the repeal attempts have been unsuccessful, Congress has twice implemented a moratorium that suspended the tax. Passing a series of moratoriums is insufficient, however. The optimal policy permanently repeals the medical device tax.
Taxing Medical Devices Is Unsound Tax Policy
Excise taxes such as the medical device tax create unwanted economic inefficiencies. Perhaps more important, the typical arguments used to justify the imposition of an excise tax does not apply to medical devices. Proponents often justify excise taxes as a means to discourage consumption of the taxed product. Regardless of this argument’s merits, it clearly does not apply to medical devices.
Take imaging technologies as the example. Imaging technologies help physicians detect diseases in their earliest stages when they are most treatable. Clearly, policy should not discourage greater use of these crucial medical technologies nor increase their price. Yet, introductory economics teaches that this is precisely the expected result from the imposition of the medical device tax.
If the medical device tax were not suspended, then an imaging device company with $10 million in revenues would have additional costs of $230,000 (the 2.3 percent medical device tax multiplied by the $10 million in gross revenues). How the company will deal with these costs is unknown. Perhaps some of these costs will be passed along to patients through higher costs for medical equipment, harming patients welfare. Or some of these costs will be absorbed by the company, which would reduce their profitability. If the costs that cannot be passed along are high enough, then the 2.3 percent tax on revenues could turn a company with minimal profits into a money loser.
The precise allocation of these costs will vary depending upon the specific price sensitivities of the patients and producers. It could be that patients bear all of the costs, producers bear all the costs, or some combination of the two. The only outcome that is not possible is that the tax does not distort the imaging technology market. Policies that lead to some combination of higher medical costs and less availability of medical technologies worsens the problems facing the U.S. health care system.
Empirical studies examining the medical device tax have differed regarding the exact magnitude of the tax’s negative economic impacts, but directionally all studies agree that the tax will adversely impact the medical device industry specifically, and the economy more broadly. For example, a 2014 analysis by Congressional Research Service (CRS) recommended against implementing the tax and found that the tax would reduce industry output and employment by up to 0.2 percent.[1] A study by Daeyong in 2018 found that when the medical device tax was effective between 2013 and 2015 it reduced industry R&D, sales, and profitability.[2] A study by Bork in 2017 found that the actual tax revenue raised also fell short of targeted goals, which was due to lower industry sales and higher industry job losses.[3]
The medical device tax also violates the widely agreed upon principles of a sound tax system. Notwithstanding the partisan rancor, there is actually widespread agreement on several core principles to which efficient tax systems should adhere. The medical device tax violates such commonly agreed upon tax principles as neutrality, simplicity, consistency, transparency, and avoiding double taxation of the same economic activity.[4]
Tax Neutrality: Tax neutrality (sometimes referred to as tax efficiency) refers to an unattainable ideal that taxes should not alter any economic incentives or decision, unless such altered incentives were explicitly desired. Simply put, tax neutrality means that taxes should avoid picking winners and losers. Tax neutrality is important because economic growth is best promoted when investors undertake projects based on their economic merits, not based on minimizing their tax liabilities. Similarly, people’s economic well-being is best promoted when they base their decisions to work, save, and consume on their personal preferences, not based on the tax consequences.
Tax Simplicity: Tax simplicity means that taxes should be as easy for taxpayers to comply with as possible, and as simple as possible for the government to administer. Simple taxes impose minimal direct costs on taxpayers when complying and require fewer outlays by the government to administer. When taxes violate the simplicity principle, resources are unnecessarily diverted away from productivity enhancing activities toward tax administration and compliance activities. Efforts by businesses that could be devoted toward innovating or better serving customers are spent complying with the tax. Consumers must devote time to tax compliance rather than spending time with their families or pursuing their interests. The result is slower income growth and lower overall economic welfare.
Tax Consistency: Ideally, taxes will be applied consistently over time and across similar economic activities. When taxes are applied consistently, taxpayers know, with certainty, how their actions will impact their future tax liabilities. Everything else equal, taxes that are inherently more consistent, or applied with greater consistency, promote economic growth by improving the ability for people and businesses to make long-term economic plans.
