Medical Technology Association Says Excise Tax Could Cut U.S. Employment

One provision of the new healthcare law is a 2.3% excise tax on the medical device industry which will take effect in 2013. This study estimates the potential effect of the device tax on employment in the medical device industry. The study finds that the tax could reduce employment in the industry by cutting back on the demand for medical devices and by encouraging American firms to shift production overseas.

• In 2009, the medical device industry provided well-paying jobs to more than 409,000 employees, who earned more than $33 billion dollars in labor compensation.

• 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 tax will also especially harm states with large employment in the medical device industry including California, Florida, Illinois, Indiana, Massachusetts, Minnesota, New Jersey, New York, Ohio, Pennsylvania, Texas, and Wisconsin.

• The new 2.3% excise tax will roughlydouble the device industry's total tax bill and raise the average effective corporate income tax rate to one the highest effective tax rates faced by any industry in the world. Moreover, the new tax will be paid both by firms that have net income and those that do not. The tax will be especially harmful to companies that innovate and tend to suffer losses in the first years or when investing in research and development for a new product but would still be required to pay the tax.

• Under the tax, U.S. manufacturers will be more likely to close plants in the United States and replace them with plants in foreign countries.

• Foreign manufacturers will improve their competitiveness relative to American firms, and U.S. leadership in this industry could be threatened.

• The Joint Tax Committee estimates that the tax will raise $20 billion in revenues over the period 2013-2019, a cost to device companies and the American consumer. The economic impact of the tax on wages and output will be significantly higher.

Within the health care law is a provision to impose a federal excise tax of 2.3% on manufacturers of medical devices beginning in 2013.³ The tax will be applied to "taxable medical devices" based on statutory definitions of medical devices⁴ as well as complex rules yet to be written by the Secretary of the Treasury.⁵ The tax will be applied to manufactured devices, but will exclude devices generally purchased by consumers at retail for individual use, and other products at the discretion of the Secretary of the Treasury.⁶ The excise tax will substantially harm the American consumer, the American medical device manufacturing industry, and workers in that industry This paper examines the effect of the tax on American consumers, American businesses, and American workers.

The new federal excise tax will be applied to all sales of a product before other forms of state and local sales taxes are applied.⁷ The federal government has applied excise taxes to some goods, such as gasoline, to support a trust fund for the payment of infrastructure, such as roads. The federal government also applies excise taxes to "sin" goods such as alcohol and tobacco whose consumption the government may reasonably seek to discourage. This excise tax is somewhat unique in that it is intended to fulfill neither of these objectives but is designed to raise revenues.

Table 1 summarizes the overall economic activity of the medical device manufacturing industry. The industry consists of thousands of firms, and these can be divided into eight industry segments: in vitro diagnostic substance manufacturing, electromedical and electrotherapeutic apparatus manufacturing, irradiation apparatus manufacturing, surgical and medical instrument manufacturing, surgical appliance and supplies manufacturing, dental equipment and supplies manufacturing, ophthalmic goods manufacturing, and dental laboratories.

Collectively, the industry employed more than 409,000 employees in 2009, who earned more than $33 billion dollars in labor compensation at more than 12,000 establishments around America.⁹ Labor costs per employee of more than $81,000 are well above average compensation for the American economy.¹⁰ The industry produced more than $116 billion dollars of products of which nearly $88 billion was value added (contributions by labor and capital within the industry). As noted above, the wholesale value of these shipments would be approximately $155 billion. The industry spent more than $3.7 billion on new plant and equipment in 2009.

Table 1 reflects the economic activity of just manufacturing related to medical devices. Not included in Table 1 are the wholesale and retail distribution channels that make medical devices available to the health care sector as well as to the general public. Nor does Table 1 include the health care industries that use medical devices to provide medical services to the public. The economic size of this distribution and industries related to medical devices are even larger than the manufacturing activities.

More details are available in Tables 2 through 5 which display, by state, the estimated employment, value of shipments, and value added in 2009 for major segments of the medical device manufacturing industry. If wholesale distribution were included, the value of medical devices would be even greater. Table 6 presents summary statistics, by state in 2009, for all of the segments of the medical device industry included in Table 1. The industry is located in each state plus the District of Columbia.

