Medical Device Tax Implementation Date Draws Nearer

The New Year brings us closer to the scheduled implementation of a controversial medical device excise tax that was included in the Patient Protection and Affordable Care Act (commonly referred to as the health care reform bill).

The legislation calls for manufacturers of almost all medical devices to pay 2.3% of their U.S. sales in taxes, beginning in 2013. This is additional to their regular corporate income taxes. Some call it a “tax on innovation” or an “innovation killer.” Supporters say it’s a painful but necessary to help pay for the expansion in health insurance coverage contemplated by the authors of the health care reform legislation.

Whatever your position on the tax itself, no doubt, if implemented in its current form, it will have a profound impact on the medical device industry broadly and the Warsaw-based orthopedic industry cluster specifically.

The ramifications of implementation are of particular concern in Indiana, which has one of the most sizeable medical device industries in the U.S. The Hoosier medical device sector makes up the largest component of the state’s life sciences industry and is comprised of a diverse set of major employers (Cook Medical, Roche Diagnostics, Zimmer, Biomet, DePuy, Hill-Rom, Boston Scientific and Medtronic). It reaches all corners of the state. With 20,300 employees, accounting for 41% of all life sciences jobs, working in nearly 300 establishments throughout the state, the medical device sector is a vital component of Indiana’s overall economy.

The Warsaw region is particularly vulnerable to the effects of the tax. Kosciusko County has the nation’s highest medical device “location quotient,” a measure of employment concentration due to its cluster of orthopedic firms. Biomet, DePuy and Zimmer are the largest employers in Warsaw and are three of the world’s largest orthopedic device companies. The county also is home to more than a dozen other orthopedic device manufacturers. Only three U.S. counties—two in California and one in the Minneapolis area—have higher levels of medical device employment.

A recent study of the medical device excise tax that was produced by a former chief economist of the US Department of Labor and a former Chief Economist of the House Commerce Committee projected the impacts on medical device company employment.1 This report estimates a near doubling of the industry’s total taxes, adding a burden of about $2.7 billion, and raises the average effective corporate tax to one of the highest rates faced by any industry in the world. The estimated impact on employment varies with assumptions, but with mid-range assumptions on the sensitivity of demand and supply to price, and a conservative assumption that no more than 10% of manufacturing moves offshore, the study projects employment in the medical device industry will decline by over 40,000 jobs with a corresponding loss of employment compensation of over $3.5 billion.

A bill has been introduced in the House of Representatives to repeal the medical device tax (and has more than 220 House co-sponsors and 19 co-sponsors for a companion bill in the Senate). No vote has yet been taken on the measure. Meanwhile, orthopedic companies are proceeding with their planning based on the law that is on the books, which calls for implementation of the tax next year. Stryker, a Michigan-based orthopedic and medical device company, has said it plans a 5% reduction in its worldwide workforce to provide efficiencies and realign resources ahead of the implementation of the tax. Other companies have said that they are factoring in the impact of the tax when considering how and where they will make investments and where future expansions might be located.

The potential for a considerable and negative impact on the Warsaw region is obvious. A 2011 economic impact study of the orthopedic cluster’s impact by the Indiana Business Research Center (IBRC) at the Indiana University Kelley School of Business2 pegged direct orthopedic employment in Kosciusko County at 6,800 jobs. Each of those jobs generates additional activity in the local economy, and the combined effects of the orthopedic devices industry accounts for 13,000 jobs in Kosciusko County. This is about 43 percent of the county’s employment. Statewide, the industry’s total employment footprint is 16,700 jobs. The average annual wage for the county’s medical device workers was above $70,000, is more than $11,000 greater than the state average and is $12,000 above the national average.

A recent report on the health of Indiana’s life sciences industry3 pointed out that it’s critical to Indiana’s broader economy that Warsaw retains its prominence as a World-Class Orthopedics Center. As David Floyd, OrthoWorx CEO, told a Congressional Field Forum on the topic, whether Indiana continues to enjoy support from its enviable position in the orthopedic industry stands to be greatly affected by how Congress addresses the medical device tax in the coming year.

1. Employment Effects of the New Excise Tax on the Medical Device Industry, Diana Furchtgott-Roth and Harold Furchtgott-Roth, September 2011.

2. The Economic Impact of Kosciusko County’s Orthopedics Industry, Indiana Business Research Center, April 2011.

3. Indiana’s Life Sciences Industry: 2002-2010, Tracking Progress and Charting the Course for Continued Success, Walter H. Plosila, PhD, June 2011.