The history behind – and future of – the medical device excise tax
Samuel Johnson, that towering figure of 18th-century English literature, once said about excise taxes “A hateful tax levied on commodities, and adjudged not by the common judges of property, but wretches hired by those to whom excise is paid.” No recent issue has roiled the non-labor side of health care more than the upcoming 2.3 percent excise tax on medical devices provided for in the Affordable Care Act (ACA). There are several key questions about this issue. How did the excise tax on medical devices come into being? What is the current implementation status? What is a prognosis for changes, if any, in implementation?
The history behind taxing health care
The interest in the federal government in taxing health care items/products goes all the way back to 1938 with the enactment of the Federal, Food, and Cosmetic Act (FDA Act). This act defined devices as “instruments, apparatus, and contrivances, including their components, parts, and accessories, intended (1) for use in the diagnosis, cure, mitigation, treatment, or prevention of disease in man or other animals and (2) to affect the structure or any function of the body of man or other animal.” The act prohibited all interstate dealings in “adulterated” or “misbranded” devices and authorized the FDA to seize such devices by proceeding against their manufacturers in federal courts. The FDA could not prevent a device from coming onto the market; it could only ask a court to stop the continued sale or enjoin the production of a device already introduced into interstate commerce.
For those of you interested in a little additional “lite” bed-time reading, the U.S. Federal Internal Revenue Code Chapter 32 (Manufacturers Excise Taxes) of Subtitle D deals with excise taxes imposed on the sales of certain products by a manufacturer, producer, or importer.
On Oct. 26, 2002, the Medical Device User Fee and Modernization Act of 2002 (MDUFMA) was enacted into law. MDUFMA amends the FDA Act to provide FDA important new responsibilities, resources, and challenges. MDUFMA has three particularly significant provisions: user fees for premarket reviews; establishment inspections which may be conducted by accredited persons (third-parties); and new regulatory requirements for reprocessed single-use devices.
Since MDUFMA, there has been some discussion of additional taxes on the health sector to fund FDA reviews.
After the 2008 election, the Obama Administration was looking for friends – and identifying non-friends – for their health reform initiative. Many health-related organizations bellied-up and supported President Obama’s health reform legislative juggernaut. The friends’ price of poker was accepting spending cuts or revenue enhancements for their sector. For this support, and/or non-opposition, the friends got to sit at the negotiating table to keep a watch on their other friends around the table. The non-friends faced a different fate. For them, they got higher cuts and/or revenue enhancements than they would have if they had chosen to be at the table earlier in the process. Thus entered the decidedly unfriendly $20 billion medical device excise tax which evolved from eventual collaboration with AdvaMed, the Medical Device Manufacturers Association, and the National Venture Capital Association.
In September 2009, Congress was at full gallop as it worked with the Obama Administration on moving national health reform forward. Over in the U.S. Senate, the Finance Committee released the “Chairman’s Mark” for the “America’s Healthy Future Act,” which incorporated a number of amendments submitted by Finance Committee Members on both sides of the aisle. The Chairman’s Mark called for the imposition of a fee on any person that manufactures or imports medical devices offered for sale in the United States. The aggregate fee on the sector was conservatively estimated to be $4 billion payable annually beginning in 2010. The proposal’s aggregate fee would be apportioned among the covered entities each year based on each entity’s relative market share of covered domestic sales for the prior year. Additionally, the provision required that the fee be paid on an annual basis. A covered entity under the provision included any manufacturer or importer of medical devices offered for sale in the United States and would include both domestic and foreign manufacturers and importers of such products. Finally, the provision stipulated that the term “covered entity” would include a parent company, its affiliates, and other related parties.
On March 23, 2010, President Obama signed the ACA into effect. It became Public Law 111–148 and included Section 4191 which imposed an excise tax on the sale of any “taxable medical device” by the manufacturer, producer, or importer of the device in an amount equal to 2.3 percent of the sale price.
In October 2010, the IRS published a notice requesting public comments on issues related to implementation of the new excise tax on medical devices imposed by section 4191 of the Code, which was added by section 1405 of the ACA. The new excise tax applies to sales of taxable medical devices after Dec. 31, 2012.
January 2011 saw Congressman Jason Altmire, a Democrat from Pennsylvania, joined with Representative Erik Paulsen, a Republican from Minnesota, to introduce H.R. 436, the Protect Medical Innovation Act. This bipartisan piece of legislation would immediately repeal the medical device tax as part of the new health care law.