California, with more than 76,000 industry employees, has the largest share of the medical device manufacturing industry. Other states with more than 10,000 employees include Florida, Illinois, Indiana, Massachusetts, Minnesota, New Jersey, New York, Ohio, Pennsylvania, Texas, and Wisconsin. Each of these states also has more than $2.3 billion in value added from medical devices. Jobs in the medical device industry pay above-average wages. As shown in Table 1, total labor compensation per employee in the industry is more than $81,000 annually. These jobs are an important component of these states' economies, and form a segment of the growing advanced manufacturing sector.

Medical device manufacturing is a major source of exports for the United States. Table 7 shows that the industry exported more than $32 billion in first eleven months of 2010. (Table 7 does not include export data for in vitro diagnostic substances, dental laboratories, or irradiation apparatus manufacturing. Export and import information is not available for these industries.) Roughly one third of medical devices manufactured in the United States are exported, an unusually high proportion for an American industry. Major markets include Japan, the Netherlands, Canada, Germany, and Mexico. Appendix C presents the exports of medical devices by segments to 215 different countries in 2010.

The United States also imports medical devices from around the world as shown in Table 8. During the first 11 months of 2010, the United States imported more than $30 billion worth of devices. Major sources of supply include Mexico, Ireland, China, Germany, and Japan. Appendix C presents the imports of medical devices by segments to more than 200 different countries in 2010.

For most segments of manufacturing, American imports substantially exceed exports. Medical devices are a rare exception with the U.S consistently enjoying a favorable balance of trade. Domestic consumption of medical devices in 2009 was approximately $116 billion at the manufacturers' level and $155 billion at the wholesale level of trade.

The effect of the new excise tax

The new excise tax is complex, and it will substantially raise the tax burden on the medical device manufacturing industry. In response to the new tax, prices of medical devices will rise, and consumers and health care providers will pay more for medical devices. The exact change in prices for medical devices as a result of the excise tax will depend on various economic parameters, but an estimated half or more of the excise tax will likely be passed along to end users in terms of higher prices.¹¹ Correspondingly, the quantity of medical devices demanded will decline in response to the higher prices that include the excise taxes.

Economists have techniques to measure the efficiency of taxes, including excise taxes. Economic efficiency for taxes is usually measured as the minimum distortion of the economic activity that would prevail absent the tax. The standard findings are that goods whose demand or supply is relatively insensitive to price changes have fewer distortions from excise taxes than goods which are price sensitive.¹² We are not aware of any economic studies that measure the price sensitivities of the medical devices that will likely be included in the final tax rules, but practically all goods have some elasticity of demand. There is no reason to assume that the demand for medical devices is inelastic. Consequently, the imposition of the excise tax on medical device manufacturers will likely lead to distortions in demand.

The estimated effect of excise taxes on the market for medical device manufactures can be viewed graphically. In Figure 1, without an excise tax, Demand is represented by the line D and Supply is represented by the line S, and prices in equilibrium as p with quantity q. Now an excise tax is applied and the supply curve shifts upwards to S^{excise tax}, with new equilibrium price of p^{excise tax} and new quantity q^{excise tax}. The government collects revenue equal to tax*(q^{excise tax} - q). The revenue is paid by lost consumer welfare represented in area A, and lost producer welfare, represented in area B in Figure 1.

Excise taxes are known to be inefficient. Excise taxes not only distort economic decisions, but they affect all firms, whether they are profitable or not. Loss-making firms will still owe the excise tax, so they could be in the peculiar position of paying taxes to the federal government while not making any profits themselves. The tax would be especially harmful to companies that innovate, and hence tend to suffer losses in the first years or when investing in research and development for a new product. Such a company might have large market share, but no profits, in the initial years after research takes place. Companies that innovate frequently have losses, but they would be required to pay the tax anyway. Thus, the market share tax could be an unintentional tax on innovation.

The possible effects of the excise tax assuming no shift in production offshore -- Sensitivity Analysis I

In Table 9, we have conducted sensitivity analyses of the losses in employment and labor compensation as a result of the new excise tax on medical devices under the unlikely assumption that no manufacturing activity moves overseas as a result of the new tax. The calculations in Table 9 are under the assumption that the tax is imposed directly on manufacturers. The inability of manufacturers to shift production offshore is implausible and is the most conservative assumption possible about the outcome of the new excise tax. The analyses look at reasonable ranges of changes in demand and supply in response to a new tax. The tax would likely increase the after-tax prices to American consumers between .02% and 2.1% with most price increases around 1%. Medical device demand would decline between $0.67 and $6.7 billion annually. Industry employment should decline between 2,300 and 23,000.

