Wizards of American medicine, Part II

June 6, 2012

A little over two years ago in a post entitled The wizards of American medicine we quoted Daniel Henninger’s argument that top-down health care reform would fail due to the “unimaginable complexity” of the system:

According to data compiled by Hoover’s business research from the U.S. Census, the health-care industry consists of 340,650 separate establishments employing 5,508,926 people. I leave it to a mathematician to calculate the number of possible economic relationships this would produce every day, much less annually….
There are 8,616 separate medical-device companies in the U.S., employing 359,065 people. Within the device industry, its two largest categories are electronic and precision equipment and surgical appliances. These are the wizards of American medicine.  The president says the special interests oppose his bill. But to pay for the bill, Congress would levy a $2 billion annual tax on the medical-device industry, which ardently opposes the legislation.

Last week in Improvised Explosive Device Tax the editors of the Wall Street Journal updated the argument with more specifics of the complexity involved with hiding just that one job- and innovation- killing tax:

(C)hanges to the ordinary corporate tax code wouldn’t raise enough money and would have hit many other innocent bystanders in manufacturing. So they chose an excise tax. About the only exemptions are for things that retail consumers buy directly, such as contact lenses or hearing aids.

So for the first time ever, the Internal Revenue Service is now writing rules that will treat some of medicine’s most inventive and complex products the same way it does gas, cigarettes, liquor and wine, guns, airline tickets and tires. Those are the commodities on which the political class normally attaches excise taxes, and the appeal is that the levies are hidden in higher prices, rather than listed separately like a sales tax.  This is somewhat awkward for a law that claims to aspire to make health care more “affordable.”

The device tax is also worse than advertised because it won’t apply to actual sale prices. The industry’s supply chains and distribution networks are idiosyncratic, but different buyers usually pay different prices due to rebates and discounts. The draft IRS rules don’t credit these common business practices and instead apply to the “highest price for which such articles are sold to distributors in the ordinary course of trade” or the “normal method of sales,” as if there is a normal method. So the tax will be assessed on income that device makers never earn.

Naturally the businesses involved will cope with the taxes by cutting their costs (personnel, R&D) or raising prices… if it were allowed:

All of this has already touched off a wild lobbying rumpus. Many providers including all the major hospital trade groups are asking the IRS to prohibit the device makers from “passing the tax to their customers, including some hospitals” by certifying on their tax statement that they haven’t.

They want civil and even criminal penalties for false claims, though how this could be proven is anyone’s guess. Perhaps the Bureau of Alcohol, Tobacco and Firearms—which does most excise-tax enforcement against bootleg smokes and rum running—should be dispatched to the device-company hubs of Boston and Minneapolis.

The providers will also be hurt from the device tax because of something they don’t like to mention, which is the government’s price controls. Medicare and Medicaid pay fixed rates per procedure, such as replacing a hip, and the rates don’t change when device prices do. So a hospital that must buy a higher-cost joint due to the device tax will have a smaller share of the reimbursement.

Fortunately, bi-partisan support to repeal the tax is growing:

Minnesota Republican Erik Paulsen’s device tax repeal bill has 238 cosponsors, including a dozen Democrats. Speaking of which, Elizabeth Warren isn’t the only apostate. Al Franken (D., Medtronic) says in a statement that “there were better ways to pay for health reform” and that he will be “fighting hard to continue to further reduce the unfair burden.”

Device tax repeal is on the docket when Congress returns from Memorial Day and maybe the most important consideration is the drag on U.S. competitiveness. Europe, Israel and Asia are working aggressively to overtake the American lead in the life sciences, which include emerging breakthroughs like tissue engineering, nanotechnology to fix individual cells and gene-based diagnostics. The rest of the world is looking on agog as Washington rushes to impose this tax.

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