Device-tax repeal surfaces as key in budget stalemate

There are growing signs that repeal of the medical-device tax, fervently sought by the politically potent device industry, may be a key element in resolving the impasse in Congress over the budget and raising the debt ceiling. But the White House continues to say it will discuss this and other issues only after the government is reopened and its borrowing authority is increased.

Eliminating the tax, a part of the Patient Protection and Affordable Care Act, would blow a $29.1 billion hole in financing for coverage expansion under the healthcare reform law over 10 years. Many wonder how that funding will be replaced—and whether a repeal of the device tax will open the door for insurers, hospitals and drugmakers to press for repeal of even larger ACA funding mechanisms that hit them.

Rep. Erik Paulsen (R-Minn.), who sponsored a bill to repeal the tax that passed the House with bipartisan support last year, told Modern Healthcare that he believes the device tax repeal could be the “linchpin” in solving the current budget stalemate. “I've had personal conversations with (House) leadership, and it's high on the radar to find a solution to the impasse,” said Paulsen, who led House members last year in the amount of campaign contributions from the medical-device industry.

The Democratic authors of the ACA established the 2.3% excise tax on sales of certain domestic and imported medical devices as the device industry's contribution to financing the law under the theory that the tax would be offset by new business that devicemakers would get from having millions more Americans covered by health insurance. The tax, which went into effect in January, is expected to bring in from $2 billion to $3 billion each year. The 2.3% rate is much lower than what the law's authors originally proposed.

“If the tax were to be eliminated, the real question is how to replace those lost savings or revenue in an appropriate manner,” Rick Pollack, executive vice president of the American Hospital Association, said in an e-mailed statement. The AHA and other hospital groups are worried that policymakers will try to make up the revenue loss on the backs of healthcare providers. The Congressional Budget Office estimates the law will result in Medicare and Medicaid payment reductions to hospitals totaling about $300 billion over 10 years.

The device industry, which employs 400,000 people in the U.S. and has estimated total revenue of $116 billion, has spent millions of dollars to argue that the tax is having a negative impact on jobs in states and congressional districts—including those represented by Democrats strongly supportive of the healthcare reform law—where device manufacturers employ lots of people. They argue that the tax is causing companies to lay off employees, move jobs overseas and invest fewer dollars in research and development. In the first half of 2013, AdvaMed, the leading medical-device trade group, and the top five devicemakers spent a combined $9.7 million on lobbying, according to the Center for Responsive Politics.

“People fundamentally understand that the tax is flawed, that it's bad for R&D, it's bad for employees, and that's why you see this bipartisan support in the House and Senate,” said Wanda Moebius, a spokeswoman for AdvaMed. “It's just a matter of finding the right way to get this bill passed.”

Some experts question the industry's claims, noting that the tax also applies to imported devices so there's no financial incentive for healthcare providers to switch to foreign suppliers. And the tax does not apply to exported products, so it does not affect U.S. manufacturers' sales to other countries.

The industry's repeal campaign angered hospitals and group purchasing organizations when reports emerged early this year that some manufacturers were contacting customers to say the tax was being passed through to them on the prices of products. Hospitals and GPOs had unsuccessfully urged the Internal Revenue Service during rulemaking to require manufacturers to certify that the tax was not passed through to customers.

A public website created in February by the Healthcare Supply Chain Association, which represents GPOs, posted the names of companies that were passing the tax along. “It was very effective,” said Blair Childs, senior vice president of public affairs for Premier. “Many if not all” of the companies reversed course about passing through the tax.

Other companies, such as Siemens Healthcare, chose not to pass the tax to customers for fear of upsetting customers and drawing negative publicity.

For many of the companies, the amount of tax they have to pay is relatively modest compared with their revenue. For instance, J.P. Morgan projects that Boston Scientific Corp. will pay about $75 million in 2014 on revenue of $7.38 billion.

Some policy experts and healthcare providers noted that the industry's case against the tax is based largely on studies funded by the device industry itself. They also argue that companies are likely to enjoy higher sales as millions more people gain access to health insurance.

