Med Device Tax: Punch in the Gut for Medtech Entrepreneurship

Medical devicesThe medical device tax—a 2.3% excise tax on all medtech company revenues—is a controversial element of the Affordable Care Act and has been making news recently as part of the recent budget talks on Capitol Hill. It also was recently supported in a surprisingly hostile yet uninformed New York Times Op-Ed piece, despite being one of the only issues in Washington these days with bipartisan support. See the medtech industry’s response here. In the last couple of months, the passing of a bipartisan budget with “non-binding language” supporting repeal is a good first step.

To get more insight on this issue, Silicon Valley Bank (a long-time sponsor of the Stanford Biodesign Alumni Association) recently shared with us the results of a survey they conducted among small, private medtech start-up companies (click here for full presentation). The survey respondents consisted of 98 device executives (largely CEOs or CFOs) of companies who were mostly non-revenue generating (61%) or were earning less than $25 M in 2012 (95%).

The results are sobering but not surprising. As a result of the medical device tax, the top 3 consequences reported by device executives were:

  1. there would be less investment in R&D (38% of respondents),
  2. the cost would be passed on to consumers, in some ways, defeating the purpose of the excise tax (34%), and
  3. companies would expand overseas vs. domestically (28%).

The impact of the device tax comes at a particularly inopportune time for small companies looking to bring new technologies to market. Over the past decade, regulatory hurdles have become more unpredictable, inefficient, and expensive. Hospitals’ and insurers’ budgets have been squeezed due to the recession, and the pain will continue due to reduced Medicare payments. Decision-making authority for the adoption of new technologies is increasingly falling to committees and away from doctors, requiring radical, costly changes in distribution, and rendering some therapies no longer viable market opportunities, even when they still provide clinical benefit.

These trends, combined with the device tax, are harming domestic job growth, reducing the ability to bring new therapies and diagnostics to patients, as well as damaging the current prospects of maintaining the US as the world leader in medical technology.

The tax hurts the big established companies, but it delivers a serious flesh wound to small medical device companies. Eighty percent (80%) of start-ups were not yet profitable in 2012. In fact, 95% of revenues from this tax will come from a few big companies, while only 5% (just $121 M) will be earned from hundreds of start-ups. The question is: why risk hurting innovation by punishing start-ups, before they are even profitable, and especially since they cannot produce that much tax revenue anyway? This is particularly poor policy, as start-ups are the driving forces behind real innovation in the medtech industry, given the “Innovator’s Dilemma” kind of risk aversion that larger companies tend to have (WSJ blog example).

Let’s look at an example. Suppose a venture-backed startup with 60 employees generates revenues of $10 million in a year. As a growing startup, they burn about $1 million a month and end the year with a loss of $2 million. To make up for this loss, the startup relies on venture capital with the belief that these losses will be paid back, with a reasonable return, once the products gain widespread adoption. With the medical device tax, this company will be responsible for $230,000 in taxes. Making up for this additional cost is unlikely to come from Sales or Marketing because money spent here directly impacts revenue. Operations and Manufacturing budgets are not likely to be cut either because of the criticality of keeping product on the shelf. Research and Development, because it is farthest away from directly generating revenue, may be the department most likely to make up for this shortfall, potentially leading to a 2 headcount reduction. In short, R&D is what will most likely get hurt with the medical device tax.

Supporters of the tax argue that medtech companies should help pitch in to help support the expansion of health insurance to 27 million more Americans (Center on Budget and Policy Priorities). However, new companies trying to get their new therapy off the ground will not always be able to sell to these new patients. In fact, the majority of technologies target the elderly Medicare population, who already have government insurance. In a recent 2005 HHS survey, 80% of the uninsured prior to 2014 are under the age of 44. However, most medical technologies target chronic diseases or illnesses of the elderly (50 years +).Therefore, the increase in potential revenues from newly insured Americans, who are most likely younger and generally healthier, will not likely offset the costs of the tax to the medtech start-up community.

The medtech industry is often vilified in the press for prioritizing profits over patient health. On the contrary, more often than not, profits for medtech companies are usually aligned with value creation for the healthcare system, whether its improved patient outcomes, reduced complications, or more efficient use of hospital or clinic time. This is especially true for medtech start-ups, because if they cannot achieve value for their customers (patients, hospitals, and insurers), they will usually fail. In fact, with more and more hospitals consolidating as a result of the ACA (see Death of a Medtech Salesman?), it is only getting harder for medtech start-ups to get their products adopted: the decision to purchase new technologies is becoming increasingly bureaucratic, and the calculations used to determine “value” of a new product may vary significantly from hospital to hospital. There is hope that in the long term, the Patient-Centered Research Institute, established as part of the ACA, may standardize these methodologies. However, in the short term, these challenges combined with the device tax only serve as additional barriers to much needed innovations in patient care.

The report from SVB makes a strong case for the current embodiment of the device tax being detrimental to US medtech innovation. The policy handicaps early-stage medtech companies during their early, fragile period, while generating little tax revenue in the process.

The Stanford Biodesign Alumni Association recommends the following:

  • A complete repeal of the device tax, or
  • A change from a tax on profits rather than revenue, or
  • An exclusion for companies making less than $100 M per year in sales

Additionally, the Association supports using the existing tax income to fund the Patient-Centered Research Institute to demonstrate which new technologies are truly providing value to patients and society as a whole and to standardize the methodologies that companies and hospitals use to evaluate new products.

Medical Device Tax Survey, 2013. Silicon Valley Bank.


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