Wizards of American medicine, part III

July 15, 2013

Thomas Eakin’s “The Clinic of Dr. Gross”

This recent op-ed in The Wall Street Journal explains why venture capital is drying up for medical-device startups facing the new 2.3% tax on their revenue under Obamacare.

…This tax will likely cut into the profits of large medical-device manufacturers, a cost that will almost certainly be passed on to health-care consumers. But its effect on U.S. medical-device startups—the small companies that fuel innovation—may prove devastating.  Coincident with the 2.3% tax, venture capital investment in medical devices has all but ceased. Why? Ask yourself two questions: Who would want to invest in a highly-regulated, government-controlled industry that faces a unique tax? What startup medical device company can reach the magical break-even point with a tax on its revenue?

When combined with the ever-increasing time it takes to get approval from the U.S. Patent and Trademark Office and the Food and Drug Administration, this levy is bound to destroy startups and stunt medical-device innovation in the U.S. and thus the quality of health care world-wide.

We are physicians and developers of medical devices, and we know firsthand that—unlike, say, the pharmaceutical industry, which requires high-cost, high-tech labs—substantial breakthroughs in our industry are made by individuals or small teams working in a space the size of a garage.

In 1993, Dr. Burbank and his small team of physicians and engineers invented the Mammotome… transform(ing) breast biopsy from open-breast surgery to a minimally invasive method requiring only a bandage to cover the skin nick at the end of the procedure.

Dr. Burbank conceived the Mammotome in his living room, creating a model made of balsa wood, a wooden dowel and a drinking straw before developing it into an actual medical device in a shop the size of a two-car garage.

To further develop and finance the Mammotome, the two of us, with pass-the-hat seed money from three other founding physicians, formed Biopsys Medical Inc. As the device succeeded in testing, Biopsys obtained investments from venture capitalists. Once the breast biopsy device proved clinically successful, investors were provided an exit through an IPO in 1996 (Biopsys Medical Inc.). In 1997, Johnson & Johnson acquired Biopsys and began selling its products world-wide.

Venture money is only available if VCs see an exit somewhere in the near future (when their invested money will be returned with a profit). Without reasonable response times from the Patent Office or the FDA, and without new medical-device IPOs and acquisitions, venture capital dries up, leaving startups stuck in the two-car garage stage of development.

These pages warned (and we weren’t the only ones) of this very scenario several times.   Last June we quoted a Wall Street Journal op-ed on the complexity involved with hiding just that one tax and the harm it will do to the nation’s competitiveness:

(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

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.

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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