“What we haven't seen is good independent research on the outcomes of it,” said Dr. Aaron Kesselheim, assistant professor of medicine at Harvard Medical School. “If the research shows that the tax is more harmful, I would think at that point it should be revisited.”

Still, the substantive merits of the device industry's arguments may not matter given the political pressure on President Barack Obama and Congress to resolve the current showdown over the budget and debt ceiling, which could tank the economy. Many observers say the device-tax repeal could be a concession by Democrats to offer a face-saver to Republicans who went out on the ledge to delay or defund the Affordable Care Act.

White House officials reportedly said last week that they would review the tax repeal proposal if lawmakers found other sources to replace the $29.1 billion in revenue that the tax was expected to raise. That's a change in position for the Obama administration, which said in June 2012 that the president would veto any legislation repealing the tax.

The device sector is one of the most profitable industries in the U.S., although in recent years manufacturers have faced increased economic pressure unrelated to the tax. As hospitals have become more cost-conscious, they have sought to negotiate lower prices on pricey devices and lower-cost medical supplies because of declining patient volume and reductions in reimbursement rates. Declining utilization rates for some technologies, such as imaging services, are also a factor.

David Fischer, Siemens Healthcare's vice president for healthcare policy and strategy, said the device tax had led his company, one of the largest medical technology firms in the U.S., to cut hundreds of R&D jobs. That likely means that new products will come to market at a slower rate, he said.

He declined to provide an estimate of the financial impact of the tax on the Malvern, Pa.-based company. “It is substantial and has already forced us to make spending decisions,” he said.

Siemens disputes the claim that the ACA's insurance expansion will boost device sales. Fischer noted, for instance, that sales of imaging equipment have declined in Massachusetts in the years since that state implemented its own insurance expansion in 2007. “We are skeptical, to say the least, that the ACA will have a beneficial impact on the company,” he said.

But Kesselheim, who co-authored a recent perspective article on the tax in the New England Journal of Medicine, said that the decline in sales of imaging equipment in Massachusetts may have been due to payment reform and stricter conflict-of-interest policies in that state.

Bob Kirby, an analyst for Fitch Ratings, said some device categories such as orthopedic implants may see a boost in sales from expanded coverage because those procedures are elective and patients generally need to have insurance to receive them. But companies that manufacture imaging equipment and other products such as cardiac implants are not likely to report notable sales increases because hospitals must provide those products and services regardless of whether patients have insurance.

“I don't think the cost of the tax offsets the anticipated uptick in utilization from the expansion,” Kirby said.

While Kirby describes the tax as negative for the device industry, he said the various outcomes—ongoing implementation, repeal or a delay—are not significant enough to move the needle on a company's rating.

On the other hand, a Wells Fargo analyst said in September that a repeal would be expected to provide companies with a 4% increase in earnings per share.

AdvaMed argued that the tax is flawed because it's based on revenue and not profits. For small- and medium-sized companies, “it makes it that much harder to get to profitability,” Moebius said.

A combination of intense lobbying and ongoing federal budget negotiations has made repeal a bargaining chip for both Republicans and Democrats in the House and Senate, and observers think the drive for repeal is gaining traction. But Minnesota Democrats such as Sens. Al Franken and Amy Klobuchar—whose state is home to device giant Medtronic—along with Republican Sen. Orrin Hatch, all of whom support repeal, previously have said the budget negotiations aren't the right vehicle for eliminating the tax.

In September, House Republicans passed a bill to repeal the tax and delay the entire ACA for one year. Senate Democrats rejected that bill. Both they and Obama have repeatedly called for a “clean” spending bill that has no demands tied to it.

Nevertheless, interest in repealing the device tax has gotten stronger in both chambers of Congress. Paulsen has reintroduced his repeal bill and now has 264 co-sponsors, including 225 Republicans and 39 Democrats. Sen. Susan Collins (R-Maine) recently proposed a plan that would fund the government for six months and repeal the device tax.

Rumors surfaced late last week that Senate Republicans were considering a deal that called for a one-year spending bill at post-sequestration levels, a temporary extension for the debt ceiling, and a two-year delay of the medical-device tax.