Tax Transparency: Tax transparency is essential for both legitimacy and for ensuring that the other desired tax principles are not eroded over time. For example, regardless of one’s definition of tax equity, it is self-evident that it easier to determine how a tax impacts different groups and who is, ultimately, bearing the burden of the tax when the tax is transparent. Hidden taxes are also subject to constant changes, high burdens, and unwarranted loopholes carved out for well-connected individuals and industries. Thus, hidden taxes will often be applied inconsistently and violate the principle of tax neutrality.
Avoid Double Taxation: Double taxing income, assets, or consumer purchases violates three of the commonly agreed upon tax principles. Systems that double tax the same activity are complex, difficult to comprehend, and biases an economy away from the activity that is being taxed multiple times. Thus, just like a hidden tax, applying multiple taxes to the same economic activity is a means for violating the core tax principles of economic neutrality, simplicity, and consistency.
The Medical Device Tax’s Principle Violations
There are several ways that the medical device tax violates these widely accepted tax principles, which has also been noted by the Joint Economic Committee (JEC).[5]
The tax is designed to impact only a subset of medical devices; therefore, by conception, the tax imposes distortions into the medical device market, and creates incentives for manufacturers to seek loopholes and exemptions to benefit their products at the expense of competitors. Further, the tax will not impact manufacturers of the same device equally. Some manufacturers may be able to absorb the costs, or make up for lost revenues on one device by increasing prices on other devices. Other manufacturers may be unable to absorb these costs causing them to lose money. Complying with the medical device tax is also complex and costly.
These costs tend to be more onerous for smaller firms, who are typically unable to afford the high compliance costs from regulations and will typically be unable to either absorb the higher costs or compensate for the higher costs on one device by raising prices on another. Harming smaller start-up companies is troubling because the genesis for a great deal of innovation in the medical device industry is from small start-up businesses. By harming these smaller companies, the medical device tax is a threat to future innovation.
The medical device tax is also hidden from the consumer who is generally unaware that this tax is priced into the costs of the product. Nor are they aware that the tax has been applied inconsistently across products due to exemptions and short-term suspensions. The exemptions and suspensions also create difficulties for firms to plan and manage the tax; and, subjects some medical devices to double taxation.
It’s Time to Repeal Medical Device Tax
The medical device tax has an undeniably negative impact on the health care sector. The tax violates the commonly accepted principles of sound taxation and imposes economic costs that dwarf the revenues raised for the government. Further, patient welfare is also negatively impacted. Whether through cost increases that make medical technologies less affordable, or by stifling innovations and new technologies that could improve patients’ quality of life, the medical device tax imposes adverse consequences on overall patient well-being
As a consequence, the right policy response is to permanently repeal the medical device tax. Toward this end, there is a current repeal bill that has been approved by the House of Representatives on July 24, 2018. While as of October 2018 it is unknown whether a repeal vote will take place in the Senate, based on the economic merits, it should. Eliminating the medical device tax will help encourage medical innovation and improve the quality of care provided by the U.S. health system.
Wayne Winegarden, Ph.D. is a Sr. Fellow in Business and Economics at the Pacific Research Institute
References
[1] Jane G. Gravelle, Sean Lowry (2015) “The Medical Device Excise Tax: economic analysis” Congressional Research Service, April 17; https://fas.org/sgp/crs/misc/R43342.pdf.
[2] Daeyong L (2018) “Impact of the Excise Tax on Firm R&D and Performance in the Medical Device Industry: Evidence from the Affordable Care Act,” Research Policy 47(5), June, 854-871; https://www.sciencedirect.com/science/article/pii/S0048733318300416?via%3Di.
[3] Bork R (2017) “Employment Effects Of The Medical Device Tax,” American Action Forum, March 2; https://www.americanactionforum.org/research/employment-effects-medical-device-tax/.
[4] (2015) “An Economic Analysis of the Medical Device Tax” Joint Economic Committee, Majority Staff Analysis, July 8; https://www.jec.senate.gov/public/_cache/files/b1537d7e-df45-450f-a32f-512a865119dd/an-economic-analysis-of-the-medical-device-tax-final.pdf.
[5] Ibid.
The benefits of repealing the medical device tax
Wayne Winegarden
As part of the Affordable Care Act, a 2.3 percent tax on medical devices and products was passed. The tax was levied on devices such as pacemakers, advanced imaging technologies (Cat Scan, MRI and ultrasound equipment), artificial joints, surgical gloves, and dental instruments. Devices that the public generally buys for individual use, such as eyeglasses, hearing aids, and wheelchairs, were explicitly exempted from the tax.