Employment compensation would likely decline between $190 million and $1.9 billion annually. We have made no assumptions about the ease with which workers would be able to find alternative employment, but economic rationality requires that the compensation in the alternative employment would be no greater -- and almost certainly much less -- than in the medical device industry.

The possible effects of the excise tax assuming some shift in production offshore -- Sensitivity Analysis II

It is impossible to predict exactly where losses in the medical device industry would occur as a result of the excise tax. In fact, some manufacturing of medical devices may shift offshore as a result of the new excise tax to minimize losses. Studies have found that many (non-device) manufacturing operations have relocated from the United States abroad in recent years with substantial losses in American manufacturing employment.¹³Many manufacturing industries have had substantial reductions of operations with employment losses well in excess of 10% over the past few years.¹⁴ Many medical device manufacturers already have plants overseas, so shifting at least some production would not be difficult.

Jobs can effectively move overseas in two ways. U.S. manufacturers can close plants in the United States and replace them with plants in foreign countries, or locate future job growth abroad rather than in the United States. Alternatively, foreign manufacturers can improve their competitiveness relative to U.S. firms with the result that manufacturing for the American market is increasingly dominated by foreign-domiciled companies. Both are likely to occur under the new excise tax.

The effect of the tax on earnings of U.S. companies is likely to be significant. In 2006, medical device manufacturers reported taxable income of $13.7 billion and paid $3.1 billion in corporate taxes. The United States already has one of the highest corporate income tax rates in the world. The new 2.3% excise tax will roughlydouble their total tax bill and raise the average effective corporate income tax rate to one of the highest effective tax rates faced by any industry in the world.¹⁵ Moreover, the new tax will be paid both by firms that have net income and those that do not.

Ninety-five percent of American device firms have sales of less than $100 million, and these firms manufacture exclusively or primarily for the domestic market. Even larger American firms with substantial international sales typically sell a much higher proportion of their products in the U.S. market than do their foreign-based competitors.

Accordingly, American-domiciled firms will be at a significant disadvantage compared to foreign competitors. Smaller companies selling exclusively in the domestic market will be hardest hit in their ability to maintain profitability, attract capital or invest in innovative products compared to foreign rivals. Even large international firms will be placed at a disadvantage relative to their foreign competitors. Large companies will move jobs abroad or place a higher share of their new employment abroad as the relative profitability of sales in foreign markets increases. Start-up companies will increasingly locate abroad rather than in the United States.

In Table 10, we have calculated the effect of the excise tax if between 1% and 30% of domestic production shifts offshore. Even with relatively modest shifts in offshore production, the effect of the tax on employment and employment compensation are much more substantial than under the assumption of no loss of production offshore. For example, if 15% of production were to migrate offshore as a result of the excise tax, U.S. industry employment would decline between 63,000 and 85,000 while employment compensation would decline between $5 billion and $7 billion. Doubling the shift of production offshore to 30 would have approximately double the effect.

The harmful economic effects of the excise tax will likely be felt in every state. It is difficult to measure precisely the losses in each state because, at any given time independent of the new excise tax, some manufacturing operations are expanding while others are contracting. Table 11 allocates lost employment and employment compensation to each state under the assumption of a mid-range values for the sensitivity of demand and supply to price¹⁶ and a conservative assumption that 10% of manufacturing activity moves offshore. Industry employment declines in every state and totals more than 45,000 nationwide. Fourteen states would be expected to lose 1,000 workers or more. Employment compensation declines by more than $3.7 billion. These states include: California, Florida, Illinois, Indiana, Massachusetts, Minnesota, New Jersey, New York, Ohio, Pennsylvania, Tennessee, Texas, Utah, and Wisconsin.

Any possible benefits of the excise tax are likely to be overwhelmed by the costs

At the time of passage of the new law, the Joint Committee on Taxation estimated tax revenue at between $2.7 billion and $3.4 billion annually between 2014 and 2019.¹⁷ The excise tax was estimated at the time of enactment to raise $20 billion over the period 2013-2019.¹⁸ These estimated revenues are likely less than lost labor income and capital income from displacement as the result of the tax as illustrated in Table 11. The excise tax may also cause dislocations outside the medical device manufacturing industry. The Lewin Group, using a multiplier analysis, finds substantial effects on employment in the broader economy from the medical devices industry.¹⁹

 

Table 1

 

 

2009 Medical Devices Industry Summary Statistics

 

 

[Editor's Note: For a larger, searchable version of the table, see

 

Doc 2011-18971 , page 10.]

