Excise Tax on Medical Equipment

This article features as part of our proprietary research into the effects of the Fiscal Cliff and related budget reduction factors on the US Health Care industry

A tax too far: How the 2.3% Excise tax on Medical Equipment will impact the Medical Device and Healthcare industries.

Against the background of a weakened economic climate, Medical equipment manufacturers based in the USA face ever-increasing threats to their revenue streams in the upcoming year. None more so than the impending repeal of a 2.3% excise tax on the sales price of medical devices in the USA, which was passed by congress in June 2012. This controversial law comes into force from 31 December 2012 and covers the whole medical equipment spectrum as defined by the FDA (Food and Drug Administration) excluding products that can be sold in a retail environment (for example, hearing aids). The intention of this tax is to recoup $29billion worth of revenues for the federal government between 2013-2022.

A multifaceted industry profile…

As the US medical device market is the world’s largest, worth an estimated $108billion in 2011 according to Episcom Business Intelligence, it may seem that the industry can take the strain of this legislation. However, that is discounting the breadth of the sector, which encompasses everything from bandages and dressings to CAT scanners (but does not include pharmaceuticals). This breadth is not only defined by product, but company size and type too, as the US listed companies differ between large multinationals offering a diversified product range to distributors of a range of medical devices and smaller domestic companies that may only specialise in one type of product.

Sharing the pain unequally among few…

All of these companies will face a reduction within their revenues from 2013, which will adversely affect their profit margins to an extent. It is clear that the burden of this tax will be felt disproportionately across the industry with the larger players such as Baxter International (NYSE:BAX) and Johnson and Johnson (NYSE:JNJ) being able to effectively hedge this tax owing to their larger global revenue streams, and diversified product portfolio. The companies that will be most at risk are smaller companies that predominantly operate in the US market. The affect of these tax increases may have already been accounted for in terms of operational streamlining before 2013 for some companies to an extent, such as Stryker Corporation (NYSE:SYK) reducing 5% of their staff with a factor being the excise tax. Many however will have not have fully prepared due to good fundamental performance in 2012, yet those who have will still face the same negative share price pressure once the effects of the reduced sales revenues become apparent.

Price pressures flow upstream…

This tax places an extra price pressure upon the healthcare industry as a whole, as the lost revenues as a result of the tax burden will be attempted to be refunded elsewhere within the supply chain, as shown in the following diagram:


Health Care Price Pressures Model, 2012

The overall trend indicates that price increases will be passed along the chain ensuring that all sectors of the healthcare industry have increased costs, although it is unlikely that they will match the initial per item tax burden imposed upon the medical device manufacturers, due to the difficulty of the rest of the supply chain taking a 2.3% price increase in a linear fashion.

Wider reaching consequences apparent…

Alongside the industry price increases there are several other negative factors brought by the tax increase, namely the reduction in staff that will be necessary in order to reduce costs for medical equipment manufacturers. Industry experts such as Robert Book have estimated that anywhere from 14,000 to 47,000 jobs could be lost due to these cuts, it is most likely that this will happen mainly within the smaller non-listed companies, as they will not be able to absorb the tax impact as effectively and will have to shed jobs to control costs. In larger companies, job losses on a smaller scale could still ensure that there is reduced manpower to maintain R&D innovation, as this is usually a prime target for spending cuts. As a long-term outlook this could jeopardise product quality, industry innovation and end patient care. Generalised job cuts could restrict the product getting to the market further adding to costs and increasing the pressure upon the healthcare industry, as a whole. The financial constraints on the industry could lead to the next generation of medical equipment being developed elsewhere with capital flight to emerging economies. These economies are already producing competitors that are fast becoming on par with US medical device companies, according to PriceWaterhouse Coopers, a global professional services firm.

The burden of saving lives flow downstream…

It is clear that the tax burden will be faced disproportionately within the medical device industry and the attempted distribution of this burden along the supply chain will not recoup all of the costs incurred in the tax but will add to the costs for other sectors within the healthcare industry. The added pressure created alongside other wider negative issues facing healthcare providers (such as reduced Medicare/Medicaid payments, increased accounts receivable and higher debt leverage) ensure that these extra costs will flow backwards along the supply chain and further compound the effects of the 2.3% excise tax for Medical Device manufacturers in the future.

By Tom Beadle Associate at PuriCassar AG