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RX for R&D: Repealing the Medical Device Tax

Tuesday, November 5, 2013

The ill-considered medical device excise tax used to fund Obamacare should be repealed. The tax will reduce spending on research and development and cost tens of thousands of jobs.

As Obamacare’s growing pains have occupied headlines for the last month, one key aspect of its rollout has fallen by the wayside: the ill-considered medical device excise tax used to help fund the ACA, the debate over which illustrates the importance of, and the many misconceptions about, the American medical device industry.

As part of the 10-year, trillion-dollar-plus expansion of government-subsidized health care, Obamacare imposes a 2.3 percent levy on revenues from qualified medical devices, a tax that came into effect on January 1 and that is expected to raise about $30 billion over the next decade.

Medical device trade groups estimate the tax will cost some 43,000 jobs — more than 10 percent of all jobs industry-wide — by eating directly into spending on research and development, which amounts to $10 billion annually.

Strong, bipartisan majorities in both houses of Congress have already taken preliminary votes to repeal this tax — twice in the House, by 270-146 and 231-192 margins, and once, by a 79-20 margin, in the Senate — and repeal appeared to be on the table during last month’s government shutdown.

A study found the excise tax would amount to a whopping 29 percent of R&D spending industry-wide.

“With the current tax environment, the regulatory environment, and the payment cuts already put in place, and the lack of venture capital,” it has been a challenging decade for the industry, Wanda Moebius, a spokesperson for the Advanced Medical Technology Association (AdvaMed), an industry trade group, told me.

While the device tax repeal foundered on the shoals of the partisan politics that eventually ended the recent shutdown, its repeal remains a possibility, and proponents of the tax remain on defense.

The New York Times’s Ill-Informed Op-Ed

Writing in the New York Times recently, health policy analyst Topher Spiro offered a full-throated defense of the tax matched in its intensity only by his equally ardent reproach of the medical device industry for its outsize profits, its “anticompetitive practices,” its artificially high prices, and its relatively low expenditures on research and development — claims, sadly, that lack a firm basis in fact.

First, Spiro boldly posits in “The Myth of the Medical Device Tax” that “the medical device industry faces virtually no price competition,” but adduces virtually no evidence to support his claim.

This argument is “fundamentally inaccurate,” says Moebius. “We have data, not our own data, but CMS [Centers for Medicare and Medicaid Services] data, showing that medical device technology has been a small but slow growing part of national health care expenditures. ... We’ve made up six cents of the health care dollar for the last 20 years. I don’t know of another sector [in health care] that is as slow-growing.”

The medical device excise tax battle has little to do with the merits and demerits of Obamacare.

Moebius also cites a “report released in September that shows that prices for major categories of implantables are declining. This is over eight categories that are seeing double-digit declines.” Indeed, from 2007-11, average inflation-adjusted prices declined in all categories of implantable medical devices considered, by 24 percent for defibrillators, by 26 percent for pacemakers, by 23 percent for artificial hips, and by 34 percent for drug-eluting stents. “These decreases and slow growth in terms of health spending,” Moebius reasons, “reflect an extremely competitive industry.”

In my own experience as an intellectual property attorney who represents, among other clients, several medical device companies, the competition on price, quality, and technology is as cutthroat as in any field. (Full disclosure: my partners and I represent medical device clients in patent and other litigation, but not in tax or lobbying matters). Device makers vigorously contest the marketplace and face powerful pricing pressures from hospitals, physicians, and reimbursers.

Second, Spiro also attempts to cite the industry’s own statistics against it, contending that according to Johnson & Johnson’s “own estimate, the device tax would amount to at most $300 million, and its investment in research and development amounts to only $1.7 billion.” Yet these numbers confirm just how destructive this tax figures to be: it would be the equivalent of as much as 18 percent of the company’s device R&D budget. I’m no economist, but that sure sounds pretty significant.

Along these lines, according to industry analysts, a 2013 Ernst and Young study found that the excise tax would amount to a whopping 29 percent of R&D spending industry-wide.

To the extent Spiro and others paint the medical device industry as an oligopoly controlled by massive, greedy, multinational corporations, a dose of reality is warranted. According to an industry study, 80 percent of companies in the field employ fewer than 50 people, and 98 percent employ fewer than 500. “Fundamentally, the industry is mostly made up of small-to-medium-sized companies,” Moebius observes. “There are large multinationals, but they’re not the bulk.”

Fair Share and Profits

Third, some excise tax proponents have argued that because, under Obamacare, medical device makers can expect to sell more products, they, too, should pay their “fair share.” Yet there’s no reason to think device manufacturers expect any sort of windfall in new sales. “If you think of heart valve replacement and many of what people would consider ‘typical medical’ devices covered under the tax, those are largely to the benefit of patients under Medicare” who are already covered and won’t be much affected by the ACA, Todd Gillenwater, senior vice president of public policy at the California Healthcare Institute, a policy and advocacy group for the life sciences community, told me in an interview.

