Left Holding the Bag

Medical Device Tax
Manufacturers, suppliers and providers wonder where the medical device tax will be felt

With medical device manufacturers facing a 2.3 percent excise tax on sales beginning Jan. 1, 2013, the question comes up, “Who’s going to get stuck holding the bag?” Will manufacturers take the hit to their bottom line? Will they try to pass along the cost of the tax to buyers? Or will buyers and sellers come together to create efficiencies that will reduce the pain that the tax may inflict on any one member of the supply chain?

The healthcare reform law gave the Internal Revenue Service the authority to impose a 2.3 percent excise tax on the sale of any taxable medical device by a manufacturer, producer or importer. The tax, which will be collected starting Jan. 1, 2013, is projected to generate approximately $20 billion over 10 years, and is intended to be the medical manufacturing community’s “contribution” to healthcare reform.
The law exempts eyeglasses, contact lenses, hearing aids and “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.”

Like so many things emanating from Washington, the tax could be considered more a work in progress than a done deal. In fact, there’s some question as to whether the law will actually survive at all. At press time, there were numerous bills floating around Congress to repeal it.

No double-dipping
Even as those battles play out, most of the major players – manufacturers, distributors and providers – responded vigorously to the IRS’s proposed ruling on the tax, which it issued at the end of 2010.

Providers expressed their concern that manufacturers will pass the tax through to their customers. In a joint letter to the IRS in late March, the Federation of American Hospitals, the American Hospital Association, the Catholic Health Association of the United States and the Health Industry Group Purchasing Association wrote, “As the [healthcare reform act] appears to permit device companies to deduct the tax from their income for federal tax purposes, to allow device companies also to pass through the tax to their customers would permit a financial ‘double-dip’ that could leave device companies in a better financial position than before the [healthcare reform law] was enacted.”

The provider groups recommended that device manufacturers be required to certify on their federal excise tax returns that the tax was not included in the price of any taxable device sold to customers.

A blow to innovation?
AdvaMed – an association representing medical device manufacturers – has consistently opposed the tax. Nevertheless, it submitted 18 pages of comments to the IRS in March, with promises of more to come.

“AdvaMed has consistently raised significant concerns with the device tax and its potential harm to patients, innovations and the global competitiveness of the industry,” says Christopher White, executive vice president and general counsel. “We believe the device tax is a serious burden for companies struggling to maintain America’s global leadership in the development of medical technology. If implemented in 2013, the tax will undermine our industry’s ability to create and maintain good jobs in the U.S., and worse, will lead to higher costs for patients, undercutting one of the primary goals of healthcare reform.”

That said, in its comments to the IRS, AdvaMed listed as its top priorities:

  • A clear definition of the word “manufacturer.” AdvaMed’s intent is to avoid multiple taxation of the same medical device, says White. That is to say, the association wants to make sure that contract manufacturers and original equipment manufacturers are not taxed twice for the same product. In its comments to the IRS, AdvaMed suggested that the IRS clarify that manufacturing activities “only involve physically transformative activities, including the re-processing or re-manufacturing of taxable medical devices.”
  • Identification of the articles subject to the tax, recognizing AdvaMed’s proposed exceptions (e.g., devices intended for animal use, investigational devices, etc.).
  • Retail exemption consistent with AdvaMed recommendations. “We believe a flexible standard to account for rapid device innovation and migration across sites of care is needed, rather than a list as suggested in legislative history,” says White.
  • Recognition of AdvaMed’s proposed exceptions to taxable “uses” for samples, demo products, etc.

Distributors express concern
Medical/surgical distributors expressed concerns of their own. Like AdvaMed, the Health Industry Distributors Association has gone on record opposing the tax. “We oppose any tax on the healthcare supply chain, because it’s counter to lowering healthcare costs,” says HIDA CEO Matt Rowan. “By raising the underlying cost structure of medical products, the tax is most likely to contribute to an increase in healthcare costs at a time when we are trying to lower them. That’s why we’re fundamentally opposed to it. But it is the law of the land, so we’re faced with making sure it’s implemented in the most efficient way possible.”

In its written comments to the IRS, HIDA made the following recommendations:

  • Exempt kits, packs and trays from the medical device tax. “Without this important clarification, medical devices in kits, packs and trays could be inappropriately taxed twice – first as it leaves the manufacturer, and a second time after it is placed in a kit, pack or tray,” wrote the association.
  • Define “sales price” for purposes of calculating the medical device excise tax as the price for the actual medical device after accounting for the impact of applicable discounts and rebates. Rowan points out that imposing excise taxes on net sales price is a common practice among other industries subject to such taxes.

