Improvised Explosive Device Tax

WSJ.com

'Taxmageddon' isn't only about the half-trillion-dollar blow to the economy that arrives in 2013 on the end of the Bush-Obama tax rates. Several of the Affordable Care Act's worst tax increases kick in too, such as the new excise tax on medical devices.

The 2.3% levy applies to the sale of everything from cardiac defibrillators to artificial joints to MRI scanners. The device tax is supposed to raise $28.5 billion from 2013 to 2022, and it is especially harmful because it applies to gross sales, not profits. Companies at make-or-break margins could be taxed out of existence, especially in an intensely competitive industry where four of five businesses are start-ups or midsized.

As even the liberal papoose Elizabeth Warren recently put it, the device tax "disproportionately impacts the small companies with the narrowest financial margins and the broadest innovative potential."

Yet this very dynamism is what led Democrats to target the industry. As part of writing ObamaCare, they decided that all "stakeholders" should contribute something, but changes 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.

To the extent they can, device makers will pass this tax on to the hospitals and provider purchasing groups that buy their products, which will ultimately show up in insurance premiums. Or they'll offset the costs with layoffs or by slashing research and development. Less innovation, fewer jobs, higher health costs—the usual ObamaCare trifecta.

All of this has already touched off a wild lobbying rumpus. Many providers including all the major hospital trade groups are asking the IRS to prohibit the device makers from "passing the tax to their customers, including some hospitals" by certifying on their tax statement that they haven't.

They want civil and even criminal penalties for false claims, though how this could be proven is anyone's guess. 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.

The good news is that the debate may be shifting from making the IRS rules a little better or a little worse to not doing the damage in the first place. Minnesota Republican Erik Paulsen's device tax repeal bill has 238 cosponsors, including a dozen Democrats. Speaking of which, Elizabeth Warren isn't the only apostate. Al Franken (D., Medtronic) says in a statement that "there were better ways to pay for health reform" and that he will be "fighting hard to continue to further reduce the unfair burden."

Device tax repeal is on the docket when Congress returns from Memorial Day and maybe the most important consideration is the drag on U.S. competitiveness. 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.