There is significant bipartisan support for repeal in the Senate, given that the Senate voted 79-20 last spring on an amendment to repeal the device tax in a nonbinding budget resolution. That move was praised by Hatch and Klobuchar, who co-sponsored a bill to repeal the tax. And in July, Klobuchar and Franken urged Sen. Max Baucus (D-Mont.) and Hatch, the leaders on the Senate Finance Committee, to include a repeal of the device tax in any comprehensive tax reform legislation. Baucus has complained that the device industry agreed to the tax.

Klobuchar pushed to reduce the tax by $20 billion over 10 years and delay it by one year during talks leading up to passage of the healthcare reform law in 2010. Besides Medtronic, St. Jude Medical and 3M are based in Minnesota.

Martin Milner, a partner at McDermott Will and Emery who represents small and large device manufacturers, said the device tax is unpopular among Republicans and Democrats because the medical-device sector is an important industry in a lot of states. “So I think it's easy to vote against it as both the House and Senate have done,” Milner said. “The hard part is when they need to offset the revenue that it raises.”

And with a price tag of $29.1 billion over 10 years, that's a huge challenge for lawmakers, especially as they remain stuck on how to re-open the government and raise the nation's debt ceiling, which will hit its limit around Oct. 17. Milner said he doesn't believe the device tax will be repealed in a stand-alone bill, but said it's definitely a negotiating point in larger budget negotiations.

Paulsen acknowledged that when the House passed the device-tax repeal bill last year, it did not address how it would make up for the billions in lost revenue. As one possible approach, he mentioned “pension smoothing”—an option Collins favors—to offset the revenue loss.

According to the Center on Budget and Policy Priorities, pension smoothing involves changing federal rules on the minimum amount that employers must contribute to employee pension plans to stay solvent. This would allow employers to “smooth out” their contributions over time, meaning they would pay less in the short term and more in the long term. Because the contributions are tax- deductible, shrinking them would raise employers' income tax payments—and overall federal tax revenue—as a way to pay for the money lost if the device tax is eliminated.

Paulsen said the House Ways and Means Committee would need to consider any proposals for how to pay for the tax's repeal. That could be problematic, since House Republicans are likely to oppose anything that could be considered a tax increase and anything that provides funding for the healthcare reform law.

But Paulsen said he is encouraged that there is a strong chance the device tax could be overturned. “If it was on its own—sure, the White House would not support it,” Paulsen said. “But if it's part of a larger package, then they're probably not going to call that out. There's opportunity there.”

If the device industry is successful, that could very well encourage various powerful interest groups to press for rollbacks in their even larger contributions to the financing of the healthcare reform law. Hospitals might try to scale back payment reductions, health insurers would seek to repeal or reduce the law's premium tax, and drugmakers might try to pare back the fees they agreed to when the law was written.

A repeal of the medical-device excise tax “would send a powerful signal to other groups and their lobbyists about the law's vulnerability to piecemeal erosion,” Kesselheim wrote in the conclusion of the NEJM perspective.

Kevin Kuhlman, manager of legislative affairs for the National Federation of Independent Business, which has opposed the healthcare reform law, said the momentum behind the medical-device tax repeal is a good indicator that other repeals may receive support. “It's an encouraging signal that both sides are willing to negotiate and provide relief where there is broad bipartisan consensus,” he said.

Meanwhile, hospital leaders are nervous about how Congress would fund a repeal of the device tax. The AHA's Pollack said in a statement that “hospitals have been concerned about the degree to which this tax—which was part of the device industry's shared responsibility in helping to finance expanded coverage for 32 million people—would ... be passed onto hospitals, who are already absorbing significant payment reductions.”

Chip Kahn, president and CEO of the Federation of American Hospitals, wrote in a blog post last week that if Congress repeals the contributions of any health sector that benefits from the ACA coverage expansion, “it should simultaneously address the changed circumstances of hospitals and provide similar relief.”

Follow Jaimy Lee on Twitter: @MHjlee

Follow Jessica Zigmond on Twitter: @MHjzigmond