The fallout
“The pressure on providers and payers to contain healthcare costs is translating into major pricing pressures on device manufacturers,” says Sharad Rastogi, director, healthcare practice, PRTM, a management consulting firm. “As hospitals seek to cut costs and operate more efficiently and new payment models emerge that better align the incentives of physicians and providers, there is a shift in device purchasing decision-making from physicians to hospital administrators,” says Rastogi, author of a 2010 study, “Medical Technology Innovation in a Time of Upheaval.” “These trends will make it difficult for device manufacturers to pass on the device tax costs to purchasers.”

Says AdvaMed’s White, “It’s important to note that the medical technology industry is extremely competitive.” Prices for medical technology have consistently increased only one-fourth as fast as the prices for other medical goods and services, and half as fast as the Consumer Price Index, according to a study by the former chief actuary of the Centers for Medicare and Medicaid Services, he says.

“Market forces ought to determine the incidence of this tax, as they do for other excise taxes …. Each AdvaMed member company will have to individually decide how to best deal with the damaging effects of the tax. For some, that might mean cutting R&D, reducing staff or other measures. Those are tough business decisions that will have to be made if this tax goes forward, and go to the heart of why we opposed the tax in the first place.”

Shared pain, shared gain
Gene Kirster, newly appointed president and CEO of Resource Optimization & Innovation, the St. Louis-based supply chain management company of the Sisters of Mercy Health System, believes the answer to the question – “Who’ll get stuck holding the bag?” – will be “nobody” and “everybody.”

“No healthcare stakeholder – provider, manufacturer, payer, etc. – wants to take a hit to their bottom line,” says Kirster. “Manufacturers will want to maintain their profitability and will be forced to either cut costs or pass along a price increase to compensate for the excise tax. Given that provider margins are already so thin and many are losing money, we are encouraging our manufacturer partners to work collaboratively with us on reducing costs in the supply chain.

“The supply chain has many inefficiencies, and creativity is required from all stakeholders to pull meaningful costs out,” says Kirster. “We can have a much bigger impact than the excise tax by attacking inefficiencies, redundancies and areas like SG&A costs, which are inflated to support today’s inefficient healthcare business model.”

ROi executives have started to have discussions with select manufacturers about steps that can be taken to reduce total supply chain costs, says Kirster. “We will be challenging manufacturers to take a critical look at their cost structure, eliminate inefficiencies, and partner with us in taking unnecessary costs out of the supply chain.”

For their part, hospital and IDN executives need to ensure their contracts contain price-protection clauses, says Kirster. “Providers must proactively begin discussions with manufacturer partners to identify mutually beneficial efficiency improvements that can help mitigate the bottom line impact of the excise tax. Healthcare’s challenges are too big for any stakeholder to solve on their own. Collaboration is the only answer.”

“I don’t think anyone wants to go out and pass this down,” says Chuck Miller, vice president of operations and vendor relations, National Distribution & Contracting Inc., an organization of independent medical, surgical and dental supply distributors in North America. Miller foresees more strategic purchasing programs in place, or “power buys,” in which groups of customers (in this case, independent distributors) would approach a vendor with a committed-volume deal in hand.

Ruthless about cost reduction
Novation has had few discussions with vendors about the excise tax to this point, says Pete Allen, senior vice president, sourcing operations. “Nobody knows its true impact as to when it will be enacted, at what level and with what certainty,” he points out. That said, suppliers and providers need to start preparing for it. They need to look at their own operations, and then help each other cut costs from the supply chain.

“I think suppliers would be naïve to expect that hospitals that are either losing money today or operating at razor thin margins are going to be able to absorb the impact of a tax that was directed at the device industry,” says Allen.

“I think the supplier community has to be absolutely ruthless about cost reduction within their own shops,” he says. Meanwhile, hospitals also need to bring about a fundamental shift in their approach to materials management. Faced with many clouds on the horizon, including reduced reimbursement, clampdown on readmissions and hospital-acquired infections, value-based purchasing and more, “they’re working diligently to strip out huge costs from their operations,” says Allen. Better compliance, greater alignment with their physician communities and other strategies are needed.

Manufacturers and distributors will be called on to help providers lower costs, says Allen. “If you look at the true cost of the delivery of care, some of it is price, but a far larger piece is around utilization, clinical efficiencies, standardization, optimization of care.” Manufacturers go to great pains to reduce variation in their processes, he points out. Perhaps they can help providers do the same.

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