 

 

 

 

Table 2

 

 

2009 Economic Values for

 

Electromedical and electrotherapeutic apparatus manufacturing

 

by State

 

 

[Editor's Note: For a larger, searchable version of the table, see

 

Doc 2011-18971 , page 11.]

 

 

 

 

Table 3

 

 

2009 Economic Values for

 

Irradiation apparatus manufacturing

 

by State

 

 

[Editor's Note: For a larger, searchable version of the table, see

 

Doc 2011-18971 , page 12.]

 

 

 

 

Table 4

 

 

2009 Economic Values for

 

Medical equipment and supplies manufacturing

 

by State

 

 

[Editor's Note: For a larger, searchable version of the table, see

 

Doc 2011-18971 , page 13.]

 

 

 

 

Table 5

 

 

2009 Economic Values for

 

In Vitro Diagnostic Substance Manufacturing

 

by State

 

 

[Editor's Note: For a larger, searchable version of the table, see

 

Doc 2011-18971 , page 14.]

 

 

 

 

Table 6

 

 

2009 Economic Values for

 

All Medical Device Manufacturing

 

by State

 

 

[Editor's Note: For a larger, searchable version of the table, see

 

Doc 2011-18971 , page 15.]

 

 

 

 

Figure 1: Effect of Excise tax on market

 

for medical device manufactures

 

 

 

 

Table 7

 

 

Exports of Medical Devices^*

 

The First 11 months of 2010

 

20 Top Export Destinations

 

(in thousands of dollars)

 

 

[Editor's Note: For a larger, searchable version of the table, see

 

Doc 2011-18971 , page 17.]

 

 

 

 

Table 8

 

 

Imports of Medical Devices^*

 

The First 11 months of 2010

 

20 Top Export Destinations

 

(in thousands of dollars)

 

 

[Editor's Note: For a larger, searchable version of the table, see

 

Doc 2011-18971 , page 18.]

 

 

 

 

Table 9

 

 

Effect of the 2.3% Excise Tax

 

on the American Medical Device Industry

 

Assuming no shift in production offshore

 

 

[Editor's Note: For a larger, searchable version of the table, see

 

Doc 2011-18971 , page 19.]

 

 

 

 

Table 10

 

 

Effect of the 2.3% Excise Tax

 

on the American Medical Device Industry

 

Assuming some shift in production offshore

 

 

[Editor's Note: For a larger, searchable version of the table, see

 

Doc 2011-18971 , page 20.]

 

 

 

 

Table 11

 

 

2009 Economic Values for

 

All Medical Device Manufacturing

 

by State with 2.3% Excise Tax^*

 

and 10% shift in production offshore

 

 

[Editor's Note: For a larger, searchable version of the table, see

 

Doc 2011-18971 , page 21.]

 

 

 

 

Appendix A

 

 

Excise Tax on Medical Device Manufacturers

 

 

In the New Health Care Law

 

 

PL 111-152²⁰

 

(a) In General. -- Chapter 32 of the Internal Revenue Code of 1986 is amended --

(1) by inserting after subchapter D the following new subchapter:

"Subchapter E -- Medical Devices

"Sec. 4191. <<NOTE: 26 USC 4191.>> Medical devices.

"SEC. 4191. MEDICAL DEVICES.

"(a) In General. -- There is hereby imposed on the sale of any taxable medical device by the manufacturer, producer, or importer a tax equal to 2.3 percent of the price for which so sold.

"(b) Taxable Medical Device. -- For purposes of this section --

"(1) In general. -- <<NOTE: Definition.>> The term 'taxable medical device' means any device (as defined in section 201(h) of the Federal Food, Drug, and Cosmetic Act) intended for humans.

"(2) Exemptions. -- Such term shall not include --

[[Page 124 STAT.1065]]

"(A) eyeglasses,

"(B) contact lenses,

"(C) hearing aids, and

"(D) any other medical device determined by the Secretary to be of a type which is generally purchased by the general public at retail for individual use.", and

(2) by inserting after the item relating to subchapter D in the table of subchapters for such chapter the following new item:

"subchapter e. medical devices".

(b) Certain Exemptions Not to Apply. --

(1) Section 4221(a) of the Internal Revenue Code of 1986 is<<NOTE: 26 USC 4221.>> amended by adding at the end the following new sentence: "In the case of the tax imposed by section 4191, paragraphs (3), (4), (5), and (6) shall not apply.".