The medical device tax was never an economically sound policy. In recognition of this tax’s many flaws, both the Senate and House of Representatives have separately passed repeal legislation. While the repeal attempts have been unsuccessful, Congress has twice implemented a moratorium that suspended the tax. Passing a series of moratoriums is insufficient, however. The optimal policy permanently repeals the medical device tax.
Taxing Medical Devices Is Unsound Tax Policy
Excise taxes such as the medical device tax create unwanted economic inefficiencies. Perhaps more important, the typical arguments used to justify the imposition of an excise tax does not apply to medical devices. Proponents often justify excise taxes as a means to discourage consumption of the taxed product. Regardless of this argument’s merits, it clearly does not apply to medical devices.
Take imaging technologies as the example. Imaging technologies help physicians detect diseases in their earliest stages when they are most treatable. Clearly, policy should not discourage greater use of these crucial medical technologies nor increase their price. Yet, introductory economics teaches that this is precisely the expected result from the imposition of the medical device tax.
If the medical device tax were not suspended, then an imaging device company with $10 million in revenues would have additional costs of $230,000 (the 2.3 percent medical device tax multiplied by the $10 million in gross revenues). How the company will deal with these costs is unknown. Perhaps some of these costs will be passed along to patients through higher costs for medical equipment, harming patients welfare. Or some of these costs will be absorbed by the company, which would reduce their profitability. If the costs that cannot be passed along are high enough, then the 2.3 percent tax on revenues could turn a company with minimal profits into a money loser.
The precise allocation of these costs will vary depending upon the specific price sensitivities of the patients and producers. It could be that patients bear all of the costs, producers bear all the costs, or some combination of the two. The only outcome that is not possible is that the tax does not distort the imaging technology market. Policies that lead to some combination of higher medical costs and less availability of medical technologies worsens the problems facing the U.S. health care system.
Empirical studies examining the medical device tax have differed regarding the exact magnitude of the tax’s negative economic impacts, but directionally all studies agree that the tax will adversely impact the medical device industry specifically, and the economy more broadly. For example, a 2014 analysis by Congressional Research Service (CRS) recommended against implementing the tax and found that the tax would reduce industry output and employment by up to 0.2 percent.[1] A study by Daeyong in 2018 found that when the medical device tax was effective between 2013 and 2015 it reduced industry R&D, sales, and profitability.[2] A study by Bork in 2017 found that the actual tax revenue raised also fell short of targeted goals, which was due to lower industry sales and higher industry job losses.[3]
The medical device tax also violates the widely agreed upon principles of a sound tax system. Notwithstanding the partisan rancor, there is actually widespread agreement on several core principles to which efficient tax systems should adhere. The medical device tax violates such commonly agreed upon tax principles as neutrality, simplicity, consistency, transparency, and avoiding double taxation of the same economic activity.[4]
Tax Neutrality: Tax neutrality (sometimes referred to as tax efficiency) refers to an unattainable ideal that taxes should not alter any economic incentives or decision, unless such altered incentives were explicitly desired. Simply put, tax neutrality means that taxes should avoid picking winners and losers. Tax neutrality is important because economic growth is best promoted when investors undertake projects based on their economic merits, not based on minimizing their tax liabilities. Similarly, people’s economic well-being is best promoted when they base their decisions to work, save, and consume on their personal preferences, not based on the tax consequences.
Tax Simplicity: Tax simplicity means that taxes should be as easy for taxpayers to comply with as possible, and as simple as possible for the government to administer. Simple taxes impose minimal direct costs on taxpayers when complying and require fewer outlays by the government to administer. When taxes violate the simplicity principle, resources are unnecessarily diverted away from productivity enhancing activities toward tax administration and compliance activities. Efforts by businesses that could be devoted toward innovating or better serving customers are spent complying with the tax. Consumers must devote time to tax compliance rather than spending time with their families or pursuing their interests. The result is slower income growth and lower overall economic welfare.
Tax Consistency: Ideally, taxes will be applied consistently over time and across similar economic activities. When taxes are applied consistently, taxpayers know, with certainty, how their actions will impact their future tax liabilities. Everything else equal, taxes that are inherently more consistent, or applied with greater consistency, promote economic growth by improving the ability for people and businesses to make long-term economic plans.