As a test case, statewide universal health insurance has been in place in Massachusetts for several years, and “there has been no suggestion or evidence that there’s been a significant uptick in device usage” in the Bay State, according to Gillenwater.

Device prices are not 'cloaked in secrecy.'

Fourth, Spiro’s analysis conflates profits and revenues. The author twice lambastes the medical device industry for its “enormous profits,” including Johnson & Johnson’s $7.2 billion in 2012. But even assuming Spiro’s characterizations are correct — and they’re not: the industry’s profit margins are hardly as “gross” as he makes them out to be, with annual profit margins industry-wide in the single digits — by his logic, the government should be taxing those profits to equalize the playing field. If the industry’s profits were truly and inequitably obscene, then taxing them would surely mint a fortune. Instead, the excise tax targets revenues, requiring even unprofitable companies to pony up, so long as they’re selling products.

Fifth, Spiro and others condemn the device industry more broadly for price inflation, at least relative to other countries:

Even the lowest-priced devices in the United States are expensive compared with those in other developed countries. According to the consulting firm McKinsey & Company, the United States spends about 50 percent more than expected on the top five medical devices, compared with Europe and Japan.

This claim is more or less true as far as it goes — but it doesn’t go very far. “The cost of care for everything in health care is lower in other countries,” David Nexon, senior executive vice president at AdvaMed, told me. “Hospital and physician charges are lower, everything is less, and devices are part of that trend. It’s a little bit like the pharmaceutical industry. We’re the engine of innovation for the whole world, and we’re paying the price for that.”

Indeed, in the medical device field, as in other high-tech spaces, the United States is the incubator for the next wave of life-saving and -enhancing technologies. “If you look at health-care innovation overall,” Gillenwater told me, “it happens in the U.S. because in many ways, the rest of the world free-rides off our innovation and the price tag for that.”

Some countries, like Canada, are able to drive down the prices of pharmaceuticals by simply refusing to pay their market value. But while fans of the Canadian single-payer system advocate re-importing Canadian drugs into the United States, “the argument for drug importation is an argument supporting the importation of government price controls on these products,” says Gillenwater, “and the end result, we certainly believe, is that a drive toward these types of price reductions and price controls is going to result in fewer dollars going toward the types of innovation we see coming out of this industry.”

By contrast, Gillenwater observes that even the most expensive and innovative devices naturally decline in price over time. He points to new cardiovascular technology that allows physicians to implant heart valves using a catheter instead of open-heart surgery. These tools, which “took many years to develop and billions of dollars to invest,” were very costly at first, but as they gained wider acceptance, their prices declined significantly, much like any cutting-edge consumer product.

It’s also important to view the issue of cost more broadly. “The debate over the prices misses half of the story,” Gillenwater says, because the hospital — or the patient, or her insurer — may spend more up front on a cutting-edge heart valve, but by avoiding open-heart surgery and the lengthy recovery time it entails, all parties concerned end up saving time and money overall. “What’s missing from the conversation,” Gillenwater contends, “is ‘What is the benefit and value this technology brings to the patient, family, society?’” Sure enough, the Congressional Budget Office recently found in the Medicare context that increased spending on prescription drugs drove down overall medical spending. Thus, a penny spent today on prevention is a pound saved tomorrow in rehabilitation.

Sixth, Spiro neglects to fully identify himself and his role in drafting and passing Obamacare. Described in the New York Times article only as “the vice president for health policy at the Center for American Progress,” Spiro’s CAP bio identifies him as the “deputy staff director for health policy for the U.S. Senate Committee on Health, Education, Labor, and Pensions under Sen. Edward M. Kennedy (D-MA)” and “a member of the team that drafted the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010.”

His readers might have appreciated knowing about his background, not only because it places his vigorous defense of the ACA into perspective but also because his experience could likely shed light on the issue. Was Spiro himself responsible for drafting the language of the excise tax? Did he meet with industry executives or other lobbyists during the process? What were their reactions to the Health Committee’s draft language, or to the concept in general? Did they express the same reservations they’re voicing now? Engaging these questions would surely have enlightened Spiro’s readers.

Room for Improvement

To be fair, some of Spiro’s suggestions — in particular, that the industry increase price transparency by posting pricing information online and that it move toward bundling insurance reimbursements into a single amount for each treatment — have merit. But these, too, are not without flaws.

With respect to transparency, contrary to his assertion in the op-ed, device prices are not “cloaked in secrecy.” Instead, Gillenwater argues, “the health care industry overall has made significant strides toward providing patients and end users with additional information about their treatment and the therapies and technologies that go into it.”

“There have been some legislative proposals to require price disclosure,” Nexon points out. But as a general matter, medical device makers tend to insert confidentiality clauses into their supply agreements with hospital chains. “Confidentiality agreements in purchasing are very common between sophisticated large purchasers and sellers,” Nexon observes, “so there’s nothing unique or sinister about them in the health system.”

