Friday, November 14, 2014

Hatch’s Excuse to Repeal the Medical Device Excise Tax

I recently noted a report by Jane G. Gravelle and Sean Lowry of the Congressional Research Service:
A July 2014 report issued by the Treasury Inspector General for Tax Administration (TIGTA) found that the number of medical device excise tax filings and the amount of associated revenue reported are lower than estimated … The IRS estimated between 9,000 and 15,600 quarterly Form 720 tax returns with excise tax revenue of $1.2 billion for this same, two-quarter period. In other words, actual medical device tax collections were 76.1% of projected collections during this period.
I suggested that the shortfall could have been the result of transfer pricing abuse with respect to the constructive price – that is the arm’s length price that the manufacturing division of the larger medical device companies would charge the wholesale distribution division. If a wholesale distributor would get between a 25% and a 35% gross margin, then this constructive price would be between 65% and 75% of the actual price, which means the effective tax rate is really between 1.5% and 2.5% of the actual price and not 2.3%. I then asked how some of the major medical device companies might get away with paying half this estimated amount?
Because the Big Four accounting firms are arguing for discounts that are twice my answer. How on earth do they justify this extreme result? It is called the Cost Plus Method with production costs being 25% of sales and a contract manufacturer return equal to 5% of sales. Of course, the $3.5 billion difference between the Big Four answer and the 35% discount rate under the Resale Price Method represents the value of the product intangibles of the medical device manufacturer. Under arm’s length pricing, no manufacturer would fail to include this amount in their price to a distributor. So how are the Big Four writing these reports with a straight face? The answer is simple – they are advocacy reports based on the assumption that the IRS is stupid.
It seems the senior Senator from Utah has a different take, which reminds me why I tend to call him Whorin Hatch. From a recent Bloomberg BNA story:
“They'll say they need the money for Obamacare, but in all honesty they're going to get less money than they ever thought because a lot of the companies that can't make a profit but have this tax on their sales, they're going out of business or going offshore,” Hatch said.
Rest assured – Covidien, J&J, and Medtronic are not going out of business as they are incredibly profitable. And it does not matter that Covidien did a corporate inversion, the excise tax applies to any U.S. sales regardless of where the device is manufactured. But are we surprised that a Republican Senator turns a blind eye to tax evasion via manipulative transfer pricing and then uses the revenue shortfall as an excuse to gut the tax? While the rest of the world is concerned about Base Erosion and Profit Shifting, Republicans have gut the IRS budget and advocate getting rid of the repatriation tax. We have the ability to enforce the tax laws on the rich and the powerful providing we have the political will to do so. But with the Republicans in charge, this political will is nonexistent.


Thomas L. Hutcheson said...

I do not see any argument for this excise tax. What is the distortion that is leading to too much production and consumption to medical devices that the tax is supposed to offset? And if the Fed does not offset it, the elimination of the tax would even lead to a tiny bit of additional Keynesian stimulus that would be welcome with unemployment still very high.

Unknown said...

Tom, the distortions are in the form of monopoly pricing: most of the firms hold monopolies over specific niche products which are difficult to displace. The cost of development for many devices is not large, but the cost of displacing entrenched oligopolies is large. So one way to address this is an assessment which goes back into funding health care costs.

ProGrowthLiberal said...

Tom - I in no way am saying this tax was something that had to pass. All I am saying is that if one is going to have a tax, one should enforce it. Actual collections are less than expected but not for the phony reasons expressed by Hatch.