In late January, 2012, Chairman David Camp of the House Ways and Means Committee held a hearing on the impact the ACA will have on the U.S. economy and employers’ ability to hire new workers and retain existing employees. At the hearing, Congressmen Paulsen discussed H.R. 436 and noted that 62 percent of the medical technology industry is small businesses that are innovators and take risks in order to create medical devices. He observed that the medical device tax will help to kill an industry, and that it will be very difficult to jumpstart it in the future. Another observation Representative Paulsen made was the medical device industry currently employs about half a million individuals. His contention was that the $20 billion medical device tax would be a real job-killer for this innovative industry.
At the Ways and Means hearing, Congressman Paulsen went on to say that the IRS proposed regulation for the medical device excise tax “further highlights the fierce urgency of repealing this job-crushing tax on innovation before it is too late. [This] move by the Obama Administration is further proof that the medical innovation tax will increase healthcare costs while putting thousands of jobs on the line.”
The companion legislation to H.R. 436 in the U.S. Senate was introduced by Senator Orrin Hatch (R-Utah). In his introductory comments he said, “Job creators and consumers shouldn’t have to foot the bill to pay for the President’s partisan health spending law.” Hatch went on to add, “Hitting medical device manufacturers – an innovative engine of our economy – with a job-killing $28.5 billion tax hike is exactly the wrong thing under a weak economy. This is a tax on innovation and job creation that will ultimately stifle the development of life-saving medical devices with costs that will be passed on to consumers. It’s time for this White House to get behind real pro-growth policies to get our economy moving again.”
A look inside the tax
Scroll forward to Feb. 7, 2012, and our friends at the Internal Revenue Service (IRS) release their notice of proposed rulemaking providing the first glimpse of how the government will implement the 2.3 percent excise tax provided for in the ACA. The IRS proposed rule defines “taxable medical devices” as those that generally meet the definition under the FDA Act and are used in humans. Under the ACA, veterinary devices and those sold for export or further manufacture are automatically excluded.
The IRS said that all devices required to be listed by the FDA Act in section 201(h) of the code as amended at 21 U.S.C. 301 et seq. (2006) are considered “taxable medical devices” and are subject to the excise tax unless the device falls within an exemption. These exemptions are: eyeglasses, contact lenses, hearing aids, and any other medical device determined by the Secretary to be of a type that is generally purchased by the general public at retail for individual use. There are other specifications related to whether the device is regularly available to consumers who are not medical professionals, and whether consumers who are not medical professionals can safely and effectively use the device for its intended medical purpose with minimal or no training from a medical professional.
Finally, the proposed IRS rule contains a safe harbor provision for many over-the-counter products that would otherwise be considered “taxable medical devices.” In short, the IRS is arguing that devices are subject to the tax if they fall within the Food and Drug Administration’s domain and are human-use products.
The next step
So what happens next? Well, on the one hand, the IRS will be moving forward aggressively to get the final rules published by this coming fall. The excise tax will apply to sales of taxable medical devices by the manufacturer or importer after Dec. 31, 2012. On the other hand, Representative Paulsen has 228 co-sponsors for his bill to repeal the medical device tax in the House – a significant political achievement. Interesting, though, is who is not a co-sponsor. The Congressman is missing 25 out of 66 members of the House Medical Technology Caucus.
Despite the significant number of co-sponsors in the House, the reality is there will not be a bright line effect of the excise tax on consumers’ costs for health care and health insurance. So consumers (a.k.a. voters/constituents) will not be actively involved in seeking the repeal of the medical device excise tax. Fact is, spending on taxable medical devices represents less than 1 percent of total personal health expenditures, so a small increase in the price would likely have an almost imperceptible effect on health insurance premiums. What is more, consumers will probably be swamped by other factors and concerns about the ACA implementation. That being said, without major constituent opposition to the excise tax, come January 2013, manufacturers will be subject to the new tax. The IRS regulations implementing the tax will most likely be finalized in the months ahead. This tax may indeed stifle medical device innovation in the future and cost needed jobs. Nevertheless, the stars are seemingly not lined up against this excise tax moving forward.
Note: The author wishes to specifically thank Kathleen Casey, Undergraduate, Columbian College of Arts and Sciences, a Political Science Major with a Focus in Public Policy, at the George Washington University, for her research contributions to this article.
Robert Betz, Ph.D., is President of Robert Betz Associates, Inc. (RBA), a well-established federal health policy consulting firm located in the Washington, D.C. area. Additionally, Dr. Betz is an adjunct professor teaching at The George Washington University where he specializes in political science and health policy. For more information about RBA, visit www.robertbetz.com.