'Prices for major categories of implantables are declining.' The industry's profit margins are hardly as 'gross' as Spiro makes them out to be, with annual profit margins industry-wide in the single-digits.

If anything, these confidentiality agreements tend to lower medical device prices, much in the way that certain retailers don’t publish their very lowest prices until the consumer enters the store, or places the item in her electronic shopping cart. “If you have price disclosure,” Nexon reasons, “you’re going to have higher prices rather than lower. Device makers give discounts, and if they publish them, they’d probably have to give them to everyone else. The published prices would become a floor, not a ceiling.”

In addition, if medical device pricing appears opaque, it’s largely because of the nature of our health care system, with its many intervening layers. Why can’t medical companies simply list their prices for the benefit of their patients, much like a grocer would for its consumers? Well, imagine that the consumer obtained his groceries not by going to the supermarket but by buying food insurance and selecting a trained shopper to negotiate pricing deals with the grocer. In that case, the consumer wouldn’t necessarily expect to learn how much his groceries cost his food insurance company, nor would he likely care very much, either. “The grocery store analogy,” Gillenwater argues, “is apples and oranges.”

As for bundling, the device industry is “generally supportive” of “attempts to move the industry away from fee-for-service toward a system designed to encourage efficiency and quality, and to coordinate care much better,” says Nexon.

But these attempts are not without their risks. “The cost reduction incentives in all those systems are really quite strong,” Nexon notes, “whereas the provisions to ensure quality are relatively weak, so you have to be concerned about that …There’s potentially a strong disincentive to adopt new treatments if they cost more, even though they’re more medically effective.”

Newer technology in particular could be jeopardized, since it’s relatively more expensive at the beginning of its life cycle and it depends on cutting-edge physicians’ and hospital groups’ willingness to invest in early stages. But if those doctors and hospitals receive a bundled reimbursement, they’ll be less likely to test out a new, expensive tool.

“The way a typical device gets disseminated,” Nexon says, “is after research, investment, FDA clearance, and insurance companies agreeing to cover it, then you’re relying on physicians who are at the cutting edge to be early adopters, and then open it up from there. But if it’s a more expensive treatment, you’re basically penalizing a physician who’s an early adopter.”

In the end, industry insiders believe bundling is a “movement in the right direction, but we need a better set of guidelines to make sure patients get the best care, not just the cheapest care.”

The Prognosis for Improvement

Yet even as the medical device industry itself has to varying extents supported transparency and bundling efforts, they are in no way mutually exclusive with repealing the excise tax. That we can improve our system through some measures doesn’t somehow mean we shouldn’t also improve it through others — a point Spiro largely ignores.

So what, then, are the prospects for this ill-considered tax? Moebius and Gillenwater will, of course, continue to push for repeal. Gillenwater says, “While I don’t think many people expect a grand bargain, this is another opportunity for the House and Senate to tackle some issues. We think the medical device tax repeal is one of those issues that could be included in any agreement, if there’s an agreement to be made.” 

'The cost of care for everything in health care is lower in other countries.'

Ultimately, and perhaps ironically, the medical device excise tax battle has little to do with the merits and demerits of Obamacare. “We don’t believe that repealing the device tax in any way affects the Affordable Care Act,” Moebius avers. “It’s just a funding mechanism, and the funds from the device tax go into the general revenue.” The administration simply uses this important, innovative industry as a piggy bank for its health care experiments.

“Repeal of the device tax,” Gillenwater says, “is still seen in many quarters as repeal of, chipping away at, or undermining the totality of the ACA. That’s not our position, and not the device industry’s position. We support the expansion of coverage. But the policy of the device tax, the arguments for it, don’t stand up to reality.”

Instead, as Moebius contends, the excise levy “is a matter of tax reform and fundamental tax fairness to keep a U.S.-based manufacturing industry competitive in the global market.” What a pity that, in their zeal to draft, enact, implement, and now defend Obamacare, Topher Spiro and his ilk have lost sight of this simple truth.

Michael M. Rosen is an intellectual property attorney and a contributor to The American. Reach him at michaelmrosen@yahoo.com.

FURTHER READING: Rosen also writes “The Right Way to Combat Patent Trolls” and “Reversing Reverse Payments: The Actavis Decision.” Michael R. Strain explains “How to Repeal and Replace: From a Tax to Tax Credits” while Thomas P. Miller contributes “Obamacare's Next Bout: More Legal Challenges.” Timothy P. Carney argues “Ending Medical Device Tax: A Win for K Street, a Loss for Tea Party” and “What a Concession! Republicans Demand that Obama Enforce His Own Law.” John E. Calfee and Gabriel Sudduth share “A Little Learning about Testing Medical Devices” while Bryan Dowd asks “Why Is the Obamacare Tax/Penalty Needed at All?

 Image by Dianna Ingram / Bergman Group

Knee illustration by: CLIPAREA l Custom media / Shutterstock

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