Tax Transparency: Tax transparency is essential for both legitimacy and for ensuring that the other desired tax principles are not eroded over time. For example, regardless of one’s definition of tax equity, it is self-evident that it easier to determine how a tax impacts different groups and who is, ultimately, bearing the burden of the tax when the tax is transparent. Hidden taxes are also subject to constant changes, high burdens, and unwarranted loopholes carved out for well-connected individuals and industries. Thus, hidden taxes will often be applied inconsistently and violate the principle of tax neutrality.
Avoid Double Taxation: Double taxing income, assets, or consumer purchases violates three of the commonly agreed upon tax principles. Systems that double tax the same activity are complex, difficult to comprehend, and biases an economy away from the activity that is being taxed multiple times. Thus, just like a hidden tax, applying multiple taxes to the same economic activity is a means for violating the core tax principles of economic neutrality, simplicity, and consistency.
The Medical Device Tax’s Principle Violations
There are several ways that the medical device tax violates these widely accepted tax principles, which has also been noted by the Joint Economic Committee (JEC).[5]
The tax is designed to impact only a subset of medical devices; therefore, by conception, the tax imposes distortions into the medical device market, and creates incentives for manufacturers to seek loopholes and exemptions to benefit their products at the expense of competitors. Further, the tax will not impact manufacturers of the same device equally. Some manufacturers may be able to absorb the costs, or make up for lost revenues on one device by increasing prices on other devices. Other manufacturers may be unable to absorb these costs causing them to lose money. Complying with the medical device tax is also complex and costly.
These costs tend to be more onerous for smaller firms, who are typically unable to afford the high compliance costs from regulations and will typically be unable to either absorb the higher costs or compensate for the higher costs on one device by raising prices on another. Harming smaller start-up companies is troubling because the genesis for a great deal of innovation in the medical device industry is from small start-up businesses. By harming these smaller companies, the medical device tax is a threat to future innovation.
The medical device tax is also hidden from the consumer who is generally unaware that this tax is priced into the costs of the product. Nor are they aware that the tax has been applied inconsistently across products due to exemptions and short-term suspensions. The exemptions and suspensions also create difficulties for firms to plan and manage the tax; and, subjects some medical devices to double taxation.
It’s Time to Repeal Medical Device Tax
The medical device tax has an undeniably negative impact on the health care sector. The tax violates the commonly accepted principles of sound taxation and imposes economic costs that dwarf the revenues raised for the government. Further, patient welfare is also negatively impacted. Whether through cost increases that make medical technologies less affordable, or by stifling innovations and new technologies that could improve patients’ quality of life, the medical device tax imposes adverse consequences on overall patient well-being
As a consequence, the right policy response is to permanently repeal the medical device tax. Toward this end, there is a current repeal bill that has been approved by the House of Representatives on July 24, 2018. While as of October 2018 it is unknown whether a repeal vote will take place in the Senate, based on the economic merits, it should. Eliminating the medical device tax will help encourage medical innovation and improve the quality of care provided by the U.S. health system.
Wayne Winegarden, Ph.D. is a Sr. Fellow in Business and Economics at the Pacific Research Institute
References
[1] Jane G. Gravelle, Sean Lowry (2015) “The Medical Device Excise Tax: economic analysis” Congressional Research Service, April 17; https://fas.org/sgp/crs/misc/R43342.pdf.
[2] Daeyong L (2018) “Impact of the Excise Tax on Firm R&D and Performance in the Medical Device Industry: Evidence from the Affordable Care Act,” Research Policy 47(5), June, 854-871; https://www.sciencedirect.com/science/article/pii/S0048733318300416?via%3Di.
[3] Bork R (2017) “Employment Effects Of The Medical Device Tax,” American Action Forum, March 2; https://www.americanactionforum.org/research/employment-effects-medical-device-tax/.
[4] (2015) “An Economic Analysis of the Medical Device Tax” Joint Economic Committee, Majority Staff Analysis, July 8; https://www.jec.senate.gov/public/_cache/files/b1537d7e-df45-450f-a32f-512a865119dd/an-economic-analysis-of-the-medical-device-tax-final.pdf.
[5] Ibid.
Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.