(2) Section 6416(b)(2) of such Code <<NOTE: 26 USC 6416.>> is amended by adding at the end the following: "In the case of the tax imposed by section 4191, subparagraphs (B), (C), (D), and (E) shall not apply.".

(c) <<NOTE: 26 USC 4191 note.>> Effective Date. -- The amendments made by this section shall apply to sales after December 31, 2012.

(d) Repeal of Section 9009 of the Patient Protection and Affordable Care Act. -- <<NOTE: Effective date.>> Section 9009 of the Patient Protection and Affordable Care Act, as amended by section 10904 of such Act, <<NOTE: Ante, p. 862, 1016.>> is repealed effective as of the date of enactment of that Act.

(1) recognized in the official National Formulary, or the United States Pharmacopeia, or any supplement to them,

(2) intended for use in the diagnosis of disease or other conditions, or in the cure, mitigation, treatment, or prevention of disease, in man or other animals, or

(3) intended to affect the structure or any function of the body of man or other animals, and which does not achieve its primary intended purposes through chemical action within or on the body of man or other animals and which is not dependent upon being metabolized for the achievement of its primary intended purposes.

 

Appendix C

 

 

2010 American Exports and Imports of Medical Devices

 

 

[Editor's Note: For a larger, searchable version of the table, see

 

Doc 2011-18971 , page 26.]

 

 

 

 

 

 

 

 

 

 

 

 

FOOTNOTES

 

²President, Furchtgott-Roth Economic Enterprises. Mr. Furchtgott-Roth was Commissioner of the Federal Communications Commission from 1997 to 2001, and Chief Economist of the House Commerce Committee from 1995 to 1997.

³ See PL 111-152, Section 1405, presented in Appendix A.

⁴ See Federal Food, Drug, and Cosmetic Act, Section 201(h), Appendix B.

⁵ PL 111-152, at Section 1405.

⁶ Ibid.

⁷ Federal excise taxes are presented in Subtitles D and E of Title 26 of the U.S. Code.

⁸ Correspondence with G. Donahoe regarding the relationship between wholesale spending and the value of manufactured shipments of medical devices, February 7, 2011. See also G. Donahoe and G. King, "Estimates of Medical Device Spending in the United States, May 2009.

⁹ The number of establishments is from the 2007 Census of Manufacturers.

¹⁰ This figure includes wages and fringe benefits for employees.

¹¹ The effect of an excise tax on prices and quantities demanded is a standard topic in introductory economics courses. Depending on the elasticity of demand with respect to prices and the elasticity of supply with respect to prices, some or all of the excise tax will be passed along to consumer through higher prices.

¹² Economists measure price sensitivity of a good through its elasticities of demand and supply.

¹³ See, e.g., S. Houseman, C. Kurz, P. Lengermann, an B. Mandel, "Offshoring and the State of American Manufacturing, Upjohn Institute Working Paper 10-166, June 2010; S. Helper and H. Wial, "Strengthening American Manufacturing: A New Federal Approach," Brookings Institution, September 2010;M. McMillan, "Production Offshoring and Labor Markets: Recent Evidence and a Research Agenda, National Bureau for Economic Research," June 2009; Paul Krugman, "Macroeconomic Effects of Chinese Mercantilism," http://krugman.blogs.nytimes.com/2009/12/31/macroeconomic-effects-of-chinese-mercantilism, December 31, 2009.

¹⁴ In just one year, all U.S. manufacturing declined by 19% between 2008 and 2009. U.S. Census Bureau, Annual Survey of Manufactures, at www.census.gov. The decline was substantially greater in many industries.

¹⁵ Robert Carroll, "An Analysis of the Proposed Medical Device Manufacturer's Fee," September, 2009.

¹⁶ We assume elasticities of 1.0 for both demand and supply.

¹⁷ Joint Committee on Taxation.Estimated Revenue Effects of the Amendment in the Nature of a Substitute to H.R. 4872, The "Reconciliation Act of 2010."March 20, 2010, JCX 17010, at http://www.jct.gov/publications.html?func=startdown&id=3672.

¹⁸ Ibid.

¹⁹ The Lewin Group, "State Economic Impact of the Medical Technology Industry," prepared for Advamed, June 10, 2010.

²⁰ See http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_public_laws&docid=f:publ152.111.

²¹ See http://www.fda.gov/RegulatoryInformation/Legislation/FederalFoodDrugandCosmeticActFDCAct/FDCActChaptersIandIIShortTitleandDefinitions/ucm086297.htm.